Even Fannie Mae (Fannie) and Freddie Mac (Freddie) should have skin in the game, according to Barney Frank of the venerable Dodd-Frank fame.

Lenders are now required to retain a minimum 5% financial risk in all loans they sell on the secondary mortgage market — a risk management concept known as skin in the game, which is outlined in the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). Presently, Fannie and Freddie are an exception to this risk management rule. The purported reason: the GSEs are backed 100% by the federal government, thus effectively allaying concerns of risk. [For more information on the Dodd-Frank risk retention mandate, see the March 2011 first tuesday article, Whose skin is in the game?]

Frank and his acolytes are not satisfied with this logic and have vowed to shepherd through legislation requiring Fannie and Freddie be held to the same 5% risk minimum standard as private lenders. The explicit goal here is to avoid another mortgage market meltdown due to the moral risk created by allowing the GSEs (read: the federal government) to shirk the risk of borrower default with a taxpayer- funded insurance policy. [For more information of Dodd-Frank exceptions to the rule of skin in the game, see the May 2011 first tuesday article, How much medicine can the sick housing market stomach?.]

first tuesday take: No surprise here! Politicians and their groupies will be heard calling for the equal regulation of Fannie and Freddie — such a proposal is tantamount to the endless cries from both sides of the aisle for Fannie and Freddie’s dissolution. This will eventually come about, but only when the private market replacements are up and running so the government can get out of the business of providing mortgages, except for the low-tier Federal Housing Administration (FHA) home mortgage insurance premium (MIP) program.

When Fannie and Freddie were brought under total government conservatorship (read: ownership) in 2008, it was proposed as a temporary stopgap implemented to “save” the secondary mortgage market, and indeed the U.S. economy as a whole.

While such federal intervention was most helpful, we have since witnessed lenders continue to glut themselves with operating profits generated on the backs of taxpayers and a concurrent flush monetary policy from the Fed without curing the underlying issue of insolvency. Freshwater or saltwater, liberal or conservative, legitimate arguments for the necessity of Fannie and Freddie’s ouster abound as they have actually overstayed their welcome.

To avoid the 5% rule, commercial bankers are predicting there will be no mortgage market without a federal guarantee as has and is now provided by Fannie and Freddie — a smoke screen to interfere with the full development of competitive private mortgage activity — the Wall Street banker connection to all this.

Requiring Fannie and Freddie’s loans to come with a 5% lender guarantee is just one way of setting the stage for the GSE’s impending curtain call. We are in the last act: the stage set, the climax long since passed and the dénouement falling precipitously like a Case-Shiller trend line — Fannie and Freddie are getting the hook.

Let’s hope there isn’t an encore.

In the meantime, the private mortgage and private mortgage insurance (PMI) markets will continue to grow and become more robust as Fannie and Freddie are phased out. Unfortunately, real estate brokers and agents are limited to being passive but informed observers.

Re: “Frank: New Mortgage-Securities Rules Should Apply to Fannie, Freddie” from the Wall Street Journal