We know that Fannie Mae and Freddie Mac are broken. But is there a viable plan for their restructuring? Who do we trust to reform the secondary mortgage market?

Hatching a plan

The climate is just right for planning Fannie Mae and Freddie Mac’s permanent vacation.

As New York Times and ProPublica columnist Jesse Eisinger recently pointed out, it’s time to chart an eventual restructuring of the secondary mortgage market. Failure to take action is likely to result in a permanently dysfunctional admixture of public welfare backed by private interest — a model proving messy for Obamacare.

Ed DeMarco thinks we need to start planning now as well. Yes, thanks to a particularly quarrelsome Congress, he remains the acting Director of the Federal Housing Finance Agency (FHFA) in spite of Obama’s worthy replacement nomination made some six months ago.

He recently spoke to a rapt (perhaps bored) audience at Zillow and echoed Eisinger’s basic thesis. Only, unlike Eisinger who wants Fannie Mae and Freddie Mac (collectively known as government sponsored enterprises, or GSEs) to become federal corporations, it’s clear that DeMarco has made it his mission in life to pry them apart and privatize.

“Preserve and conserve”

If you’ve followed DeMarco’s tenure at the FHFA, you know that he has a Terminator-like tenacity when it comes to conserving the GSEs’ resources. To prevent “moral hazard” from compromising the chastity of the housing market, DeMarco has unmercifully squashed every cramdown proposal that has come across his desk.

As conservator of the enterprises, the FHFA has a mandate to “preserver and conserve” Fannie Mae and Freddie Mac. Yet, under the Emergency Economic Stabilization Act of 2008, DeMarco is also required to maximize assistance to homeowners and limit further foreclosures.

Speaking of this dual mandate, DeMarco said:

In my view FHFA has successfully balanced these responsibilities over the five years of conservatorship.

No more negative equity?

It’s difficult to impeach DeMarco on this point, as home prices have risen steadily since the beginning of 2012. As we’ve recently reported, prices are reaching a boiling point, both in California’s metro regions and nationwide.

The home price increases of late have the appearance of providing relief to many erstwhile underwater homeowners.  Property “values” have increased considerably, and many have avoided short sale and foreclosure.

But the truth behind these price spikes is just now starting to be reported in the broader media. Whereas it was previously taken for granted that higher prices equaled a housing recovery, it is now understood that this asset price inflation is the result of speculation. Speculation, by the way, that is winding down in the absence of end-user demand to provide that ready flip for speculators who have made foolhardy bets.

So the reality of negative equity is skewed in the current market. While DeMarco may argue his success by the numbers, a slightly deeper analysis shows that the slowing of foreclosures and decrease in negative equity is more the result of speculator-driven asset price inflation than from the success of homeowner assistance programs (see HARP’s monumental failure).

The rhetoric heats up

In his late-October speech, DeMarco admonished his audience that despite the GSEs’ recent positive net incomes, they remain miserable failures. Keep in mind, at the time of his speech, the enterprises were reporting strong profits and had nearly paid off their taxpayer-funded bailout.

Here’s what he had to say:

While the Enterprises’ recent financial results and improved operations are positive developments, it does not alter the fact that the GSE business model remains broken. [. . .] We expect [the] legislation to include provisions for how key business functions and activities at Fannie Mae and Freddie Mac will be repositioned back into the private market.

He went on to quote former Treasury Secretary, Hank Paulson, who said in 2008:

There is a consensus today that these enterprises pose a systemic risk and they cannot continue in their current form. […] We will make a grave error if we don’t use this time out to permanently address the structural issues presented by the GSEs.

The flaw in the GSEs is simple to understand. They are neither all public nor all private, but rather a mutant hybrid of all the least practical aspects of each. The taxpayer subsidizes Fannie Mae and Freddie Mac’s shareholder profits. Yet, investors enjoy a government guarantee even if the underlying mortgages default. Really, the GSE model reflects the basic tenor of the American economy as it operates today: socialized risk, privatized profits.

A hasty path to privatization

DeMarco has already implemented strategies for phasing out the GSEs, including raising guarantee fees and cutting loan limits. In other words, he remains a pretender to the FHFA throne, yet he wields great power over the future of our secondary mortgage market. He has forged a path to privatization without the blessing of Congress or the American people.

Yes, the GSE model is broken and ought to be fixed — but a bad solution isn’t going to improve the situation. And DeMarco’s stance smacks of the very same anti-government, free market-at-any-cost ideology that got us into the housing and financial crises to begin with.

Hopes of reform

Although DeMarco’s persistence sometimes feels like a pestilence, there are some positive outliers on the horizon.

Mel Watt, President Obama’s nominee for permanent FHFA Director, is one. Unlike DeMarco, Watt has shown a willingness to use cramdowns to correct the nation’s negative equity plague.

Further, DeMarco may be a rogue shadowboxer for the moment, but several other contenders are willing to step into the ring. The Senate Banking Committee has made real progress toward bi-partisan mortgage market reform.

A bill introduced by Sens. Bob Corker (R., Tenn.) and Mark Warner (D., Va.) attempts to stitch together the disparate interests of the left and the right. While this will undoubtedly prove a challenge, a compromise from a cohort of senators has to be an improvement on DeMarco’s lone-wolf approach.

The secondary mortgage market is the veritable lifeblood of real estate finance and thus the primary source of wealth for all real estate industry professionals. A great deal is at stake in this conversation. California’s real estate agents and brokers ought to make their voices heard, rather than allow DeMarco and the trade association-run housing lobby to speak for them.

So what have you got to say?