The public bailout
The capital buffer is expected to hit zero on Jan. 1, 2018, opening Fannie and Freddie up to the possibility of a future public bailout. That is one of the biggest arguments for re-privatizing the institutions.
“If they are private entities, there is no risk to the taxpayer,” says Spencer Cowan of the Woodstock Institute. “There is no potential for the public sector having to bail them out if they do not manage their portfolio properly.”
Based on Aug. 2016 FHFA-run stress tests for both Fannie and Freddie (a regular practice mandated in the Dodd-Frank Act), should they remain under conservatorship, the threat of a future public bailout remains very real.
The test found that in a “severely adverse scenario” – i.e., GDP declines 6.25 percent, unemployment skyrockets to 10 percent, and inflation hits 1.9 percent – the GSEs combined could require a public bailout of as much as $125.8 billion.
The longer we wait, the harder it gets
Threat of a bailout is certainly the most obvious argument for getting Fannie and Freddie out of conservatorship, but as Watt explained early last year, it is not the only argument.
“A less discussed, but related, challenge posed by a continuing conservatorship is Fannie Mae and Freddie Mac’s insulation from normal market forces that would otherwise inform their operations and business practices,” he said.
By removing Fannie and Freddie from the tides of the market, Watt argues that the government has effectively charged the FHFA with maintaining the GSEs’ market discipline and ensuring they are both appropriately competitive.
He added, “The longer the Enterprises remain in conservatorship, the greater and more complicated this responsibility becomes.”
That feeds into the overarching problem of having to totally manage the two massive institutions in protracted conservatorship. According to Watt, the task is doubly difficult because of how uncertain Fannie and Freddie’s futures are.
“Experience demonstrates that it is difficult to manage the Enterprises in the present without establishing some kind of plans for the future,” he said. “Without looking somewhat down the road, FHFA and the Enterprises would both lose their momentum and jeopardize day-to-day success.”