Illustration by Liz Meyer
Illustration by Liz Meyer

When Congress voted on Dec. 23 to fund a temporary extension of the payroll-tax holiday in part by requiring Fannie Mae and Freddie Mac to increase their fees, it effectively ended the fiction that the two mortgage-financing giants are part of the private sector.

Lawmakers should now recognize budgetary reality and put the firms’ liabilities on the government balance sheet and include their spending in the federal budget. The purpose of doing so shouldn’t be to keep the firms as part of the government, however. Rather, it should be to motivate reform that leads to a housing system driven by private capital.

When Fannie and Freddie -- known as government-sponsored enterprises -- were put in conservatorship as their finances deteriorated in September 2008, officials didn’t put them on the budget. Adding their roughly $1.5 trillion in debt and $3.5 trillion in mortgage guarantees to the gross U.S. debt might have raised questions about the country’s financial stability and exacerbated the financial crisis then under way (even though the $5 trillion of liabilities were matched by nearly as much in assets). And conservatorship was only intended to be temporary.

Three years later, with the government now using the firms as cash cows to pay for activities unrelated to housing -- and with everyone from the president to Congress to the Federal Reserve looking to dictate their refinancing standards and other activities -- the White House’s assertion that Fannie and Freddie aren’t government agencies is no longer tenable.

Two Problems

Increasing the fees that Fannie and Freddie charge banks for guaranteeing a mortgage against a default is wise policy -- over the long term. The fees were too low relative to what the private sector would charge, and the government should be adequately compensated for the risk it takes by standing behind the loans. But the recent fee increase creates two problems.

First, the new revenue isn’t part of a plan that returns housing finance to the private sector or winds down Fannie and Freddie. Instead, it will be used to pay for new government spending. It would be more appropriate to first pay back the more than $130 billion it has already cost taxpayers to bail out Fannie and Freddie.

Second, raising the fees acts like a tax on homeownership that runs counter to other government efforts. This is because banks pass along the higher guarantee fees to borrowers in the form of higher mortgage rates -- thus making it more expensive to buy a home. The irony is that President Barack Obama just this fall sought to use Fannie and Freddie to make homeownership more affordable -- and to boost refinancing -- by strong-arming them into reducing the fees they charge to cover mortgages made to relatively risky borrowers.

In other words, the White House is trying to use the firms to make housing cheaper, even while the president has signed legislation that will have the unintended result of making housing more expensive. It’s hard to imagine a better example of schizophrenic policy making.

The increased guarantee fees shouldn’t work as an ad hoc money grab, but as part of a larger plan to get the government to step back from guaranteeing nearly all U.S. mortgages. The goal should be to allow the private sector to take on housing risk and figure out which homeowners can handle a loan.

This plan would involve several initial steps: 1) require private capital to take losses ahead of the government guarantee; 2) narrow the scope of mortgages eligible for a government guarantee by taking into account loan size and income; and 3) decrease the quantity of government insurance offered. Higher guarantee fees should be part of this reform.

A Clear Framework

These changes will take place over time, so it’s important for the government to announce a clear framework and timetable at the outset so home buyers, sellers and the suppliers of capital can adjust.

Reform efforts to date have focused on privatizing Fannie and Freddie. This is certainly a worthwhile goal, but it’s unlikely to happen any time soon, especially if the firms remain in their current state as off-balance-sheet sources of revenue for government spending. The longer we wait for the perfect piece of legislation, or for the ideal political dynamics, the longer Fannie and Freddie can be used for disjointed policy purposes.

It is far better to move forward with incremental reforms to ensure that the government’s role in insuring mortgages declines over time and to encourage private capital to start investing in housing without a full government guarantee.

Putting Fannie and Freddie on the federal budget should be the first step toward broader reform. Explicit recognition of the costs of taxpayer support for housing -- and of the mortgage debt that taxpayers guarantee -- could help bring together Republicans and Democrats who share an interest in fiscal responsibility. And it would make clearer the taxpayer benefits that go along with steadily shrinking the volume and scope of mortgages that the government insures.

More than 90 percent of new mortgages are now guaranteed by government agencies. With these enterprises honestly accounted for on the federal balance sheet, the incentives will finally be aligned to start shifting housing finance to the private sector.

(Christopher Papagianis is managing director of Economics21, a nonpartisan policy-research institute. He was a special assistant for domestic policy to President George W. Bush. Phillip L. Swagel is a professor at the University of Maryland School of Public Policy. He was assistant secretary for economic policy at the Treasury Department from 2006 to 2009. The opinions expressed are their own.)

Read more opinion online from Bloomberg View.

To contact the writers of this article: Christopher Papagianis at papagianis@economics21.org and Phillip L. Swagel at pswagel@umd.edu.

To contact the editor responsible for this article: Timothy Lavin at tlavin1@bloomberg.net.