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President Obama's chief economist, Jason Furman, weighed in behind efforts to privatize Fannie Mae and Freddie Mac last week. The main plan on the table is a bill forward by Senators Tim Johnson and Mike Crapo, the chair and ranking member, respectively, on the Senate Finance Committee.
At the moment, it seems Fannie Mae and Freddie Mac are doing their job just fine. They are issuing mortgage backed securities (MBS) that include more than 60 percent of new mortgages. Interest rates on mortgages are low and both companies are making substantial profits that are refunded to the government. Why is there any need to overhaul this system?
The financial industry is of course unhappy with this situation. It sees the money being earned by Fannie Mae and Freddie Mac as money that could be going into its pockets. Of course there is nothing that prevents Goldman Sachs, Citigroup, and the rest from going out and issuing their own MBS right now.
The problem is that they have a really awful track record. Remember the financial crisis? And of course it is especially hard for them to compete with two relatively efficient government-run issuers like Fannie and Freddie.
Johnson-Crapo solves both problems for the industry. First, it shuts down Fannie Mae and Freddie Mac. This means Wall Street no longer has to worry about competing with them. But, Crapo-Johnson does more than just wipe out Wall Street's competition; it also allows banks to issue MBS that carry a government guarantee.
Under Johnson-Crapo, investors would have 90 percent of the price of a privately issued MBS guaranteed by the government. This means that no matter how much garbage Goldman Sachs or J.P. Morgan threw into an MBS, investors wouldn't have to worry about losing more than 10 percent of their investment. After an initial 10 percent loss, the taxpayers would be on the hook for the rest.
Proponents of Johnson-Crapo argue that the risk of losing 10 percent of their investment will ensure the quality of these MBS. Apparently these people are not old enough to remember back to the days of the housing bubble when investors gobbled up MBS issued by the Wall Street banks even though they could in principle lose 100 percent of their investment.
The moral hazard created by Johnson-Crapo, in which private banks get the profit and taxpayers get the risk, virtually guarantees the sort of abuses we saw during the housing bubble years. In fact, if we feel the need to get rid of Fannie Mae and Freddie Mac as government-run companies, it would make far more sense to just get the government out of the MBS market altogether.