Fannie, Freddie Were at Center of Financial Crisis But Are Not Included in Obama’s New Financial Regulations
Testifying before the Senate Banking Committee on Thursday, Treasury Secretary Tim Geithner said that the administration’s new regulations were only meant to address the most fundamental issues of the recession.
“We considered a full range of options and decided that now is the time to pursue the essential reforms,” Geithner said. “Those that address the core causes of the current crisis, and that will help to prevent or contain future crises.”
Those “essential reforms” include the establishment of a new Financial Oversight Council to coordinate between banking regulators and watch for systemic risk; new powers for the Federal Reserve to supervise all systemically important firms; a new National Bank Supervisor to oversee all federally chartered banks; and new powers to allow the federal government to wind down any failing financial institution.
Absent from Treasury’s 88-page proposal were any new regulations for the government-run mortgage companies Fannie Mae and Freddie Mac, two organizations widely cited as being at the heart of the country’s fiscal problems.
The absence of either Fannie or Freddie is notable, because the two companies once owned or controlled nearly $6 trillion worth of home and commercial mortgages, nearly half of the total U.S. mortgage market – and both companies were pioneers of the now infamous sub-prime mortgages that caused the mortgage market to implode late last year.
In analyzing the mortgage crisis, economist Walter E. Williams has written: “Starting with the Community Reinvestment Act of 1977, that was given more teeth during the Clinton administration, Congress started intimidating banks and other financial institutions into making loans, so-called sub-prime loans, to high-risk homebuyers and businesses.
“The carrot offered was that these high-risk loans would be purchased by the government-sponsored enterprises Fannie Mae and Freddie Mac. Anyone with an ounce of brains would have known that this was a prescription for disaster but there was a congressional chorus of denial,” he added.
“The financial collapse of Fannie Mae and Freddie Mac is not a failure of the free market because lending institutions in a free market would not have taken on the high-risk loans,” said Williams. “They were forced to by the heavy hand of government.”
During Geithner’s Senate testimony, he admitted that both Fannie and Freddie played a central role in the financial crisis, telling Sen. David Vitter (R-La.) that the two government-sponsored enterprises (GSE) were a “core part” of the country’s financial woes.
“Absolutely,” Geithner said. “Fannie and Freddie were a core part of what went wrong in our system.”
Geithner explained that the administration did not have the time to come up with coherent regulations regarding Fannie and Freddie because of its other legislative priorities.
“We did not believe that we could have, in this time frame, lay out a sensible set of reforms to guide and determine what their future will be,” said Geithner. “We didn’t think it was an essential thing to do just now, but we do believe it is an essential thing to do.”
Geithner said that at some point in the future the role of the GSEs would have to be “fundamentally reexamined.” He described the problem as one of government “exiting” the private housing market.
“Our challenge with Fannie and Freddie, and this is true about the government’s role in the housing market more generally, it’s more a challenge for exiting, what the future should be,” said Geithner.
“We have to fundamentally rethink what the appropriate role of the government is in the future [because] we did not get that right [in the past],” said Geithner. “It’s more about the questions we face about how the government gets out of and dials back and reverses these extraordinary actions we’ve been forced to undertake.”
Despite the recognition that the federal government needed to figure out how to wind down the billions of dollars it has invested in both private firms and in Fannie and Freddie, Geithner admitted that the Obama administration had yet to come up with such an exit strategy.
“To be honest,” Geithner told Sen. Mel Martinez (R-Fla.), “We have not designed yet the full details of the process we think will be helpful in exploring all alternatives.”
Geithner did promise to work with Congress and other federal agencies in trying to solve the Fannie and Freddie fiasco, promising some type of proposal in early 2010.
“Treasury will coordinate the process,” he said. “We will consult, not just with this committee but with your counterparts in the House, and we’ll try to consult broadly in the markets and in the academic community as we think through broad options. I think it would be reasonable for us to bring forward recommendations and options in the first half of next year.”