No sacred cows

Fannie/Freddie losses: Turns out even the “good” part of Fannie Mae and Freddie Mac is bad. A new federal report on the U.S. mortgage giants shows it was their guarantees, not portfolios of home loans and securities, which caused the bulk of the whopping $226 billion of losses to date. Yet most of those involved in the American mortgage debate cling to the need for guarantees in some form.

The two government-sponsored enterprises have been on a drip-feed from Uncle Sam since September 2008. Their overseer, the Federal Housing Finance Agency, has unsurprisingly concluded that most, though not all, of the damage was done by non-traditional home loans - Alt-A and interest-only structures, for instance - taken on in the reckless years of 2006 and 2007.

More astonishing is the conclusion that Fannie and Freddie’s guarantees accounted for 73 per cent of all the losses. That’s not far out of line with the relative scale of the two business areas. But the combined $4 trillion-plus of GSE guarantees are widely seen as underpinning mortgage markets in a more valuable way than their purchases of assets. And any losses on the guarantees were supposed to be funded by fees.

Politically, government guarantees of U.S. mortgages seem to be an article of faith - though some reform proposals do want Fannie and Freddie replaced by smaller and more tightly constrained guarantor vehicles. Bond guru Bill Gross of PIMCO reckons such guarantees aren’t just desirable but necessary. Tim Geithner, the US Treasury secretary, has talked recently about a “strong case” for the stability government guarantees provide. Geithner at least recognized that any guarantees should be priced properly to cover the risks and structured to minimize taxpayer exposure. But no doubt that was the original aim with Fannie and Freddie. In the end, the policy objectives and the special status conferred on the two GSEs failed to foster commercial prudence.

Creditworthy borrowers in markets where the government has minimal involvement in mortgages – the UK, for instance – can generally find home loans at affordable interest rates. The terms may be less borrower-friendly than in the US market but that hasn’t prevented high levels of home ownership, presumably the policy goal behind the US approach. Unfortunately, guarantees – with their distortions and risks for taxpayers – seem to be a sacred cow in the United States. Policymakers shouldn’t rule out slaughter.