McCain’s Amendment On Fannie And Freddie Would Seriously Harm The Fragile Housing Market

It’s a favorite pastime for conservatives to blame the financial woes of the last two years on Fannie Mae and Freddie Mac — the two government sponsored mortgage giants — no matter how many times such claims are debunked. So Republicans in Congress have been making a lot of noise about how the financial regulatory reform bill currently being debated in the Senate doesn’t include an attempt at reforming the two GSE’s, particularly after the company received another $10 billion in federal funds this week.

To that end, Sen. John McCain (R-AZ) has introduced an amendment, along with six co-sponsors, that sets a date certain for unwinding Fannie and Freddie and eventually dissolving them. The amendment limits the assets that the GSE’s can hold, increases their capital standards, and puts a cap on the amount of federal funding they can receive. “Fannie Mae and Freddie Mac are synonymous with mismanagement and waste and have become the face of ‘too big to fail’,” McCain said.

First, I would argue that the giant banks and insurance company that the government had to rescue are the face of too big to fail. But far more importantly, McCain’s amendment would wreak havoc with the economy by arbitrarily setting a date certain for removing the GSE’s support for the housing market, resulting in a massive withdrawal of credit, and by not laying out a way to replace the legitimate purposes that the housing giants do serve. As one of my colleagues suggested, you might as well call this amendment “The Credit Crunch Restoration Act of 2010.”

Now, there is an undeniable need to reform housing policy in the U.S., and to achieve our affordable housing goals without the behemoth GSE’s operating with a federal backstop. As CAP’s Sarah Rosen Wartell told Congress in March, “the current situation, in which the federal government, through the GSEs or FHA-insured loans in Ginnie Mae guaranteed MBS, backstops almost 90 percent of the market for home mortgages, is not desirable or sustainable.”

But it’s precisely because so much of the mortgage market depends on the government that we can’t haphazardly disassemble Fannie and Freddie like McCain suggests. Adopting McCain’s plan would chase investors away from mortgage-backed securities, causing a large drop in liquidity when the housing market is still weak and fragile. As the Center for American Progress Action Fund economic team explained:

Some 95 percent of mortgage originations are currently being backed by the federal government, with the vast majority of this coming through the GSEs. The McCain amendment would cause significant uncertainty among the investors in GSE-issued mortgage-backed securities, threatening the primary source of mortgage credit we have at this time, without offering any alternative sources of liquidity. Such a large drop in mortgage liquidity could strongly threaten the prospects of economic recovery.

As Rep. Barney Frank (D-MA) said, to abolish Fannie and Freddie “and not do anything to replace the functions they are now performing with a conservatorship, would be a disaster for housing, and therefore for the economy as a whole.” We definitely need to rethink the role, if any, the GSE’s will play in the housing market — and make our housing subsidies explicit, if we still want them — but McCain’s plan would result in short-term turmoil while punting on the long-term implications of a world without Fannie and Freddie.