Fannie and Freddie and the Budget
The Obama Administration held a conference yesterday discussing how to fix federal housing programs, with the goal of submitting a comprehensive Fannie Mae and Freddie Mac reform proposal by January. Many reform options were presented by the financial and economic minds present at the conference, and each would have significant implications for the federal budget -- especially because they each seem to necessitate the government's increased involvement in Fannie and Freddie, and even more federal money spent on them in turn. But Treasury Secretary Geithner maintained that the reform plan will focus largely on improving the current system, rather than implementing massive changes, and he reaffirmed the U.S. government's role in supporting American mortgages.
In September 2008, just a week before the collapse of Lehman Brothers kicked the financial crisis into high gear, the Treasury Department placed Fannie and Freddie into a government conservatorship in response to their growing losses in the mortgage market, thanks to the Housing and Economic Recovery Act of 2008. Before their federal takeover, Fannie and Freddie were not considered part of the federal budget by either CBO or OMB, even though the GSEs were considered to have an implicit guarantee backed by the government's financial resources (as proven by their relatively low borrowing costs and lax regulations). But the government's acquisition of Fannie and Freddie's mortgage guarantees in 2009 cost $291 billion according to CBO's initial risk-adjusted present value method of inclusion (which counted all of the GSEs' loans as if they were indeed made by explicitly federal agencies, a la the TARP legislation). This method converts the estimated net cash flows of the GSEs' mortgage commitments into present values and estimates the risk they face in the same way a private corporation would over ten years. CBO expects an additional $100 billion to be added to our federal deficit in paying for Fannie and Freddie over that period, with the stabilizing of the mortgage market accounting for the lower annual costs relative to 2009.
By contrast, OMB has kept Fannie and Freddie off-budget, counting only the federal government's cash infusions to them (excluding the costs of providing current and future guarantees on their assets). Where do these amounts come from? Beginning in September of 2008, the U.S. Treasury also committed itself to buying up to $200 billion in preferred stock and mortgage-backed securities from the former GSEs in a further attempt to stabilize them. So far, Treasury purchases have totaled about $95.6 billion in cash outlays to Fannie and Freddie, with an additional $65 billion expected over the 2010-2019 period--and it is this sum which OMB tallies as the direct costs to the federal government. Since its initial projections, CBO has changed its method to a cash basis looking backward, while keeping its risk-adjusted present value estimations for the future, in an attempt to measure the burden placed on the federal budget by Fannie and Freddie.
Reform of the GSEs should affect not only how much they could cost taxpayers (by ensuring that they aren't so exposed in the future), but also how they are treated in the budget, something we discussed in our previous blog on Fannie and Freddie. Treatment of less straightforward aspects of the federal budget -- like loans and guarantees -- is referred to as "budget concepts." Here's what we argued for back in February regarding GSEs and budget reform:
Budget reform needs to look at the subsidies conveyed by government sponsorship of large financial enterprises such as the Federal Home Loan Banks and the Farm Credit System. The budget should not shy away from recording the real cost of government commitments to the stability of such quasi-private entities. The subsidies are real, taking the form of lower funding costs than would be demanded of such risky entities if the Government were not behind them. The budget should record the costs of such federal commitments when they arise, not just when the bills are due. If the budget recognizes the potential costs of these programs as subsidies are conveyed, policymakers can act ahead of time to limit or offset the cost of the government subsidy and reduce the risk of a future bailout of other housing funds or programs.
As the Peterson-Pew Commission finishes up work on its second report -- focusing specifically on budget reform and to be released this fall! -- we will have more to say about this topic very soon.