A bad idea
Published in Housing Finance International Journal.
The U.S. national housing finance market is uniquely dominated by two government mortgage companies, Fannie Mae and Freddie Mac. They do exactly the same thing, creating mortgage-backed securities that are de facto government-guaranteed. They are both completely dependent on the credit support of the U.S. Treasury, and thus dependent on American taxpayers. Both went broke in 2008, and both were bailed out by the Treasury, which still owns $193 billion of their senior preferred stock, sixteen years later. Both are in an unending conservatorship of a very political government bureaucracy, the Federal Housing Finance Agency. They are in effect a single huge market intervention and subsidy.
Fannie/Freddie are truly massive, with combined assets of US$ 7.6 trillion.1 They create a systemically risky concentration of national mortgage credit exposure in Washington DC. They are and always have been politicized. They are popular with many politicians because they can be used to create subsidies to favored political constituencies without Congress having to appropriate funds. They are highly popular with Wall Street firms because they create securities easy to sell to domestic and global investors by using the credit of the U.S. Treasury.
Fannie/Freddie were central to causing the U.S. housing bubble of 1999-2006 and its subsequent collapse,2 and supported the explosive house price inflation of 2019-2022, which has made U.S. house prices widely unaffordable.
Should the European Union import this dubious American idea? A distinguished committee chaired by the former Governor of the Bank of France, Christian Noyer, thinks so. Its April 2024 white paper, “Developing European Capital Markets to Finance the Future,” proposes a “European securitization platform,” which would “target a massive asset class,” and “target a homogeneous and low-risk asset class, such as residential loans.”
The paper maintains that “a European platform for securitization could be a powerful tool for deepening capital markets.” So it might, but an essential requirement of the proposal is to move credit risk to the government at a combined European level, analogously to what Fannie/Freddie do. “To achieve the objectives the platform must grant a European guarantee of last resort for securitization of mortgage or SME loans.”3 By providing the guarantee, “a common platform would create a new common safe asset.” The safety for the investors comes from the guarantee: “Any residual heterogeneity would be eliminated, from the investor’s point of view, by a broad government guarantee.” In other words, remove the credit risk from the investors by moving it to the government and the taxpayers.
The U.S. model is clearly in mind: “Platforms for issuing and guaranteeing mortgagebacked securities are long-established in the US,” the proposal observes, and “Guaranteed securitized assets broadly work as safe assets, especially agency MBS,4 which are used as collateral in almost one-third of repo transactions in the United States and trade at close to sovereign rates.”
In short, what is being proposed is a European Fannie/Freddie.
Well aware of the housing finance bailouts previously provided by U.S. taxpayers, the white paper sets an “objective of zero cost for public finances” for a European securitization platform. The zero public cost objective is a nice idea, but the American experience warns of many government guarantee schemes which were similarly supposed to be selffinancing, but failed instead. The Federal Savings and Loan Insurance Corporation, the Farm Credit System, the Pension Benefit Guarantee Corporation, the federal Student Loan program, and of course Fannie/Freddie, all became insolvent and costly to the public finances. Confronted by the combination of political pressures to subsidize current borrowers and the uncertainty of future credit crises, it is very difficult for government guarantee programs to achieve their zero public cost aspirations.
The white paper introduces a further difficulty. The platform is to operate with a European-level guarantee, and “supervision at EU-level should be mandatory.” Nonetheless, “The guarantee provided by the platform should be structured to exclude any transfers between Member States.” This is certainly different from the American model with respect to U.S. states. It is impossible to imagine how Fannie/Freddie could operate without pooling income and losses among states, and it is likewise hard to imagine how European-wide guarantees could involve no transfers among Member States. How this is proposed to work is not clear.
The white paper displays a particular danger of all government guarantee schemes. It develops a securitization proposal obviously designed for mortgage loans, based on the need for “low risk” and “homogeneous” loans with a “standardization objective.” Then it slips in, doubtless as a political thought, that maybe the platform could also be used for commercial loans to small and medium-sized enterprises (“SMEs”). Such loans are of an entirely different kind, with fundamentally different risk characteristics. This is a good example of how a government guarantee is always subject to political pressure to move to riskier loans, just as Fannie/Freddie were pressured into buying low quality, nonprime mortgages, helping inflate the housing bubble.
The European Fannie/Freddie proposal has been accurately criticized by Mark Weinrich, Secretary General of the International Union for Housing Finance. I will stress four of Mark’s arguments, then state them less diplomatically. His arguments and my changes follow:
Weinrich: “Government backing of mortgage-backed securities can encourage risky lending practices, as lenders may believe that losses will ultimately be absorbed by the government.”
Pollock: “…as lenders will believe that losses will ultimately be absorbed by the government.”
Weinrich: “Government intervention in the mortgage market can distort pricing and allocation of credit.”
Pollock: “Government intervention…will distort pricing and allocation of credit.”
Weinrich: “A centralized entity would concentrate mortgage risk with a single institution, potentially creating a single point of failure.”
Pollock: “…thereby creating a single point of failure.”
Weinrich: “Creating a centralized European securitization platform could increase systemic risk.”
Pollock: “…will increase systemic risk.”
All of these problems have already characterized Fannie/Freddie in the American experience. Creating a massive government guarantee while claiming that it will be selffinancing tempts people to believe it will be free. It won’t be.
- 1
Fannie Mae and Freddie Mac, 10-Q filings, June 30, 2024.
- 2
See Peter J. Wallison, Hidden in Plain Sight, 2015; and Alex J. Pollock, Boom and Bust, Chapter 7, “A $5 Trillion Government Failure,” 2011.
- 3
We address the troublesome addition of “or SME loans” below.
- 4
“Agency” MBS are Fannie/Freddie MBS plus those of Ginnie Mae, which has a separate government guarantee.
