The Treasury Should Revive the Snow Plan for Limiting GSE Debt Issuance

Excess Reserves, Fannie Mae, Freddie Mac, Steven Mnuchin, mortgage finance
Cutting credit card, purchased on Thinkstock, modified.

CreditCard ImageDespite both the recent release of a set of “GSE reform principles” by the Mortgage Bankers Association and Treasury Secretary Designee Steven Mnuchin’s promise to prioritize reform of Fannie Mae and Freddie Mac, as matters stand such reform seems likely to remain stalled for some time: while there may be a consensus to “do something,” there is far less agreement concerning what that something should be.

To jump start the debate, protect taxpayers, and encourage a more private mortgage market, Mr. Mnuchin, if confirmed, should strongly consider reviving a plan developed by his predecessor, John Snow. That plan would take advantage of the Treasury’s authority to place limits on Fannie and Freddie’s debt issuance to reduce those agencies’ indebtedness. The reduction can and should be done in a controlled manner that could be easily reversed if necessary; a 5 percent monthly reduction, for instance, should work smoothly.

The Treasury's Authority

Some may be surprised to learn that the Treasury Secretary has such broad, unilateral authority. For those in doubt, the authority is found in the largely identical charters of Fannie Mae and Freddie Mac. According to Section 306(j)(1) of Freddie Mac’s charter, for example,

Any  notes,  debentures,  or  substantially  identical  types  of  unsecured  obligations   of   the   Corporation   evidencing   money   borrowed, whether  general or subordinated, shall be issued upon the approval of the Secretary of the Treasury and shall have such maturities and bear such rate or rates of interest as may be determined by the Corporation with the approval of the Secretary of the Treasury (emphasis added).

Section 306(k)(1) of the same document allows for similar Treasury authority over the GSE’s issuance of mortgage-backed securities. In short, neither Fannie Mae nor Freddie Mac can issue debt without the approval of the Treasury. (Those who still doubt this broad interpretation of the Treasury’s powers under Section 306 may wish to consult the Congressional Research Service" (CRS) independent legal analysis supporting the interpretation offered here.)

Under then Treasury Secretary John Snow, the Bush Administration announced its intention to more fully implement this authority. It’s position, as expressed by the Office of Management and Budget in the fiscal 2008 budget (page 75), was that

Fannie  Mae  and  Freddie  Mac  fund  their  portfolios  by  issuing  debt,  and  the  U.S.  Department  of  the  Treasury  has  the  responsibility  to  review  and  approve  these  GSEs’  debt-issuances. The  Treasury  Department’s  debt  approval  authority  is  contained  in  Fannie  Mae’s  and  Freddie  Mac’s  Charter  Acts,  and  the  Department  has  approved  Fannie  Mae  and  Freddie  Mac’s  debt  on  a  regular  basis. Treasury  is  developing  a  more  formalized  approach  to  their  debt  approval  authority. As  part  of  that  approach,  Treasury  is  developing  new  debt  approval  procedures  to  enhance  the  clarity,  transparency, standardization,  and  documentation  of  Fannie  Mae’s  and Freddie Mac’s debt issuances.

The powers granted to it in Section 306 also allow the Treasury to increase the percentage of GSE debt that is in the form of mortgage backed securities, rather than unsecured debt. By taking this further step, the Treasury would help to reduce the interest rate risk carried on the GSE’s balance sheets.

No Serious Disruptions Likely

Some might be concerned that such a move would cause disruptions in the GSE debt markets.

The primary objection to these suggested reforms relates to a concern about mortgage rates. But one should keep in mind that by reducing the flow of GSE debt, all else equal, the Treasury would be pushing up the price of GSE debt, which, of course, will result in lower interest rates. Given that jumbo mortgage rates are currently very similar to conforming rates, other market players should be able to take any reduction in GSE market share with little impact on overall mortgage rates. The excess reserves in the commercial banking system alone could fund the entire mortgage market for at least a year or more. It is also helpful to note that when the original Snow plan was contemplated no disruptions to the GSE debt markets occurred.

Despite this and the CRS's favorable review that the Snow plan was an acceptable interpretation of the law, John Snow resigned before it was implemented. Alas, his replacement, Hank Paulson, shelved Snow’s effort. We, of course, know the rest of that story. But if the next Treasury Secretary wants to 1) protect the taxpayer, 2) protect the financial system, and 3) motivate Washington (especially Congress) to do the hard and much needed work of reforming our mortgage finance system, he should take the Snow plan back off the shelf.

  • The agencies referenced should be privatized and lose any and all taxpayer guarantees. Once privatized, and no longer guaranteed by taxpayers, whatever role they play in the mortgage market, moving forward, can be determined by market forces.

    The purported benefit of lower interest rates, by having Fannie and Freddie, are illusory. The costs, it is true, are not born by the parties directly involved, they are simply transferred to third parties, namely taxpayers. Lenders can simply charge higher rates where higher risks are involved, use third-party insurers like privatized GSEs, or simply not make the loan.

    • Ray Lopez

      Here here! Very true, very true. By some measures the subsidy to Fannie and Freddie are 100 basis points a year, and, if you count this subsidy, the bailouts of 2008 have NOT been paid back in full, contrary to press releases to the contrary, and moral hazard continues unabated.

  • Totally agree. Thanks for reminding us of yet another indicia of control exercised by the Treasury over the GSEs….

  • barrystutner

    Do the pass through securities issued by the agencies count as unsecured debt? They are secured with mortgages.

  • Spencer Hall

    The GSEs create a secondary market for some mortgage lenders. If Congress, the Fed's 300 Ph.Ds., and professional economists, understood the savings-investment process, there wouldn't have been a DIDMCA and Freddie and Fannie wouldn't have become behemoths.

    .

  • John Jr

    Mark,
    The purpose of your suggestion is not clear.
    After passage of HERA, is this not the function of independent authority FHFA?