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Banks Look to Socialize Mortgage Risk

The willingness of big banks to assume the role of Fannie Mae and Freddie Mac is just the sort of socialist utopia that only Wall Street could invent.

Not to put too crude a point on it, but the willingness of big banks to assume the role of Fannie Mae and Freddie Mac — securitizing residential mortgages, but this time, with an explicit government guarantee — is just the sort of socialist utopia that only Wall Street could invent.

While bankers like to espouse their love of the free market, what they are really committed to is making money. And what could be more ideal than a business model in which the profits are private and the risks are socialized among the taxpayers?

That is the essence of the plan reported in The New York Times, which says Wells Fargo and other big banks have made clear their desires through the use of lobbying groups. The Obama administration is expected within a few weeks to issue a report on the fate of Fannie and Freddie, the quasi public mortgage insurers that many believe helped fan the flames of the subprime blowout by making guaranties that encouraged banks to lower lending standards and issue too much debt. The agencies themselves have an implicit government guarantee.

The banks have proposed paying a fee for the government insurance, of course. But as the Wall Street Journal notes, citing the conservative American Enterprise Institute (AEI), the issue is whether the government is capable of pricing that risk close enough to its real value. The real costs of issuing such a guarantee are doubtless too expensive to pass on to consumers, and banks won't be keen on picking up too much of the balance. 

And below-market price government insurance is likely to lead to lower lending standards and the sort of over-lending that led to the subprime bubble. The AEI argues that it would make more sense to limit mortgages to higher-quality borrowers and require the holders of primary mortgages to give their approval to second mortgages.

Some analysts, the Times tells us, warn that the housing market is likely to suffer a massive hit if government guarantees of one form another are eliminated.

Who is right? To some extent, they both are. One can have the broadest possible access to the housing market, but that carries a lot of risk, as we have learned over the last few years. Choose your poison.

The banks are clearly inclined to drink from the government's poisoned chalice. Yes, it's a dangerous brew, they can handle it. They know when to stop. The banks have promised to temper the excesses for Fannie and Freddie by the very riskiest of deals, the "affordable housing" loans.

And if another housing bubble did develop, the government and the taxpayers would be on the hook for a bailout that would make TARP look like child's play. And until the bubble did burst, big banks would be able to create an oligopoly in the massive residential market, about 80 percent of which now belongs to Fannie and Freddie.

Wouldn't this new arrangement essentially maintain the risks and contradictions that made Fannie and Freddie so combustible? Yes, indeed they would. But they also would preserve the cash flow that made Fannie and Freddie so powerful in their heyday.

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