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    The Fannie and Freddie gravy train

    Stop me if you’ve heard this one before: “Two senators with a plan walk into a room . . .” Actually, there’s no punch line. Because it was no joke when Republican Senator Bob Corker and his Democratic colleague Mark Warner announced their proposal to reform Fannie Mae and Freddie Mac last month. They even captured the interest of cable news for a few minutes, before the networks quickly returned to courtroom dramas and Edward Snowden’s travel plans.

    The unusual twist, however, is that the plan is bipartisan, substantive, and bold — three words not often found together in today’s Washington. That doesn’t make it perfect. But as in the old joke about “1,000 lawyers at the bottom of the ocean,” it is a good start.

    Retooling the country’s two mortgage giants has been on Congress’ to-do list ever since it omitted the task from the 2010 Dodd-Frank financial overhaul. Calling out new regulations for banks, hedge funds, and insurance companies was easy. Fundamentally reforming Fannie and Freddie, the two institutions responsible for $185 billion in taxpayer losses, was hard work. So Congress decided to skip it.


    Created by Congress to help finance home ownership, Fannie and Freddie were publicly traded companies when the government bailed them out in 2008. Today, they are still in conservatorship, owned and controlled by the federal government. With the housing market in slow recovery, they’re profitable once again — a condition that, some fear, will make it even tougher to step away from massive government intervention in the mortgage markets. But Corker and Warner are at least willing to give it a try.

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    Their plan starts with a simple premise: Move as far as possible from the old model, in which government subsidizes Fannie and Freddie shareholders’ private returns, while taxpayers remain on the hook for losses when interest rates and mortgages go bad. Over a five-year transition period, the firms would be replaced by a new Federal Mortgage Insurance Corporation. Private companies securitizing pools of qualifying mortgages could buy insurance from the new corporation to cover 90 percent of any losses. Fees charged would cover the losses, plus a 2.5 percent capital cushion. With 10 percent of their own capital at risk, the private financiers should have incentives to manage risk more effectively than in the past.

    Free-market advocates take issue with the decision to maintain a government guarantee at all. Their concern, as with any taxpayer-backed insurance program, is that it either sets the risk premium too high (in which case the private sector could provide the same protection at lower expense) or too low (encouraging excessive risk and potential taxpayer losses). Beyond that, the history of government insurance funds for savings and loans, pension systems, and flood zones has been awash in red ink.

    But the most organized opposition will come from defenders of the status quo. They’ll argue than any restraints on the ability of Fannie and Freddie to borrow money, purchase securities, or issue guarantees will mean higher mortgage rates for homeowners. Even during the two firms’ heyday, economists estimated that Fannie and Freddie lowered rates by less than 1 percentage point. But dire warnings from realtors and homebuilders were enough to scare politicians into inaction.

    Ironically, the two mortgage giants’ return to profitability may also be a roadblock to reform. With combined profits of $12.7 billion in the most recent quarter, Fannie and Freddie have become the new gravy train for the US Treasury. The temptation is to hope that if held long enough, these businesses might pay back the funds taxpayers sank into them. But if we can’t reform during good times, and we can’t reform during a crisis, then when exactly will it ever get done?


    The most desperate argument against the Corker-Warner plan is that it would wipe out any residual value in the Fannie and Freddie shares still held by investors. For the past couple of years, several prominent hedge funds have been speculating that a return to profits might eventually mean Fannie and Freddie will resume paying dividends and share prices will rise.

    Delaying the most overdue element of financial reform out of concern for speculative hedge fund investments would set a new standard for irony. But in Washington, anything is possible.

    For now, the plan represents the beginning of a long process. As its authors would concede, there will be many changes along the way. This is real legislation that already carries cosponsorship from eight of the 22 Senate Banking Committee members. That may not guarantee a receptive audience, but it may help ensure that Corker and Warner get the last laugh.

    John E. Sununu, a former Republican senator from New Hampshire, writes regularly for the Globe.