Treasury’s GSE Reform Plan – A Case Study of Political Economy in Action

Friday, September 27, 2019 | Don Layton

The US Treasury released in early September its much-awaited Housing Reform Plan in response to the Presidential Memorandum of March 2019. The plan has a lot of specific and reasonable content and represents a substantive start to housing reform, but it has many open issues which could take years to fully work through.

Taken together, the 45-page plan is a classic result of the intermixing of politics and economics in housing finance, produced through a policy-making process inside a presidential administration. The plan says a lot about some topics, and avoids saying things about others. It represents different groups inside the administration jostling for policy dominance, and then compromising, sometimes agreeing to wording which allows each side to claim some measure of victory but leaving the public unclear exactly what is being said.

It is government in action that reflects real life with all its necessary compromises.

Since housing finance is the lifeblood of the housing sector, which comprises about one-sixth of the entire US economy, and since the cost of housing usually accounts for the largest monthly budget expense of the typical American family, it is worth closely examining what is really going on with Treasury’s reform plan to get a better understanding of what is likely to happen over the next year or two.

To do this, I have written “My Top Ten Political Economy Insights” about the Treasury plan. As examples, I note such things as:

  • How the plan reflects the virtually complete policy rehabilitation of the two GSEs, which were almost universally being slated for full “wind down” for most of the prior decade. It’s a major reversal of fortunes, and one least expected to come from a Republican administration.
  • How the investors in the historic common and preferred equity shares of the companies – disenfranchised by the two firms being placed in conservatorship (a legal status where they are essentially wards of the US government) and suing over aspects of that conservatorship – were given no hint of how Treasury plans to address their concerns. The investors, now dominated by professional institutions that purchased the securities at large discounts (such as private equity firms), had very much been forecasting some positive announcement.
  • How certain key issues were missing, unmentioned, or unaddressed – perhaps in the hope that few would notice their absence. This includes the impact of the reform plan on the federal budget, which could easily amount to a $100 billion or more net loss of revenue over the usual ten-year budget forecast.
  • How the plan calls for literally dozens of studies, some of which could potentially result in major changes in the size and scope of the two GSEs, and in some aspects of their business model. This is potentially destabilizing to the two companies, and certainly makes valuing them for any capital-raising problematic until the studies are done and disposed of one way or another.

I conclude with the greatest political economy challenge of the Treasury’s reform plan: with all the studies it calls for that could materially impact the revenue and expense streams of the two GSEs, with its contradictory call for a competitive market with many guarantors while also wanting all sorts of limitations and restrictions on what those proposed guarantors can do, along with empowering its regulator, the Federal Housing Finance Agency, to be a sort of super-regulator able to massively intrude in the operations of the two companies, why would investors be interested in putting at risk at least $100 billion of equity in the existing GSEs, much less newly-created guarantors?

In short, the Treasury plan has a long development process ahead of it. Between all the studies to be done and its inherent contradictions that need to be addressed, the government is going to take a long time to fully work it all out.

Read More About: Housing Markets and Conditions
Don Layton

Don Layton

Senior Industry Fellow

Mr. Layton was the CEO of Freddie Mac from May 2012 until June 2019, which he undertook as public service given the company has been under Federal government control since 2008....

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