Greenspan Blasts Approach In US’s Fannie, Freddie Fix

Alan Greenspan usually surrounds his opinions with caveats and convoluted clauses. But ask his view of the U.S. government’s response to problems confronting mortgage giants Fannie Mae and Freddie Mac, and he offers one word: ‘Bad.’

The former Federal Reserve chairman, who has been warning for years that Fannie’s and Freddie’s business model threatens U.S. financial stability, acknowledges that a government backstop for the shareholder-owned, government-sponsored enterprises was unavoidable. Not only are they crucial to the ailing mortgage market now, but the Fed-financed takeover of investment bank Bear Stearns Cos. made government backing of Fannie and Freddie debt ‘inevitable,’ he says. ‘There’s no credible argument for bailing out Bear Stearns and not the GSEs.’

His quarrel is with the approach the Bush administration sold to Congress. ‘They should have wiped out the shareholders, nationalized the institutions with legislation that they are to be reconstituted — with necessary taxpayer support to make them financially viable — as five or 10 individual privately held units, and auctioned off,’ he says in an interview this week.

Instead, Congress granted Treasury Secretary Henry Paulson temporary authority to use an unlimited amount of taxpayer money to lend to or invest in the companies. In response to the Greenspan critique, Mr. Paulson’s spokeswoman, Michele Davis, says, ‘This legislation accomplished two important goals — providing confidence in the immediate term as these institutions play a critical role in weathering the housing correction, and putting in place a new regulator with all the authorities necessary to address systemic risk posed by the GSEs.’

At 82 years old, Mr. Greenspan remains sharp and his fascination with the workings of the economy undiminished. He maintains a high public profile, both defending his nearly 19-year tenure at the Fed from criticism that he is to blame for today’s woes and promoting his book, the paperback version of which is to be issued next month with an epilogue.

In a conversation in his well-windowed, oval-shaped Washington office this week, Mr. Greenspan predicts U.S. house prices will begin to stabilize in the first half of next year. He also offers a novel suggestion to bolster the housing market: Increase the number of potential home buyers by admitting more skilled immigrants.

The former Fed chairman has argued for years that Fannie and Freddie shouldn’t be allowed to borrow cheaply because of an implicit government guarantee of their debt and to finance a huge — and, in good times, profitable — portfolio of mortgage-backed securities. Their current vulnerability offered a chance to dismantle them, he says. ‘This was the ideal opportunity to come to grips with what is a fundamentally flawed model, which privatizes profits and socializes losses. That is fiscally tolerable in small amounts, but in trillions of dollars, it isn’t,’ he says.

Nationalizing the companies and later selling them off in pieces sounds radical. It is far from clear that Congress would have embraced it even with President George W. Bush’s blessing. But the notion has been raised by several other prominent observers. ‘If they are too big to fail, make them smaller,’ former Nixon Treasury Secretary George Shultz says. Critics say the Paulson approach, even if the government never spends a nickel, entrenches current management and offers shareholders the upside if the government’s reassurance allows the companies to weather the current storm. The Treasury hasn’t said what conditions it would impose if it offers Fannie and Freddie taxpayer money.

Fear that financial markets would react poorly if the U.S. government nationalized the companies and assumed their approximately $5 trillion debt is unfounded, Mr. Greenspan says. ‘The law that stipulates that GSEs are not backed by the full faith and credit of the U.S. government is disbelieved. The market believes the government guarantee is there. Foreigners believe the guarantee is there. The only fiscal change is for someone to change the bookkeeping.’

A longtime student of housing markets, Mr. Greenspan has been assembling data from government and trade-association sources to divine when house prices will stop falling. His desk, couch, coffee table and conference table are strewn with printouts of spreadsheets and multicolored charts of housing starts, foreclosures and population trends.

His bottom line: ‘Home prices in the U.S. are likely to start to stabilize or touch bottom sometime in the first half of 2009,’ he says. Tracing a jagged curve with his fingers on a tabletop, he cautions that even at a bottom ‘prices could continue to drift lower through 2009 and beyond.’

An end to the decline in house prices, he explains, matters not only to American homeowners but is ‘a necessary condition for an end to the current global financial crisis.’

‘Stable home prices will clarify the level of equity in homes, the ultimate collateral support for much of the financial world’s mortgage-backed securities. We won’t really know the market value of the asset side of the banking system’s balance sheet — and hence banks’ capital — until then,’ he says.

Mr. Greenspan’s forecast rests on two pillars of data. One is the supply of vacant, single-family homes for sale, both newly completed homes and existing homes owned by investors and lenders. He sees that ‘excess supply’ — roughly 800,000 units above normal — diminishing soon. The other is a comparison of the current price of houses — he prefers the quarterly S&P Case Shiller National Home Price Index because it includes both urban and rural areas — with the government’s estimate of what it costs to rent a single-family house. As other economists do, Mr. Greenspan essentially seeks to gauge when it is rational to own a house and when it is rational to sell the house, invest the money elsewhere and rent an identical house next door.

In the past, Mr. Greenspan’s crystal ball has been, at best, cloudy. He didn’t foresee the sharp national decline in home prices. Recently released transcripts of Fed meetings do record him warning in November 2002: ‘It’s hard to escape the conclusion that at some point our extraordinary housing boom . . . cannot continue indefinitely into the future.’

Publicly, he was more reassuring. ‘While local economies may experience significant speculative price imbalances, a national severe price distortion seems most unlikely in the United States, given its size and diversity,’ he said in October 2004. Eight months later, he said if home prices did decline, that ‘likely would not have substantial macroeconomic implications.’ And in October 2006, nine months after leaving the Fed, he told an audience that, though housing prices were likely to be lower than the year before, ‘I think the worst of this may well be over.’ Housing prices, by his preferred gauge, have fallen nearly 19% since then.

Mr. Greenspan urges the government to avoid tax or other policies that increase the construction of new homes because that would delay the much-desired day when home prices find a bottom.

He does offer one suggestion: ‘The most effective initiative, though politically difficult, would be a major expansion in quotas for skilled immigrants.’ The only sustainable way to increase demand for vacant houses is to spur the formation of new households. Admitting more skilled immigrants, who tend to earn enough to buy homes, would accomplish that while paying other dividends to the U.S. economy.

He estimates the number of new households in the U.S. is increasing at an annual rate of about 800,000, of whom about one-third are immigrants. ‘Perhaps 150,000 of those are loosely classified as skilled,’ he says. ‘A double or tripling of this number would markedly accelerate the absorption of unsold housing inventory for sale — and hence help stabilize prices.’

David Wessel