A Dubai Fannie? American Lessons

There have been recent reports that Dubai is considering developing its own version of Fannie Mae, the US government sponsored enterprise which is now in receivership.

While the recent collapse of Fannie Mae and huge prospective losses (well beyond $200B and counting) has rightfully destroyed Fannie Mae’s reputation, there was a time when it achieved a hugely successful societal mission. It is these positive aspects that are worthy of exploration, to see if it possible to replicate the positive elements without experiencing the severe negative consequences.

Fannie Mae was borne out of The Depression of the 1930’s, when the social fabric of the US was ripped apart. There was a dramatic rise in popularity of Marxism, and the level of popular unrest very much concerned the leaders of the country, and was tied to the lack of an economic “stake” that the average citizen possessed. At the time, about 25 per cent of Americans owned their residence, and mortgages were typically 5-year 25 per cent down mortgages that required total refinancing.

In addition, a very small proportion of Americans owned any kind of capital asset. The result was a dynamic, diverse large country, but one still susceptible to periodic eruptions of public unrest (as had been the tradition throughout the 1880’s-1910’s of industrial and mining strikes).

The goal of Fannie Mae was to enable the creation of a majority of voters who would own their homes and thus provide a social bulwark to American capitalism. The concept did prove to be a successful one. By developing a non-recourse 30-year amortising mortgage, authorising the underwriting, and making a secondary market in mortgages and issuing Government supported bonds to fund these purchases, Fannie Mae made homeownership affordable to a vast new swath of the American public.

There was an implicit US government guarantee, that was an important, but not critical feature. Home Ownership rose from 25 per cent to the low 60 per cent by 1960’s. There were some pre-conditions and some negative side effects that began to sow the seeds of Fannie’s (and Freddie’s ) destruction.

Underwriting requirements were initially prudent- 20 per cent down-payments, 3X income requirements, 30-year fixed rates (in a fixed exchange rate and interest rate environment) and sufficient mortgages kept on the book of the originating banks to ensure that risks were underwritten prudently. There was also a downside - most predominately minority (African–American) neighbourhoods were “red-lined”, made ineligible for Fannie loans, which enforced racial discrimination and depressed home values.

Conditions which enabled Fannie to provide both a social mission and be profitable started to slowly come apart as a result of two main trends that began in the late 1960’s—1) financial deregulation and 2) the US Civil rights movement. The development of the unregulated Eurodollar market was the first crack in the deregulation of US interest rates, and the collapse of Bretton Woods in 1971, moved the developed world to a regime of floating exchange rates which inexorably resulted in the deregulation of the US financial system.

The Civil rights movement led to political pressure to create programmes to subsidise housing programmes that would, in their advocates’ minds, address past social wrongs. The resulting pressures resulted in laws such as the Community Reinvestment Act (CRA) in 1993 under the Clinton administration, and later congressional requirements to Fannie and Freddie to increasingly write loans for low income households which resulted in lowered underwriting standards.

The Bush administration’s Ownership Society initiative in 2004-2006 only added fuel to the flames, and the ability of the originating banks to sell all their risk in the loans resulted in even those underwriting standards not being adhered to.

The issue then for Dubai is;

1) first, does there already exist mechanism for the citizens to have a stake in the government and society? Better forms such private pension plans, ownership of capital assets/stock within the country are more efficient ways to build social cohesion. Renting is not a bad choice for cost citizens, as long as there is a deep enough rental market to enable competitions and easy ability to add new supply through new construction.

2) Secondly, if supporting home ownership is a social goal, how can it be set up to avoid political interference and imprudent risk taking, while being objectively fair to all citizens? In this regard, it must be a private corporation set up with a defined grant of capital and provided a clear charter of its goals. It will be truly successful when it has proven the concept of long-term mortgages are viable, and can be taken over by solely private enterprises.

My take, when all is said in done, is that in the current highly mobile and fluid capital markets, a Dubai Fannie is unneeded, and society’s resources better focused on giving citizens a stake through direct ownership of financial assets and an education which ties them to a global, flexible economy.

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