Capitalisn’t: Will Privatizing the Mortgage Giants Solve the Housing Crisis?

Bethany: I’m Bethany McLean.

Phil Donahue: Did you ever have a moment of doubt about capitalism and whether greed’s a good idea?

Luigi: And I’m Luigi Zingales.

Bernie Sanders: We have socialism for the very rich, rugged individualism for the poor.

Bethany: And this is Capitalisn’t, a podcast about what is working in capitalism.

Milton Friedman: First of all, tell me, is there some society you know that doesn’t run on greed?

Luigi: And, most importantly, what isn’t.

Warren Buffett: We ought to do better by the people that get left behind. I don’t think we should kill the capitalist system in the process.

Bethany: If you want a story that combines housing, politics, Wall Street hedge funds, and hundreds of billions of dollars, you just need to look at two institutions you might not think about much anymore: Fannie Mae and Freddie Mac.

Luigi: And yet the fate of these government-sponsored enterprises, or GSEs, is at the heart of the American housing market, which itself is at the heart of the American economy.

Bethany: Fannie Mae was founded during the Great Depression. The idea was that you could make mortgages more widely available by buying loans from banks because Fannie bought the loans that enabled the banks to make more loans, thereby keeping mortgages available.

Freddie Mac came along in 1970 to provide competition and help increase liquidity even more. Over time, this evolved into a system where the companies then packaged up these loans and sold them to investors. The existence of the so-called GSEs, government-sponsored enterprises, is why America and, I think, Denmark are the only countries where people can get 30-year, fixed-rate mortgages.

While many people may not have heard of Fannie and Freddie—people often think Fannie May, the candy company—they are actually the backbone of the mortgage market. Today, they still back roughly 50 percent of mortgage loans, with other government agencies like the FHA making up another chunk.

Luigi: It’s funny you mention it, Bethany, because at the beginning, when I was fresh off the boat in this country, I had a hard time figuring out Fannie Mae versus the candy company.

Bethany: Well, it is a really weird . . . The fact that they both have the same name is super strange. Anyway.

Luigi: It’s also super strange that, as you said, Fannie Mae does not appear directly anywhere but is behind everywhere. I think that this two-sided nature makes it complicated to keep track of how important it is.

Bethany: Fannie and Freddie were created to make housing finance more stable and accessible for ordinary Americans. But over time, this hybrid structure that they have, part private and part public, turned them into some of the most controversial institutions in our financial system.

This perception that they were part of the government resulted in this weird concept of an implicit guarantee, meaning that investors believed the government would step in and save the companies if there were a crisis, but the government officially didn’t stand behind them. That’s partly why investors wanted to buy the loans that Fannie and Freddie sold because of that implicit guarantee, and that helped lower Fannie’s and Freddie’s borrowing costs, hence their ability to help with mortgage rates.

But this whole idea of an implicit guarantee is a really screwed-up concept, isn’t it, Luigi?

Luigi: Oh, absolutely. I think it’s particularly screwed up if you let these companies be privately managed because there is a huge incentive to exploit this guarantee. Part of what happened before 2008 is that not only were Fannie and Freddie making loans more easily, but also, they doubled down by investing their assets in mortgage-backed securities to take advantage of the spread between their financing and the yield on those mortgage-backed securities. That’s clearly a problem that needs to be taken into consideration, especially if we’re thinking about privatizing those entities.

Bethany: It’s interesting because part of the controversy around Fannie and Freddie was these portfolios of mortgages that they bought. Fannie and Freddie always insisted that somehow helped lower mortgage rates because they own this whole portfolio of mortgages.

I suppose there is an interesting question there, and maybe there is something to that. But perhaps more importantly, it juiced the company’s profits for a long time, thereby enabling executive compensation to be much higher because it was stock-based, and the stocks were really good performers for a really long period of time.

The funny thing is, though, because managing the interest-rate risk on a huge portfolio of mortgages is extremely risky, everybody always thought that Fannie and Freddie would blow up because they mismanaged interest-rate risk. Almost none of the critics thought they would blow up because they mismanaged credit risk. And that’s, of course, exactly what happened.

In 2008, the government seized Fannie and Freddie during the financial crisis. In fact, even before Lehman went under, Hank Paulson, who was then the Treasury secretary, argued that they were about to go bankrupt, and if they did, the economy would stop functioning because people would be unable to get mortgages. Fannie and Freddie were put into what’s known as conservatorship. The idea was that this would be temporary. Ha! Seventeen years later, here we are.

Luigi: There’s nothing as permanent as something that is claimed to be temporary.

Bethany: Good point.

Luigi: Part of the issue is that this is a big political football. What might seem like ancient history is becoming relevant now because, as you might have read, the Trump administration has floated plans to take these companies public again, raising billions through new stock offerings and finally letting them rebuild capital. But the question is, would that actually help fix today’s housing crisis, or would it actually make it worse off?

Bethany: Yeah. There is a lot of money involved because hedge funds, including Bill Ackman’s Pershing Square, made massive bets on Fannie and Freddie after the crisis. They bought the stock, which continued to trade as penny stocks, for pennies on the dollar. These hedge funds have spent over a decade suing the government over some of the terms of the bailout.

If the companies are ever released from conservatorship and taken public again, those investors could stand to make a lot of money. Even rumors of release from conservatorship—it sounds like a release from prison, which it kind of is—have already sent the stocks surging. That potential windfall has turned what could be a dry policy debate into one of the most heated financial battles of the last decade.

Luigi: We’re talking about hundreds of billions here. Even if the topic is a little bit arcane, don’t lose sight of the fact that we’re talking about a lot of money. Getting a little bit more or less of this gigantic pot makes somebody rich, generationally rich. As you can imagine, there are a lot of sharks around these two entities.

Bethany: Luigi, let’s get into some questions here, and let’s start with you. Do you think the way the US has structured mortgage finance makes any sense?

Luigi: It depends what the objective function is. There was an idea that you wanted to favor homeownership for a number of positive reasons. You can argue that it creates stability. You can argue that people are happy when they’re homeowners and so on and so forth.

Now, maybe this emphasis is too big. It’s not an obvious thing that you want to favor housing purchases. However, if you do, the idea behind Fannie and Freddie, which is to make it easier to absorb this prepayment risk . . . Really, the most complicated thing is not that these mortgages are 30-year mortgages. The most complicated thing is that you can prepay them at any time without any penalty. This is what doesn’t exist in nature.

This creates a very complicated thing to hedge because there are a lot of behavioral components. You know that when interest rates go down, people tend to refinance. However, there are people who are too busy or people who are in too much financial trouble to do it.

After a round of lower interest rates, then you’re left with a pool of people who are very strange because they are basically inattentive and people close to default. That changes the risk profile dramatically, and this is really, really complicated for the private sector to handle.

But the other side is that they absorb the default risk. Whenever the government intervenes, there is a strong incentive to free ride on the government and get it at a lower price. And so, not only is the government providing the service, which is already a big help because I don’t think that this would be done by the private sector, no matter what, but in addition, even the CBO, even government organizations, say that the government is underpricing that fee.

Fannie and Freddie do charge you a fee to cover your default risk, but they tend to undercharge you with respect to what the right rate is. Of course, it is a bit in the eye of the beholder, but even government agencies claim that this is too low a number.

Bethany: I guess a couple of other things are that there was always a big fight over money, and this is part of the lead-up to the financial crisis. Wall Street always resented Fannie and Freddie because the mortgage market is a huge, huge market, and they always perceived that Fannie and Freddie were taking more than their share of the profits from this market. Wall Street always wanted to get into this business.

At the same time, there was always a push from the government to expand homeownership by offering loans to people who didn’t have the credit to qualify for a Fannie and Freddie loan. So, there was a lot of pressure on Fannie from its Democratic supporters to extend their credit box, to allow people with lower credit scores to get a Fannie or Freddie mortgage. Fannie and Freddie, actually, always pushed back on that. In fact, the definition of a nonconforming mortgage was a mortgage that Fannie and Freddie couldn’t buy.

Wall Street essentially saw its opening and created another set of mortgage loans known as private-label loans. What that meant was that subprime mortgage lenders started to crop up in the late ’90s, and they would make loans to all sorts of people with lower credit ratings.

Fannie and Freddie actually wouldn’t buy those loans. Instead, Wall Street banks would. They would securitize the loans, meaning turn them into loans that investors could buy. They would securitize the mortgages in the same way Fannie and Freddie did, but without any backing. There was no government backing to these mortgages. They were called private-label mortgages because they weren’t Fannie and Freddie securities. That’s the run-up to the financial crisis. Do you agree with my summary, Luigi?

Luigi: Yeah. Let me give you my interpretation of the next step, which is the most interesting one.

Bethany: Well, if you say so.

Luigi: What?

Bethany: I’m teasing you.

Luigi: At some point, the private-label business became so big that Fannie and Freddie felt threatened that they would lose their raison d’être, their reason for existence. They started to actually lower the standards to compete with the private label.

What happened is like those guys who show up late at a party, and they don’t even get drunk, and the police show up, and they get arrested without having done anything, Fannie and Freddie basically got left with the burning mortgages toward the end when they did not initiate this, but they were slower in getting out because the private sector was much faster. They got blamed completely for the financial crisis when, in my view, most of the reckless lending was done by private labels.

Bethany: Well, it absolutely was, but there was a lot at stake in this particular debate because Wall Street and Republicans had a lot at stake in saying: “Oh, no, no, no. We didn’t do anything wrong. It’s Fannie and Freddie. It’s the government involvement in markets. That’s what’s to blame for it. If it hadn’t been for the government involvement, we, Wall Street, would have handled everything perfectly and there would have been no financial crisis.”

What seems like an arcane issue is actually a huge ideological battle over whose fault this was. It’s actually really clear, if you look at the data, that it wasn’t Fannie and Freddie’s fault. The worst loans by far were made by these private-label mortgages.

When I think about conservatorship and the fact that Fannie and Freddie were taken over on far more onerous terms than the banks were, it’s unfair because in the financial crisis, everything became a government-sponsored enterprise. This idea that Fannie and Freddie were unique in having this implicit backing, this implicit guarantee from the government—well, it turned out banks had an implicit guarantee, too. All of their executives were axed, whereas the bank executives were allowed to continue and go back to paying themselves a lot of money. Fannie and Freddie were barred from lobbying in the future.

It wasn’t just that the interest rate they were charged was double that of the banks, it’s that the restrictions that were put on the companies really were more onerous.

Whether or not you quibble about the terms of Fannie and Freddie’s conservatorship, something happened in 2012 that opened the door to a lot of lawsuits, and that is, again, a really big deal today. It’s something called the third amendment. Instead of paying a fixed dividend—

Luigi: Which is not the Constitution here.

Bethany: No. But kind of. Instead of paying a fixed dividend to Treasury, the companies had to send nearly all of their profits to the government every quarter. They could never, in effect, pay back the government because they were required to send all of their profits to the government.

The investors who had put money into the company suddenly found themselves with an investment that was worthless because instead of these highly profitable companies, they had these companies that were required to send all of their profits to the government. The government said at the time that it was trying to prevent a death spiral, that if Fannie and Freddie were to head into financial problems and the government had to give them more money, then it could spiral into another financial crisis.

Investors say that this was an expropriation of profits. I think it’s pretty clear, in retrospect, it was an expropriation of profits because Fannie and Freddie were already immensely profitable, and it was clear they were going to continue to be profitable.

Luigi: Actually, what I read is that the government lied because the government said that one of the reasons why they did this restructuring is because they didn’t think that they could pay the dividend on a regular basis. But, in fact, they knew already that the company would become much more profitable because in a matter of months, the accountants forced them to revise some very conservative assumptions about their liability. As a result, they started to spin off profits, and in some of the litigation, they revealed in the documents that the government knew that.

Bethany: Yeah. It’s a really ugly chapter, even though very few people care about it. But it’s really clear that the government did know that Fannie and Freddie were going to become profitable, and this whole idea that they were going to become these money pits was a complete fiction created in order to justify the third amendment.

While the court cases are really complicated, in most cases the investors have lost for all sorts of complicated legal reasons. They haven’t lost based on the common-sense merits of what took place.

Luigi: There is actually one award that they received that’s not been paid out yet, precisely because they were accused by the large shareholder, which was the government, of not acting in good faith.

Bethany: Yeah. I think the problem for that is that it’s not really clear how the government should be penalized for lying because at least the upshot, I think, out of all the battles that have been waged in the court is that, legally, the government was mostly entitled to do what it did, and even in the places where the courts have found for the investors, there’s not a huge payday forthcoming.

Luigi: Can I be a little bit cynical?

Bethany: Yes, always.

Luigi: Most of the cases that the investors lost were in the federal claims court in Washington. These are judges without juries. The case they won was a case with a jury. I think that judges are not inclined to give money to investors, and the jury is much more sympathetic to that.

Bethany: Yeah. Well, I think that’s a really fair point,

Luigi: One justification for the government could be that the right market outcome for Fannie and Freddie at the time would have been bankruptcy. Bankruptcy would have completely wiped out the equity. At the end of the day, those investors were saved simply by a technicality. They basically used all their power to deliver what maybe was the right outcome from the beginning but in the wrong way.

Bethany: I hear that point of view. It is a controversial argument in that there are people who argue that Fannie and Freddie would not have gone bankrupt, that there was enough value there, and private-market investors were trying to put together a plan.

I’d still argue in that case that they were treated differently than other financial institutions. By that standard, everybody would have been bankrupt. Some shareholders got to make out okay, and others didn’t, so that still wasn’t fair. What is particularly ugly about the whole thing is that the government was encouraging community banks to buy Fannie and Freddie preferred in the run-up to the crisis, and then they wiped it out. There was also a little bit of unfairness in that.

Luigi: Yeah. That was tough on the community banks, for sure.

Bethany: Yes. Yes. Yes. Yes. I believe that, practically speaking, the companies have paid the government back, but accounting-wise, they have not, and they never can. That’s part of the problem with this IPO, that the government has to decide what it’s going to do with this unpayable debt that Fannie and Freddie owe.

Luigi: Yeah, I think it’s a super tricky political issue because if you were to now cancel this outstanding debt, as Bill Ackman is asking, you are giving a gigantic payday to Bill Ackman, and it would certainly look like an inside job of major proportions.

This aside, let’s discuss first principles. Do you think that Fannie and Freddie should go public?

Bethany: Well, let me push back on that first statement for a little while because in an economy or a Washington where everything is starting to look like an insider job of massive proportions, I’m not really sure how concerning yet another one would be.

I actually do. A public Fannie and Freddie with this split responsibility between doing the right thing for homeowners and having responsibility to the bottom line, it’s actually about as good a way as I can think of to structure a mortgage market.

The companies want to make mortgages that are profitable, that are going to pay off over time. They don’t want to take too much credit risk because they need to earn a return. It means, on the other hand, that there is also pressure on them from the government from being too mercenary and that there is some pressure on them to do the right thing for homeownership and to give back to homeownership. I think that balance is about as well constructed as it can be.

I think a dynamic like now, where the companies are in conservatorship and are subject to political whims over what their credit standards should be, that’s really dangerous. You can see an administration that could put a lot of pressure on them, and there’s already pressure in some quarters to have them weaken their credit standards immensely in order to make mortgages more available to people. You want there to be a legal mechanism for them to push back from that.

I don’t think that you can have a functioning Fannie and Freddie if you get rid of the implicit government guarantees. Trump says he’s going to keep that. I’m a fan of the way they were structured in the past. I know you could argue with this, but yeah, I do think that that should be the case.

But you could also structure a public company so that it earns a utility-like return, so that it’s not supposed to just swing for the fences also and make the biggest returns it possibly can, but so that its returns are capped like utilities’ would be.

Luigi: First of all, the fact that there is not now some huge favoritism in mortgages or political favoritism, I think is not true because when it comes to areas like in Florida, if you were to factor in the real risk involved, I think that almost nobody would get a mortgage in Florida, but that’s not politically doable.

Bethany: Well, that’s what I mean. It is very political now because Fannie and Freddie have been in the hands of the government for 17 years, and so there’s been pressure on them through different administrations to either make or not make mortgages, and, for sure, things are happening under the surface. If they were independent, publicly traded companies, there’s at least another mechanism there of responsibility, not just to their government overlords.

Luigi: You are advocating to go back to Fannie and Freddie before—

Bethany: I am.

Luigi: —which didn’t work that well to begin with. The risk that they are going to take advantage in some way of the government guarantee to do something crazy, with the excuse of being privately owned, is pretty big.

Bethany: Fannie and Freddie held out in the financial crisis for a lot of years, and you’re right, they finally folded because they had immense pressure from their shareholders and from the government to get back in the game because they were losing so much market share to Wall Street’s private-label mortgages. They had pressure from all sides, from community activists, from their shareholders, and from the government that they weren’t doing enough in this subprime-lending area. That is a real problem.

I’d posit that it’s more broadly a problem with financial institutions that there does seem to be . . . I’d love to know if there are any academic studies or if there could be one about what makes finance suddenly kick into a race to the bottom instead of a race to the top. You want to believe any business should be a race to the top, but at every point in a financial cycle of some product, it becomes a race to the bottom, where everybody’s competing to offer credit on looser and looser terms.

That was a problem for Fannie and Freddie. It was a problem for the Wall Street banks. It was a problem for the entire economy. I do agree that you need a safeguard against that, and maybe there is some kind of countercyclical measure you can put in place, such that they can’t. They step back from the market in those times if the private market is facilitating everything. Or maybe you cap their returns like a utility, and maybe that’s one of the mechanisms that you can put in place. But I think you want them to have shareholders. You want them to be independent from the government.

Luigi: But how do you reconcile the fact that if you want to do that, you need to float them once they are properly capitalized, and to properly capitalize, you need to raise hundreds of billions of dollars? There’s no way they’re going to raise it in the IPO. It’s too much. If you really want to recapitalize it, you have to wait 10 years to do so.

Bethany: Doesn’t it partly depend on what you do with this money that the government says it is owed? If there is some forgiveness of that debt, it becomes easier to recapitalize them.

If you are a believer that the GSEs were being punished . . . Part of the nefarious design of the third amendment was to make it so that it was impossible for them ever to be publicly traded again because they’d never have the capital, whereas if they had been allowed to start rebuilding their capital right then, with all of the immense profits they were generating, none of this would be a topic of discussion now because they’d have the capital.

I know, I know, conspiracy theories. But still.

Luigi: What is your argument to completely wipe out the liability to the government?

Bethany: I don’t know what to do with that, to be honest. I don’t know what to do with the liability to the government. I think the right end state is for Fannie and Freddie to be publicly traded again. I don’t know how to get there from where we are now.

What do you think the right end state is?

Luigi: I actually think that, at this point, it’s better to keep them under government supervision because the moment you create private incentives, my latest thinking is that the worst combination is some government subsidy with some high-powered incentive scheme of the private sector.

It’s like private equity with student loans: a disaster. Private equity with Medicare: a disaster. Every time you have this combination, it is a disaster, and to some extent, this was also true with Fannie and Freddie in 2008. Even if I don’t consider them responsible for the financial crisis, they created or exacerbated the problem. At least at the beginning, they forced a massive government intervention.

Bethany: I agree with you except that, I hate to break it to you, because they are such a huge portion of the mortgage market, that incentive already exists. There’s a controversy among inner Fannie and Freddie circles. The GSEs were encouraged to do these credit-risk transfers that were supposedly transferring some of the risk of the mortgages they made to Wall Street institutions.

There are some people who would argue that very little risk was actually transferred, and Wall Street made a lot of money, because with Fannie and Freddie as government entities, they don’t have the backbone or necessarily the caliber of well-paid people to stand up to Wall Street firms.

Those incentives that you talk about with government guarantees and the government involvement in the market mixed with the private sector are there, regardless of whether Fannie and Freddie are publicly traded or whether they’re owned by the government.

I like the transparency of them being publicly traded, in that at least you can see what’s happening in their financial statements. At least they do have a responsibility to their own bottom line that stops them from being completely suckered by Wall Street.

If I had perfect clairvoyance, I would bet that Wall Street has made billions of dollars off Fannie and Freddie being in government conservatorship. They found all sorts of ways to skim from that, and they will continue to. I like the idea of a Fannie and Freddie with a backbone of their own.

Luigi: What makes it worse vis-à-vis the current situation is the high-powered incentive scheme that you’re going to get. Maybe you should force them not to lobby, retain the right not to lobby and to pay their CEOs very little and not to have a high-powered incentive scheme. Maybe that could be a compromise in that dimension.

Bethany: Yeah. Well, if you capped their returns like a utility, then they wouldn’t have the incentive to swing for the fences. If you capped executive compensation somehow such that you were getting something that was enough to lure talented people . . . The old Fannie had some smart people working there who had come out of places like Goldman Sachs because you could get a job at Fannie Mae.

Maybe what you do instead is you make it so that if you ever take a job at the GSEs, you can’t go on to work in politics because that was the ugly part of the old Fannie. It was a place for people who had been in politics to go and then make a lot of money. It was this revolving door of ugliness, but particularly in the Democratic Party, and you definitely don’t want that again. Maybe there could be some restrictions around your ability to come from government and go into working for Fannie and Freddie. I think there are ways to alleviate that. I like the transparency of the two of them being publicly traded companies required to file financial statements and with shareholders looking at them.

Luigi: They are required to file financial statements even now.

Bethany: I know, but you don’t have the detailed scrutiny of them that you had when they had a big shareholder base.

Luigi: What do you make of the argument that . . . You heard this guy from the Mercatus Institute, Kevin Erdmann, saying that, actually, to some extent, Fannie and Freddie are too conservative. They are lending too little, and, as a result, they are creating a crisis in housing affordability.

Bethany: That’s precisely what I mean. In government conservatorship, they can fall victim to exactly that line of argument that it’s Fannie and Freddie’s fault. All they need to do is lower their credit standards. There’s no independent check on the need for those loans to be profitable and to be creditworthy because the government can tell them what to do.

I don’t like that. I don’t know if it’s true or not that Fannie and Freddie’s standards are too strict. I would suspect not. I would suspect that this is exactly the push because the private-label market never came back after the financial crisis because investors just won’t trust Wall Street firms and won’t trust subprime lenders. That market has still been done 17 years later.

Now, people who want the subprime market to come back are trying to push Fannie and Freddie to take those credits. Do you want them to, as a taxpayer? Where is that line between what you might want them to do as a homebuyer and what you might want them to do as a taxpayer who’s responsible for their losses? Well, a publicly traded company with responsibility to shareholders at least has a chance of getting that balance right.

Luigi: Yeah. I think I can see your point, but I also think that there are very strong incentives to manipulate the subsidies in various ways to maximize the return for the shareholders. The easiest way to make money in a business like this is to manipulate the agreement with the government. Why do you have to innovate or do something fancy when you have a way to extract? They specialize in extracting.

If there is some profitability now, I would prefer this profitability to be spent in expanding access to credit to new families rather than to give money to Bill Ackman, to be honest.

Bethany: We should at least, then, have an honest conversation as a country. Do you want them to extend credit to people who may not be creditworthy, for taxpayers to bear the losses on those loans if, indeed, they don’t work out, rather than just having it forced on the American public through the two companies being under government conservatorship? That’s a conversation worth having, and who should bear the losses for that is a conversation worth having.

I don’t like the idea that this is just happening in the still of the night, under the cover of darkness, where Fannie and Freddie suddenly expand their loan box to allow for weaker credits, leading then to huge losses that are taxpayers’ responsibility, without anybody being told that that’s what was going to happen.

Luigi: But in the last 17 years, they’ve been super profitable, suggesting they have done too little.

Bethany: Well, not necessarily. They’ve been super profitable, but we also haven’t had an economic downturn. Whether they would be super profitable if we head into a recession is a different question. None of their loans have really been stress tested. The idea that you want them to start weakening their credit quality after this huge bull market, right when we might be on the border of a recession, I think is asking for a problem.

Again, maybe it won’t. Maybe the US economy will just continue to be on this incredible tear for decades. But we should at least have a conversation about the trade-offs involved in that.

I’ve always thought that you should also separate this question of first-time homebuyers from access to mortgage credit. They’re really two different things. One is a subset of the other. You may want to encourage first-time homebuyers to be able to have a house, but that’s really different than broadly encouraging access to mortgage credit that allows people to do cash-out refinancings and allows people to purchase investor properties.

It’s those latter two things that really led to the financial crisis, not first-time home buyers. Somehow, in any design that encourages homeownership, you want it to actually be encouraging homeownership. You don’t want it to be encouraging speculation and allowing access to credit.

Luigi: No. I completely agree. But there is a system, and the system is you have to declare what you’re doing. If you lie, that’s a different story. There wasn’t enough attention to people lying. But there are two different standards. When you buy a property for investment, you get a completely different rate, not only because of the subsidy, but also because the lenders know that you’re much more likely to leave a house, abandon a house, if you’re not living in it. If the house is under water, but you live there with your family, you tend to stick around, unless it’s massively under water.

Bethany: Well, that was true until the financial crisis. My point is that if you were to go into the territory of encouraging Fannie and Freddie to weaken their lending standards, you would want that to be very specifically for first-time home buyers. You would not want that to be weakening their lending standards for any other kind of mortgage, whether a cash-out refinancing or purchase of investor homes.

I just think that we have to be really careful to make sure that you’re encouraging the kind of behavior that you want to encourage. There always has been, back in the run-up to the financial crisis, this huge blurring of the lines. Congress really played this double game because they knew full well, due to testimony from executives from subprime mortgage companies, that most of their business was cash-out refinancings.

There was always this, let’s pretend it’s homeownership because everybody wanted to keep the economy going via cash-out refinancings. Nobody wanted to look too closely at was what was really taking place. That’s the problem: there are people who want to play that game by blurring that line because it allows for the illusion of a healthy economy until the home equity is gone.

I’m really opposed to continuing that in any way. It’s already starting today. The pressure on people to do cash-out refis is everywhere. It’s almost back to the day . . . I remember driving through the city of Chicago after the financial crisis and seeing the banner flapping on the abandoned building saying, “Let your home take you on vacation.” We’re heading back into that same territory now.

Luigi: I think you’re absolutely right. Going back to one of your favorite topics, which is private equity, as you know, there is a lot of private equity entering into residential housing precisely in the range of smaller houses for first-time buyers. That, to me, suggests there is some friction. How is private equity making money? They can rent at a rate that is much better than the financing rate. Somebody is not getting credit that otherwise they could get.

Bethany: I’m not sure that’s true. I’m not sure what the volume of private equity’s purchases of housing has been. It was very high when housing was beaten down after the financial crisis. I’m not sure it’s been as high in recent years when home prices have run up.

Private-equity firms definitely have better access to debt markets for their portfolio companies than an individual does. I don’t know that you want that arbitrage there where you want a private-equity firm to be able to buy houses for X amount of money and then turn around and rent them to people for Y amount of money with the private-equity firm capturing the spread. That feels, to me, like a dangerous way to run an economy where you already have wealth inequality on steroids.

Luigi: But, actually, is it true? Most private-equity borrowers have no recourse. I’m not so sure that their rate is much better than what you get in a qualifying mortgage with Fannie and Freddie.

Bethany: Well, it’s definitely better. I’m sure that there’s a spread. I don’t know if there would be a spread at today’s home prices, but I’m sure that there’s a spread based on where private equity bought the housing and the rate that they’re paying on their debt and the rental prices they’re getting, or they wouldn’t be making money. It has to work that way.

They’re not turning around and selling these homes to people. They’re renting them. That gets into this broader conundrum of homeownership in America, which is that even if you wanted to argue that we should unwind, it’s too deeply entrenched in our society.

For a long time, people have retired on the equity they’ve built up in their homes. If you’re suddenly going to tell people that we’re not going to encourage homeownership anymore, and they’re just going to be renters, then what are you going to do with people in retirement, given that we don’t have the social systems in place that other countries that don’t encourage homeownership do? We’ve used homeownership as a substitute for other retiree programs. That gets into pretty questionable territory, too. Do you want a whole mass of 60- and 70-year-old Americans suddenly having no place to live?

Luigi: The current older people are going to sell to the large organizations that are going to rent. It’s not that they don’t cash out from their properties. They do.

Bethany: But they cash out, and then they have that money to retire on and to fund their retirement. If you’re going to change American housing policies such that people are no longer going to have as much opportunity to own their own homes, you’re changing the entire way of what retirement looks like in America. Historically, people have had a home to live in or a home to sell in order to then have money for retirement. We don’t have the social safety nets in place that other countries do.

If you’re going to get rid of the social safety net provided by housing, you’re going to have to really rethink your economy more broadly. That’s my point. Does that make sense?

Luigi: Yeah. Starting with younger people. This is not for the old generation. It’s for the younger people.

Bethany: As they get older. Yeah.

Luigi: But I think that part of the problem, the way I understand it, is that as the economy is changing, there are many more gig workers. If you are a gig worker, I’m not so sure that you can easily get a mortgage because it is not well-established income demonstration. These people are not getting a house anyway. Either you expand the access to credit in some way, or you’re back to your problem.

Bethany: Maybe it doesn’t. Maybe we’re screwed regardless of whether we reform housing or not. Maybe that would argue for just blowing the whole damn thing up and starting from scratch with a system that makes sense. But we’re never going to do that.

Luigi: But the other possibility is the younger generation doesn’t have as many children. You might not want to be tied down to a mortgage. It’s much easier to take five months off and travel the world if you don’t have a mortgage. Now, if you have a child, you don’t do that anyway, so the marginal cost of having a mortgage is zero. But if you don’t have a child, I think that that’s a serious issue.

Bethany: It’s an issue, but again, you’re really restructuring American society. It’s why housing is so important. You’re restructuring American society in a way that goes beyond whether or not people own homes, that gets into how people provision for themselves in retirement, when we’ve long been a country where homeownership has been an important component of retirement and a really important component of building wealth.

If you’re going to get rid of that, what do you do instead? Are we even more of a draconian society where you are whatever you eat, and no helping hand from the government? Maybe. Maybe that’s the right way to go.

I guess the point that I’m trying to make is that housing is deeply integrated into the entire fabric of our lives and our financial futures and financial security and how retirement and wealth building has always worked. If you’re going to change this system, you need to think broadly about all of these issues, not just about housing specifically.

Luigi: That’s without doubt, but remember that there is a fertility crisis. We discussed that with Niall Ferguson. It’s not obvious that houses will maintain their value in the future. What has been a source of wealth for retirement might be a liability for retirement for the next generation.

I actually see benefits of having that risk borne by the stock market and being diversified rather than being borne by individuals. You bear a lot of idiosyncratic risks because at the end of the day, if you bought a house in Boston, you made a fortune no matter what. If you bought one in Detroit, it was a disaster. It is a very coastal view that houses pay for your retirement. In the other parts of the country, at best you can live in your house, but certainly you cannot retire by selling your house.

Bethany: Well, but at best you can live in it. There was that. I think the pockets of the country where people have actually lost money on their homes are pretty isolated. There are lots of places where people haven’t made fortunes, true. The making of fortunes is a coastal issue or a hot housing-market issue. But there are lots of places where homes have appreciated by smaller degrees.

But you’re right, my view and the argument I’m making is trapped in an old-school way of looking at the economy, which is that the future economy will be as the past economy has been. That’s assuredly not accurate, given that we’re in a time of such incredibly seismic change on so many levels.

Maybe we are better off, then, as a nation of renters with the risk of home prices borne elsewhere. Maybe we are, and maybe that should be an important part of the Fannie and Freddie conversation. How much do we want to continue to encourage homeownership? That question is really key to what you think the future of Fannie and Freddie should be.

But I would point out that with Fannie and Freddie in conservatorship over the last 17 years—my God, I say that, and I just can’t believe that—if you did believe that would result in the government having a smaller share of the mortgage market, you would be wrong. There is now nothing other than the government in the mortgage market. That’s not quite true, but it’s mostly true.

For those Republicans who believed that taking over Fannie and Freddie would somehow lead to some massive rethink of the government’s involvement in the housing market, no. If you want to rethink and make anything different than it’s been in the past, you need to rethink what you want these two companies to look like and be very strategic about what you want them to look like.

Luigi: Maybe you want to force a higher pricing of that guarantee. Maybe you are right that we should go to privatization, but before privatization, we need to have very good regulation written. I don’t trust this government to design this regulation in a way that is good for the country overall. The risk that it is going to be an inside deal is too large, in my view.

Bethany: The risk that it’s an inside deal? I might almost say the certainty that it’s an inside deal. A friend of mine I was chatting with also pointed out, which is really an appalling thought, that Wall Street firms are all, of course, eager for a piece of a Fannie and Freddie IPO because the fees on it will probably be huge. That also incentivizes Wall Street even more to go along with whatever Trump is saying and doing, because with a Fannie and Freddie IPO lurking on the horizon, and the almost certainty that the IPO will be doled out to those firms that Trump likes the most, nobody’s going to take the risk of pissing him off. There’s nothing about it that’s good.

Luigi: Paul Weiss will be the advisor.

Bethany: Paul Weiss will be the advisor. I actually don’t know which Wall Street firm has been the friendliest to Trump, but whichever ones have been would be my guess. That will be a sign of which firms he likes the most, whoever gets the business. Maybe that should be a warning to Wall Street firms that you should be trying to run away from the Fannie and Freddie IPOs, lest you be tarred with the Trump brush. But I think they all want that.

When Joe and I wrote our book called All the Devils Are Here about the financial crisis, the final chapter was this . . . All my final chapters have turned out to be such BS. It’s really embarrassing. But the final chapter of this book was that maybe the silver lining would be that we would really think about housing finance and try to figure out what the right way to structure this really important part of our economy was.

Of course, we haven’t thought about that. Seventeen years later, here we are. I guess the better way of saying that is my silver linings have this funny way of never materializing.

Luigi: It’s better to be cynical. As I told you, by being cynical, you commit a sin, but you’re right.

Bethany: That’s very depressing, Luigi. Very depressing.