Financial reform without Fannie/Freddie isn’t reform at all.

Here’s Duncan Currie:

Here’s one thing you won’t find in the 2,300-page financial-overhaul legislation that passed the Senate Thursday afternoon: any serious reform of housing giants Fannie Mae and Freddie Mac, the longtime “government-sponsored enterprises” (GSEs), both of which have been in federal conservatorship since September 2008. Last summer, the Congressional Budget Office (CBO) estimated that the cost of subsidizing the GSEs would amount to $389 billion through 2019. This figure accounted for “substantial losses on the entire outstanding stock of mortgages held or guaranteed by Fannie Mae and Freddie Mac at that time.” In January, the CBO updated its forecast, projecting a total price tag of at least $373 billion through 2020. By comparison, it now expects the much-maligned Troubled Asset Relief Program to cost just $109 billion.

Those numbers help put the GSE bailout in perspective, yet they tell only part of the story. Fannie and Freddie currently own or guarantee roughly $5.5 trillion worth of mortgages — over half the residential market. If these liabilities were included in the federal budget, Americans would better appreciate the true fiscal impact of rescuing the GSEs.

But Fannie and Freddie are not counted in the budget, a maneuver “worthy of Enron’s playbook, except not quite so hidden,” as Bloomberg columnist Jonathan Weil has written. Their exclusion “makes a joke” out of the U.S. balance sheet, says former SEC commissioner Paul Atkins. The argument for bringing them on budget became even more compelling in December, when the Obama administration removed a cap on their Treasury Department credit line, essentially giving the GSEs a blank check. A few months later, after House Financial Services Committee chair Barney Frank (D., Mass.) suggested that GSE debt obligations were not backstopped by the federal government, Treasury spokeswoman Meg Reilly affirmed that “there should be no uncertainty about Treasury’s commitment to support Fannie Mae and Freddie Mac as they continue to play a vital role in the housing market.”

… In December 2008, mortgage-finance consultant Edward Pinto, who served as Fannie’s chief credit officer from 1987 to 1989, told Congress that “Fannie and Freddie went from being the watchdogs of credit standards and thoughtful innovators to the leaders in default-prone loans and poorly designed products. They introduced mortgages which encouraged and extended the housing bubble, trapped millions of people in loans that they knew were unsustainable, and destroyed the equity savings of tens of millions of Americans.”

In a new paper, George Mason University economist Russell Roberts points out that the GSEs bought roughly twice as many home-purchase loans made to below-median-income buyers in 2003 as they had in 1997. It was during this period — from the late 1990s through 2003 — that “Fannie and Freddie played an important role in pushing up the demand for housing at the low end of the market. That in turn made subprime loans increasingly attractive to other financial institutions as the prices of houses rose steadily.” From 2004 to 2006, Roberts adds, commercial and investment banks played a larger direct role in the subprime market than the GSEs did, though Fannie and Freddie were still very active in the mortgage markets in ways that contributed to the subprime problem. In 2006, they bought 390,000 loans with less than 5 percent down, compared with just under 269,000 two years earlier. In 2007, they purchased more than 608,000 such loans.