There is Still a Very Big Need for Fannie and Freddie

Dean Baker argues that Fannie and Freddie should be run as public corporations. There are (at least) two ways to support this, one is as a means of promoting home ownership, and the other is to stabilize housing markets. Not everyone agrees with the first justification since it distorts markets (assuming the promotion of home ownership is not correcting a market failure in which case it would be hard to argue against). However, the second justification – stabilization – is, I think, harder to dismiss since volatility in these markets produces large welfare losses:

Freddie’s dead, by Dean Baker, Comment is Free: Fannie Mae and Freddie Mac finally kicked the bucket this weekend, with the Treasury department stepping in to take over the companies. The top management is being sent packing (albeit with multi-million dollar severance packages), and the shareholders will stop seeing dividends, probably forever. …

The big question is what these institutions will look like going forward. There is a strong argument for keeping these institutions publicly run. In effect, both Fannie and Freddie can be operated as public corporations, which was the case with Fannie Mae prior to its privatisation in 1968.

The current disaster should not lead people to forget the benefits that these companies conveyed to homeowners. By creating the secondary mortgage market, they created first a national and then an international market for home mortgages. This had the effect of equalising interest rates across the country and making homeownership affordable to millions of families.

Perhaps the private sector would have created a secondary mortgage market on its own, but it didn’t. Furthermore, private issue mortgage backed securities have performed far more poorly in the current crisis than the securities issued by Fannie and Freddie. This is why private issue mortgage backed securities have virtually disappeared over the last year, and Fannie and Freddie are now financing almost 80% of the new mortgages being issued. Those who tout the virtues of the private sector in the secondary mortgage market are arguing based on faith, not evidence.

There is still a very big need for Fannie and Freddie to ensure a well-operating secondary mortgage market. … Fannie and Freddie can best serve their role of providing the stable anchor of the secondary mortgage market…

Private banks would still be free to be creative and innovative in developing complex new mortgage derivatives, if they can find anyone to buy them. The difference is that the taxpayer would not be standing behind the private sector banks, prepared to absorb any losses even as the stockholders and top executives got rich off the gains.

The federal takeover of Fannie and Freddie will force a debate over their ultimate status. It is clear that many Republicans want to see them broken up and privatised, which has long been their explicit agenda.

The current crisis has shown the failing of Fannie and Freddie in their role as public/private hybrids. We should see that as reason for ending the private side of the equation. The only obvious value added by the private side is the tens of millions of dollars of compensation received by the CEOs. The CEOs can go to Wall Street if they want those salaries.

Originally published at Economist’s View and reproduced here with the author’s permission.

2 Responses to "There is Still a Very Big Need for Fannie and Freddie"

  1. RealThink   September 9, 2008 at 10:32 am

    There is a much more important side of this issue, which can be appreciated only when viewed from the perspective of the physical limits to growth (or “from the top of Hubbert’s Peak”). If you are aware of Peak Oil and Peak Everything, and that Easter Island’s society could have avoided catastrophic collapse if they had stopped building moais in time, it is clear that the housing correction is not the biggest risk, but the biggest HOPE for the US. Because when house prices fall below construction cost, residential construction grinds to a halt. Which, from a Hubbert’s Peak-aware perspective, is exactly what the doctor orders. Because construction of more suburban and exurban McMansions is just digging further in the already deep hole most of the US population is in, as inevitably higher fuel prices will turn those homes into traps for their occupants.So, while the “Preferred Stock Purchase Agreements” part of the plan is completely justified and was necessary for the very reason stated by Paulson: ensure the GSEs can fulfill their EXISTING debt “held by central banks and investors throughout the United States and the world”, it is the “GSE MBS purchase by the Treasury” part of the plan which is most unwise in the light of the physical limits to growth. Sure enough, that part, as Paulson says, would be necessary “”to further support the availability of mortgage financing for millions of Americans, (…because…) During this ongoing housing correction, the GSE portfolios have been constrained, both by their own capital situation and by regulatory efforts to address systemic risk. As the GSEs have grappled with their difficulties, we’ve seen mortgage rate spreads to Treasuries widen, making mortgages less affordable for homebuyers.” What Paulson (and practically the whole political/economic/financial establishment) cannot see is that a decrease in the availability of mortgage financing is a GOOD thing for Americans, just as a decrease in the availability of drug financing is a good thing for a junkie.Again, lack of mortgage credit -> house prices fall further -> eventually they fall below construction cost -> residential construction grinds to a halt, which, from the way and places houses are being built today, is a GOOD outcome.And if the US Treasury does not know what to do with the pile of cash it is sitting on (?), here are a few areas where it could be used instead:- Wind farm construction- Upgrading the electric grid to handle the above item- Electrifying the US freight railroads and replacing the double and triple tracks taken up in recent decades- Building electrified urban rail

  2. Anonymous   September 9, 2008 at 1:23 pm

    Of course there’s a big need for them. These institutions are never going to broken up and privatized however much our friends at the WSJ dream about it. The reason, which those who wish to break them up never actually address, is that they provide liquidity in the domestic mortgage market when private capital flees as boom turns to bust. This happens about every ten years and is in fact the current situation. Running them as public corporations seems the best solution, Fannie should have stayed that way where it worked fine for thirty years. It was turned into a GSE as part of a bit of budgetary legerdemain by Johnson and it was a mistake.