Fannie & Freddie Were A Disaster That Was Forty Years In The Making

Great blog post from the FT’s John Gapper on a possible future of the mortgage GSEs:

From FT:

Fannie was originally established in 1938 to buy and hold mortgages insured by the federal government through the Federal Housing Administration. The idea was to provide government backing so that low income families could afford to buy homes.

That was clear enough: Fannie was a public entity with an explicitly social purpose. The problem came in 1968 when it was re-chartered into a government-sponsored private corporation that could buy all kinds of mortgages and securitise them to provide general liquidity in the housing market.

James Surowiecki has recorded the curious fact that the fateful change in 1968 was due to Lyndon Johnson wanting to get housing debt off the government books. In other words, Fannie and later Freddie became off-balance sheet vehicles for the government.

But we know what happened. Fannie and Freddie skillfully worked the ambiguity about whether they were really government-backed entities or private ones. They steadily expanded their balance sheets and profits on a slim capital base because investors assumed the government stood behind them.

Their half-public, half-private status has to be ended if a repeat of the debacle is to be avoided.

For my money, it would be damaging to have Fannie or Freddie survive as private entities in the long-term because, since the government has come to their rescue once, everyone will believe it would happen again.

I think the best idea would be to reverse the misguided 1968 charter entirely. If either is to survive in the long term, it should be as a public agency with explicit and limited social aims.

The evidence is that the private mortgage market as a whole can survive quite well without a federal agency in the middle: most other countries do quite well without one. If it cannot, then taxpayers’ money should not be used to prop it up.

I couldn’t agree more the mortgage GSEs were a disaster that was forty-years in the making, now that they’ve been bailed out the potential for a future calamity is significantly increased as government backing is now explicit as opposed to the implicit guarantee that existed before. Furthermore if they’re to exist on a go-forward basis they should be public agencies with a rather limited scope. Their mission should be to enable home ownership for those on the lower end of the economic scale, as opposed to the present when their scope includes homes that less than 5% of the population can afford. The goal shouldn’t be to subsidize the entire housing market, but to enable home ownership for those that need it the most.

Sources:

The Financial Times: “The diminished future of Fannie and Freddie” — John Gapper, September 8, 2008.

Disclosure: at the time of publishing the author didn’t own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn’t be viewed as financial or investment advice.

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