Click amount to donate direct to CounterPunch
  • $25
  • $50
  • $100
  • $500
  • $other
  • use PayPal
DOUBLE YOUR DONATION!
We don’t run corporate ads. We don’t shake our readers down for money every month or every quarter like some other sites out there. We provide our site for free to all, but the bandwidth we pay to do so doesn’t come cheap. A generous donor is matching all donations of $100 or more! So please donate now to double your punch!
FacebookTwitterGoogle+RedditEmail

Fannie and Freddie: Live Public or Die

The administration took its first step towards resolving the final status of Fannie Mae and Freddie Mac with a big conference at the White House last week. In keeping with its housing policy to date, it seems intent on taking the worst possible course.

These mortgage giants have played an important role in making housing more affordable in the United States. Fannie Mae created the secondary market in mortgages when it was established as a government-owned company during the New Deal. Its willingness to buy mortgages from banks essentially created the basis for the 30-year fixed rate mortgage that is the standard today.

The virtue of the original Fannie Mae was that it was simple and cheap. It bought and held 30-year mortgages. It did not securitize them. This avoided the costs and risks associated with securitization. At every step in the securitization process the financial industry expects to make money, and often lots of it, since salaries are so bloated. In addition to saving these costs, a public Fannie also had no incentive to engage in risky gambles to inflate profits. Its top management was paid civil servant wages, not the tens of millions that go each year to top Wall Street executives.

Holding the mortgage on its books meant that Fannie Mae, and therefore the government, was bearing the interest rate risk associated with the mortgage, in addition to the risk that the mortgage would go bad. Interest rate risk is the risk that interest rates will rise. If the standard interest rate for a 30-year mortgage rises from 5.0 percent to 6.0 percent, then a newly issued 30-year mortgage will lose more than 12 percent of its value. Sharper rises in interest rates, as we saw in the inflation wracked ’70s, led to large losses on mortgages for Fannie and Freddie, as well as banks and savings and loans that held 30-year mortgages.

While this risk is raised as a danger if these government-owned mortgage giants are allowed to hold their mortgages, it really does not pose a problem for the government. The government is a massive issuer of long-term debt. In the event that a government-owned Fannie and Freddie are taking a big hit due to a rise in inflation rates, then the government simultaneously getting a bonanza from the reduction in the real value of the debt it owes.

In other words, insofar as a sudden burst of inflation erodes the value of the mortgages held by Fannie and Freddie, it will likely be offset by the reduction in the value of the debt the government owes the public. In short, we are hedged against this risk.

If we are interested in a cheap and efficient way to sustain the secondary mortgage market, it would be hard to beat the old government-owned Fannie model. It may make sense to keep Freddie as a source of competition and to ensure some dynamism, but if efficiency is the goal, then keeping Fannie and Freddie as government-owned companies would be the way to go.

But, this approach seems to be off the agenda since it makes too much sense. Instead, the consensus seems to be to design some hybrid model in which private profit-making banks will decide which mortgages will get a government guarantee.

We are assured by the housing finance wizards that the government regulators will effectively police the private banks. The basic issue is the problem of moral hazard: Private banks have incentive to issue the guarantee to the worst junk around, since they can will make money on the process and the risk goes to the government. It is difficult to believe that anyone who has lived through the crisis of the last three years would want to re-establish this sort of situation.

The alternative to the hybrid or the government-owned Fannie/Freddie route is simply to let them die over a period of 5-10 years and leave mortgages to the private sector. We know that the private sector can and does issue mortgages without government support.

This is demonstrated by the existence of the jumbo mortgage market. Jumbo mortgages exceed the size limits set for a loan to be purchased by Fannie and Freddie. Even in the current environment the spread is only 90 basis points (9/10ths of a percentage point) compared with the Fannie/Freddie backed conformable mortgages, and it is typically much less.

If ideological and political considerations prevent us from establishing the most efficient mortgage system, relying on a purely private model is almost certainly better than trying to construct a convoluted hybrid. The potential benefits from this mixed system are fairly modest – a slight reduction in mortgage interest rates. While the risks from not doing right are large.

If we want to have the government subsidize the mortgages of moderate- and middle-income homeowners, it can be easily done through the tax code or other mechanisms. There is no reason to set up a whole new system of finance to accomplish this purpose.

Unfortunately, the smart money is on the convoluted route because the big money stands to gain this way. The waste in such a system is income for folks like Citigroup and Bank of America. And we all know that the most dangerous place to stand in modern America is between the financial industry and a policy that will enhance its profits. So, looks for more bad housing policy coming out of Washington.

DEAN BAKER is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of Plunder and Blunder: The Rise and Fall of the Bubble Economy and False Profits: Recoverying From the Bubble Economy.

This column was originally published by The Guardian.

More articles by:

Dean Baker is the senior economist at the Center for Economic and Policy Research in Washington, DC. 

Weekend Edition
October 19, 2018
Friday - Sunday
Jason Hirthler
The Pieties of the Liberal Class
Jeffrey St. Clair
A Day in My Life at CounterPunch
Paul Street
“Male Energy,” Authoritarian Whiteness and Creeping Fascism in the Age of Trump
Nick Pemberton
Reflections on Chomsky’s Voting Strategy: Why The Democratic Party Can’t Be Saved
John Davis
The Last History of the United States
Yigal Bronner
The Road to Khan al-Akhmar
Robert Hunziker
The Negan Syndrome
Andrew Levine
Democrats Ahead: Progressives Beware
Rannie Amiri
There is No “Proxy War” in Yemen
David Rosen
America’s Lost Souls: the 21st Century Lumpen-Proletariat?
Joseph Natoli
The Age of Misrepresentations
Ron Jacobs
History Is Not Kind
John Laforge
White House Radiation: Weakened Regulations Would Save Industry Billions
Ramzy Baroud
The UN ‘Sheriff’: Nikki Haley Elevated Israel, Damaged US Standing
Robert Fantina
Trump, Human Rights and the Middle East
Anthony Pahnke – Jim Goodman
NAFTA 2.0 Will Help Corporations More Than Farmers
Jill Richardson
Identity Crisis: Elizabeth Warren’s Claims Cherokee Heritage
Sam Husseini
The Most Strategic Midterm Race: Elder Challenges Hoyer
Maria Foscarinis – John Tharp
The Criminalization of Homelessness
Robert Fisk
The Story of the Armenian Legion: a Dark Tale of Anger and Revenge
Jacques R. Pauwels
Dinner With Marx in the House of the Swan
Dave Lindorff
US ‘Outrage’ over Slaying of US Residents Depends on the Nation Responsible
Ricardo Vaz
How Many Yemenis is a DC Pundit Worth?
Elliot Sperber
Build More Gardens, Phase out Cars
Chris Gilbert
In the Wake of Nepal’s Incomplete Revolution: Dispatch by a Far-Flung Bolivarian 
Muhammad Othman
Let Us Bray
Gerry Brown
Are Chinese Municipal $6 Trillion (40 Trillion Yuan) Hidden Debts Posing Titanic Risks?
Rev. William Alberts
Judge Kavanaugh’s Defenders Doth Protest Too Much
Ralph Nader
Unmasking Phony Values Campaigns by the Corporatists
Victor Grossman
A Big Rally and a Bavarian Vote
James Bovard
Groped at the Airport: Congress Must End TSA’s Sexual Assaults on Women
Jeff Roby
Florida After Hurricane Michael: the Sad State of the Unheeded Planner
Wim Laven
Intentional or Incompetence—Voter Suppression Where We Live
Bradley Kaye
The Policy of Policing
Wim Laven
The Catholic Church Fails Sexual Abuse Victims
Kevin Cashman
One Year After Hurricane Maria: Employment in Puerto Rico is Down by 26,000
Dr. Hakim Young
Nonviolent Afghans Bring a Breath of Fresh Air
Karl Grossman
Irving Like vs. Big Nuke
Dan Corjescu
The New Politics of Climate Change
John Carter
The Plight of the Pyrenees: the Abandoned Guard Dogs of the West
Ted Rall
Brett Kavanaugh and the Politics of Emotion-Shaming
Graham Peebles
Sharing is Key to a New Economic and Democratic Order
Ed Rampell
The Advocates
Louis Proyect
The Education Business
David Yearsley
Shock-and-Awe Inside Oracle Arena
FacebookTwitterGoogle+RedditEmail