Thursday, March 3, 2011

Freddie & Fannie – time to go

I enjoy watching the myriad of house hunting, decorating and renovation shows that are on TV. Seeing what money would buy in LA versus Kansas versus New York is illuminating and a great way to escape the dredge of figuring out how to pay the mortgage. Several entire networks are dedicated to these shows and variations appear across the cable box – and they are all rooted in perpetuating home ownership.

Americans have a tradition of home ownership – from the 1800’s “land run” where previously-restricted land was opened for homesteading often on a first-come basis. By 1900 46.5% of Americans owned their house. During the Great Depression of the late 1920’s and early 1930’s many lost their homes.

Fannie Mae was established in 1938 as part of President Roosevelt's New Deal. Once a bank approves a loan to their customer, the bank then sells the loan to the government and uses the funds to loan to somebody else for their home. Banks no longer had to wait to be paid back before having the capital to lend again allowing more people to get loans. Home ownership increased to 62.9% by 1970 thanks to the additional availability of federal dollars.

Freddie Mac was created in 1970 to expand the secondary market for mortgages. Similar to Fannie, Freddie buys mortgages from banks. Freddie then packages the mortgages together to sell off to other investors. This increases the pool of dollars for banks and investors to lend. By 2000 the home ownership increased to 66.2% and by 2010 was essentially stagnant at 66.9%.

I am a homeowner and it's likely that my house is owned by the government since Freddie and Fannie guarantee more than half of all mortgages in the U.S. Combined they have $9.5 trillion in assets, carry $3.4 trillion in mortgage backed securities and have debt of $1.6 trillion. (The entire U.S. budget is approx. $3.7 trillion.) For years Freddie and Fannie were pseudo-government agencies run like private corporations with shareholders but were collateralized by tax dollars. On September 7, 2008 they were put under the conservatorship of the Federal Housing Finance Agency (FHFA). It was (so far) the single largest government takeover of a private (or semi-private) institution in history. $134 billion (so far) to bail out the companies.

President Obama has proposed three options for shrinking the U.S. involvement in housing. Each of the Obama recommendations have merit and begin to reduce the dependence on taxpayers…but the options are incremental. The Obama administration must be lauded for actually taking on this issue: it’s a complex and dry policy that replaces counting sheep as a solution for insomnia. It is a good entry point to determine what the appropriate role of Government is.


Government has been involved in shaping and guiding housing policy forever – at least since feudal times. Rather than incrementally tweaking what would it look like to see the Government get out of the mortgage business altogether? Imagine: 
Banks would look at a property, evaluate the value of the land and the qualifications of the potential buyer to determine whether it was worth the risk to give them money and then earn some interest as the money is paid back over time. If the bank made a bad decision their recourse would be (as it is today) securing the property back from their customer and reselling it to somebody else…sometimes taking a loss, sometimes not. The bank would actually be accountable and suffer a consequence for its decision without having the Government backstop the loan.

Arguments for government financing housing are powerful: the private sector market on its own provides very few opportunities where risk is present (bad neighborhoods, nontraditional buyers, etc.). Lending costs would be higher because there would be fewer loans. Access to housing for minorities might be difficult as it was prior to the 1970’s.

These issues are legitimate, real and there is historical precedent to be aware of. Note I am not suggesting a change to housing laws and protections: just government financing of housing. A purely market-based solution allows for the concerns to be addressed. Not-for-profit corporations can act as banks, can provide supplemental funding for distressed neighborhoods or less than perfect applicants. And maybe we have 40% of people owning homes – but it’s 40% who can legitimately afford to. And maybe I won't be one of them.  It won’t be perfect, but the Government guaranteed and taxpayer funded solutions isn’t perfect now.

The issue isn’t whether Government has an interest in housing…it’s whether Government should be financing housing. Freddie and Fannie have proven that despite the best intentions, they are ineffective. Banks have proven their own incompetence as well during this financial disaster – so by no means are banks the salvation, but they operate within rules and regulations. If the authorities don’t hold people and companies accountable when they break those rules that’s an issue of enforcement. The problem is that during the financial disaster of 2007-09 banks had no consequence for their decisions and actions. Government bailouts or government forced mergers prevented banks from having to be liquidated.

The justification was that the entire financial system had to be saved or the average person would be hurt. The result was that the essential part of capitalism, the part that I believe makes capitalism work, was taken out of the equation:  there was no penalty, no consequence. So the message is: screw up and be rewarded, not punished. Of course the consequence is present, the U.S. taxpayer (thanks to our Chinese friends) will clean it all up over the next 50 years.  Glad the average folks didn't get hurt!  Until institutions are held responsible for their actions, it won’t much matter whether Fannie and Freddie continue to require billions in bailout dollars or is tweaked ... nobody but the taxpayer will be left holding the bag. Eliminating taxpayer funding of housing is a good place to start...right "House Hunters."

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