Five years ago, financial markets were rocked by news that Fannie Mae and Freddie Mac – two privately-owned but government-sponsored firms considered mainstays of the U.S. housing finance system – had been placed into conservatorship by federal officials. Their collapse was quickly followed by the near-collapse of other financial giants invested in housing related securities. Warning that the developing financial collapse could lead to a second Great Depression, then-Treasury Secretary Hank Paulson called for a massive program of government bailouts throughout the financial sector.
Eventually, Fannie and Freddie received nearly $200 billion from taxpayers, one of the largest taxpayer bailouts in American history. Perhaps more importantly, the activities of Fannie and Freddie helped trigger the broader financial crisis. Their purchase of questionable mortgage securities, while not the sole cause of the housing bubble whose collapse triggered the financial meltdown, abetted its growth.
Today, the housing market is finally recovering, with house prices rising, new construction resuming and foreclosures dropping. Fannie and Freddie are well on the way toward paying back their bailout funds (although taxpayers are still on the hook for nearly $4 trillion in liabilities), so there is a temptation to continue business as usual. But that would be like a homeowner declining to fix his roof after a damaging storm because it is no longer raining.
Fannie Mae, created in 1938, and Freddie Mac, which dates to 1970, were intended to ensure a steady flow of affordable financing for potential homeowners through a variety of activities, including the purchase of mortgages from loan originators, and issuing securitized loans to investors. Until the late 1980s, the two were secondary players in the housing finance world, as savings and loan institutions dominated the market. After the S and L crisis, however, the GSEs grew in importance.
Although privately owned, Fannie and Freddie are chartered by the federal government, and enjoyed an implicit federal guarantee of their obligations. In return, they were expected to promote federal housing goals, such as support for lower-income, affordable housing. In the early 2000s, however, they became deeply involved in the market for “sub-prime” mortgages, leveraging their federal guarantee against the risks inherent in that market.
Since their 2008 collapse, Fannie Mae and Freddie Mac have been in limbo legally and politically. Calls for their elimination have come from both sides of the political aisle. Even President Obama has called for them to be put down. But elimination of these two enterprises doesn't necessarily mean an end to disruptive federal intervention in housing markets. The leading proposal in the U.S. Senate, for instance, would simply replace Fannie and Freddie with a new Federal Mortgage Insurance Corporation, which would enjoy an explicit federal guarantee of 90 percent of its obligations.
But this would merely continue the disastrous policies of the past, albeit under a new management. A far better alternative would be to remove the federal thumb from the housing marketplace scale altogether. Despite arguments that markets require government guarantees and subsidies to ensure that housing is affordable and available, there is little evidence that they have done much good.
A 2012 econometric study published by our colleagues John Ligon and William Beach at The Heritage Foundation, suggest that Fannie Mae and Freddie Mac provide few benefits for homeowners or the economy. Looking specifically at 1980 to 2010, they found that if Fannie Mae and Freddie Mac did not exist (and were not replaced), homeownership rates would have been only 0.1 percent lower. Housing starts, meanwhile, would have been a paper-thin 0.026 percent lower, and the median sales price of a home would have been 0.038 percent less (a good thing for prospective buyers, but bad for sellers).
This isn't to say that nothing would change in an open housing finance market. It is widely expected, for instance, that the traditional 30-year fixed loan, with the option to refinance at will, would become less prevalent. But this isn't necessarily bad news for consumers, who pay an interest rate premium for the security and flexibility of these loans. Thirty-year loans, in fact, are rare outside the U.S., which ranks only 8th in homeownership rates compared to 16 European countries.
Today's conventional wisdom discounts the possibility of an end to Fannie and Freddie-style intervention in the housing market. Housing is just too important, say skeptics, too be left to the market. But as homeowners and taxpayers can attest, the risk of government meddling may be larger. It's time to give markets a try.
- James Gattuso is a Senior Research Fellow in Regulatory Policy and Norbert J. Michel is a Research Fellow in Financial Regulations at The Heritage Foundation.
Originally appeared in the Orange County Register