With the Treasury and Federal Reserve in effect promising to
keep Fannie Mae and Freddie Mac afloat, the mortgage giants' crisis
seems to be over. But the fundamental cause is still there - and
without fundamental reform, we may very well endure a repeat
performance in a few years.
Consider how Fannie and Freddie work: They play a dominant role
in today's housing market by buying mortgages from lenders,
packaging them into bond issues and then reselling them to
investors around the world. They also guarantee mortgages and hold
about $5 trillion worth of them in their portfolios. To operate,
they need to borrow billions on a continuous basis.
That's fine in a bull market - but not in a bear one. Recent
concerns about Fannie's and Freddie's capital levels caused a
sharp, continued drop in their stocks.
That, in turn, spooked lenders - and forced the government to
But experts have warned for decades that neither entity has
enough capital, investor funds and retained earning to protect
Where most banks have $1 of capital for every $12 in assets,
Fannie Mae and Freddie Mac only have $1 for every $20. Congress
looked at higher standards in the '90s, but a sustained,
high-powered lobbying campaign took every tooth out of the
Recall, too, that while private stockholders own both Fannie and
Freddie, they're really government creations that differ greatly
from true private-sector companies. That's why
they're allowed to dominate mortgage securitization - and also why
Fannie and Freddie need close oversight to ensure that they remain
solvent and compete fairly.
Sunday's announcement - that the government, via the Fed and
Treasury, will lend both entities money and, if needed, buy stock
in both - sent the necessary signal that neither will be allowed to
fail. That's what the lenders needed to hear, and they promptly
lent Freddie Mac $3 billion on Monday. Fannie plans to borrow that
much later this week.
This is vital to homebuyers: If Fannie and Freddie failed,
mortgage funds would dry up, at least temporarily, halting home
sales in their tracks. Plus, foreign governments own hundreds of
billions of dollars in Freddie/Fannie bonds; the shock would've
hurt the dollar.
But the job isn't done. Fannie and Freddie are leftovers from an
era when giant government entities seemed essential to achieving
social goals. The fact that both were later privatized doesn't
change their essential nature as dominators of a market, rather
than mere participants in it.
And this crisis is proof positive Fannie and Freddie can't
continue in their current form, no matter how well they have worked
in the past.
Congress should look at breaking up both. A larger number of
smaller entities could compete with each other without artificially
dominating the market. In other words, let's bring real capitalism
to the housing-securitization markets.
The new companies would be owned by private stockholders and
overseen by a regulator with enough teeth to ensure that they're
safely run. They could be bought, merged or even go out of business
without the potential disruption that this crisis caused. Most
important, they wouldn't have the potential to bring housing
lending to a screeching halt, or potentially required
multibillion-dollar taxpayer bailouts.
Poor management and inadequate capital at Fannie Mae and Freddie
Mac have caused enough turmoil. We need more than just stop-gap
measures now to prevent the next crisis - and keep
housing markets from suffering yet another blow.
David C. John is
a senior research fellow in economic-policy studies at The Heritage