After years of warning and months of high drama, the Treasury
Department recently took the unfortunate but necessary step of
seizing Fannie Mae and Freddie Mac (Fannie and Freddie). Treasury
placed the two institutions into conservatorship and provided the
means and terms by which Treasury would recapitalize them as
necessary. The cost to the taxpayer is unknown at this time and
represents payment for serious mistakes made years ago and repeated
The Treasury's actions were unfortunate because the problems
with Fannie and Freddie could have been avoided had previous
Congresses heeded the many warnings about their systemic risk. The
actions were necessary, however, because the collapse of either or
both of Fannie and Freddie would have had devastating repercussions
for the housing market, credit markets, and the economy generally.
By acting as it did, Treasury chose the lesser of two evils.
The takeover of Fannie and Freddie was a vital move toward
reform, but this should be seen only as the first step. Fannie and
Freddie are the result of outdated "Great Society" programs, and
they should be wound down-not replaced, reformed, or rejuvenated.
The private sector can and should be allowed to perform the roles
formerly exercised by Fannie and Freddie. At the very least, as
Congress crafts future legislation it must ensure that neither
Fannie and Freddie nor any successor institution ever again becomes
a systemic risk by becoming "too big to fail."
The First Step
Placing Fannie and Freddie into a conservatorship is not an end
unto itself but a first step toward the final breakup.
Unfortunately, the vital step of settling the long-term policy will
have to be left to the next President and Congress.
Looking to the future, the worst action Congress could take
would be to retain the current structure whereby Fannie and Freddie
are quasi-governmental entities with conflicted goals and distorted
incentives. This system has failed at an as yet untold cost to U.S.
The Treasury's current plan is to shrink Fannie and Freddie's
portfolios of mortgage-backed securities gradually over the coming
years. Just as important is denying Fannie and Freddie the
authority to continue securitizing mortgages in the future. Many
years ago the private sector could not have picked up this
business, which is why Fannie Mae was created in the first place.
However, the private sector today is already a major participant,
rising to a market share that reached 56 percent in 2006. Fannie
and Freddie should be forced to step aside and allow private-sector
participants to perform this role. If preserved in any form, Fannie
and Freddie should be so constrained in their activities that they
can never again be suspected of being too big to fail.
First, clean up the mess. Then, implement real reform. The
Treasury Department was put in a tough spot, and Secretary Henry
Paulson did what was necessary. Decades of policy mistakes creating
and protecting Fannie and Freddie finally led the predicted system
risk to become a dangerous financial reality. However, once the
market is stabilized, free-market reform must be implemented to
prevent a recurrence. The next President and Congress should allow
Fannie and Freddie in their current form to wither to extinction.
The private sector is ready, well-prepared, and subject to the
proper incentives to continue to ensure a steady flow of correctly
priced capital to America's housing markets.
J. D. Foster, Ph.D.,
is Norman B. Ture Senior Fellow in the Economics of Fiscal Policy,
David C. John is Senior
Research Fellow in Retirement Security and Financial Institutions,
and Stephen A. Keen is a
Research Assistant in the Thomas A. Roe Institute for Economic
Policy Studies at The Heritage Foundation.