Monday, September 8, 2008

Government Takeover of Freddie Mac and Fannie Mae

The housing market is not my specialty, but this was too big a story not to mention. Treasury Secretary Paulson has announced that the Feds will be taking over the two large mortgage companies Fannie Mae and Freddie Mac. This was done to provide financial stability to the housing finance market. Yet, while this may be a temporary fix, it does not get at the heart of the problem: these two Government Sponsored Enterprises have always been nationalized in a sense. The two GSEs were able to make a private profit, but the losses were always implicitly promised to be at the expense of the taxpayer. Now, that responsibility to the taxpayer has been made explicit and official.

Through unfair protection, the government allowed for Fannie Mae and Freddie Mac to consume an enormous part of the housing mortgage market. This placed the market’s well being on two companies that had an implicit government bailout to lean on. Did no one else think this was a recipe for disaster?

The goal of the next President should be to truly privatize Fannie Mae and Freddie Mac, which means both profits and losses should be privatized. The cord between government and these two GSEs needs to be cut once and for all. Then, with true competition and a level playing field, the housing finance market may finally be able to function without the risk of repeating the current financial crisis.


Pete Abbate said...

Haha, Tim, you beat me to this post. Here is a question for you, though. Didn't the government just organize a bailout in March for Bear Stearns, a 70+ year old investment bank on Wall Street? Bear Stearns' balance sheet lost liquidity and the company would've needed to declare bankruptcy. In this case, it was a totally private corporation, but the government still deemed it too necessary to the financial markets to be allowed to fail. Granted, Bear was purchased by private company JP Morgan, but it was purchased largely with the US government's money, as well as a guarantee that the government would take care of many of the company's less-desirable assets. It seems to me the problem goes beyond just Fannie and Freddie.

Earlier this summer, I read some pieces suggesting that Fannie and Freddie were outdated. Any opinions on the necessity of these two corporations on a 21st century housing market? Also, what are everyone else's opinions on the recent run of government bailouts (will they encourage risk-taking by creating an implicit guarantee, or will they lead to better regulation of markets because regulating is cheaper than continuing bailouts?)?

Pete Abbate said...
This comment has been removed by the author.
Pete Abbate said...

Here is an interesting look at Fannie and Freddie, all the way back in 2003, courtesy of the Wall Street Journal. Former White House Chief Economist Greg Mankiw offers some interesting insight five years ago, and chimes in with some more wisdom on his blog.

Tim Moreland said...

I definitely agree with your point about Bear Sterns. Although, the difference between Bear Sterns and Freddie/Fannie was that F&F were doing business knowing that the government would assume the cost of any failed risks, while Bear Sterns did not necessarily know that the government would come to their aid. However, now that the government has shown that they will come to the aid of pretty much anyone, the whole housing finance market is becoming illegitimate. So yes, the problem definitely goes beyond just Fannie and Freddie.

As for F&F's role in the 21st century housing market, the GSEs are not doing what they were intended to do. Research shows that Fannie and Freddie have caused Americans' to buy too many homes. This means that Americans are forgoing other goods and services to invest in artificially cheap homes. As well, F&F have achieved this without particularly helping low- and middle-income first-home buyers, which was their targeted group when first formed. Instead, homebuyers are purchasing larger houses than they would have otherwise purchased or second homes. In this respect, Fannie and Freddie are a liability to taxpayers without even fulfilling their goal of increasing home ownership for less well-off citizens.

Tim Moreland said...

As a sidenote, the Fed's decision to "bailout" Bear Sterns was probably the correct move at that point. Obviously, the government needs to restrain itself with who it bails out. As well, the Fed needs to watch not to create bubbles with low interest rates, like in the years leading up to the current crisis, so that bailouts won't be necessary.

Bottom line: The "bailout" of Bear Sterns provided needed stability at the time, but it should not be viewed as part of a long-run solution that should be focused on preventing a crisis such as this from occurring in the first place.