Fed Takeover of Freddie and Fannie May Provide Temporary Stability, But Is it Just a Band-Aid?

By now, most have heard the news that the Federal Government stepped in on Sunday to exercise the authority granted to it by Congress in July to bail out government sponsored enterprises (GSEs) Freddie Mac and Fannie Mae. The major features of the move include the ouster of the two companies’ chief executive officers, the acquisition by the Treasury of $1 billion of the companies’ preferred stock and a pledge of up to $200 billion more, and the placing of the companies in conservatorship (a type of federally-managed bankruptcy) with management control placed into the hands of the Federal Housing Finance Agency.

This report in the Silicon Valley Business Journal discusses the potential impact of the takeover on interest rates and taxpayer dollars. Government officials, such as those quoted in this fascinating MSN article, have hailed the move as providing necessary stability to a volatile market and keeping mortgages affordable. Others are questioning whether this will be enough to balance out the markets, especially given the cost (see Seattle Times article here).

Though few can argue that the stability of the mortgage markets is a worthy goal, I find the takeover troubling for a variety of reasons. Fannie Mae was created as a government agency in the late 1930s expressly to provide liquidity to the mortgage market. It was later converted into a private corporation in 1970, at the same time that Freddie Mac was created to provide competition to Fannie’s monopoly, to establish a secondary market to purchase mortgages and repackage them as securities. Since then, these organizations have existed as quasi-governmental entities in the murky ether between public and private. This uncertainty about what exactly these organizations are and who they represent has often led to an increase rather than a decrease in volatility in the mortgage markets.

This has been especially true in recent months as speculation about Freddie and Fannie’s fate swirled around Wall Street. If these are governmental agencies, then they should be supported by the full faith and credit of the United States Government. If they are private corporations, then they should fail. Instead, we have seen them handled with hesitancy, and with a bailout that many say has come too late.

But the status of these organizations is really a secondary question to the one that nobody seems to want to address – is the stated purpose of Freddie and Fannie a goal the U.S. Government, or anyone for that matter, should promote? Namely, do we really want to artificially inject liquidity into the mortgage market? This entire subprime crisis, and the broader credit crisis it has spawned, can be fairly attributed to an excess of liquidity in the mortgage market. This and the process of securitization, by which each player in the chain (borrower to broker to lender to investment bank to investor) could pass on the risk of a mortgage to the next, created a market in which anyone who could fog a mirror could get a loan. Was this a good thing? Nobody cared if a given borrower could really repay a loan because the secondary market’s appetite for these loans was voracious. Did this ultimately result in either a stable or a liquid market?

This takeover is therefore all the more troubling because it seems only to prop up the misguided policy at the heart of this crisis. Returning to the stated goals of government officials, it’s clear that injecting liquidity into the mortgage market was again one of the foremost drivers behind this move. But, nobody stopped to ask whether keeping mortgages affordable for all who want them is a good thing. Maybe borrowers who cannot afford nice homes should settle for more modest homes or (gasp) rent until they can afford them. What a novel concept!

It seems to me that the goal should be a mortgage market that accurately reflects the value of real estate and the available financing, not one that treats home ownership as a Constitutional right.

This entry was posted in broader credit crisis, causes of the crisis, education, Fannie Mae, Freddie Mac, legislation, lenders, liquidity, mortgage market, securitization, stability, subprime, takeover. Bookmark the permalink.