Is it Time to Push Fannie and Freddie Out of Home Loans?
At the beginning of August, President Barack Obama took the stage at Desert Vista High School in Phoenix and outlined the third cornerstone of his Better Bargain for the Middle Class. Addressing an audience that lived at the epicenter of the housing crisis — median home prices fell 53 percent during the period and two-thirds of all residential mortgages in the region sank — the president said home ownership was at the heart of the middle class and that fixing America’s broken housing infrastructure was at the heart of his agenda.
“It’s not just important for the person who owns the house — our economy is so impacted by everything that happens in housing,” he said. “Consumers feel better when their home values are in a better place, so they’re more willing to spend. A lot of people who want to start a business, their savings may be locked up in their house. Construction workers, contractors, suppliers, carpet makers, all these folks are impacted by the housing industry.”
The tremendous, systemic importance of the housing industry is one reason why the government intervened with a heavy hand during the crisis. Not only was legislation was passed to assist homeowners with underwater mortgages and not only were lawsuits brought against predatory or negligent mortgage lenders, but the government orchestrated a $188 billion bailout of Fannie Mae and Freddie Mac, two quasi-governmental agencies that came to dominate the secondary mortgage market in the wake of the financial crisis.
Fannie Mae and Freddie Mac are both government-sponsored enterprises. They were created by Congress to enhance the flow of credit to specific sectors of the economy that were being undeserved by the private sector. Fannie Mae — or, the Federal National Mortgage Association — was founded in 1938, a product of New Deal thinking. Fannie Mae’s purpose was to expand the market for secondary mortgages by creating mortgage-backed securities. Freddie Mac was created in 1970 for pretty much the same purpose.
Together, the two GSEs purchased mortgages on the secondary market, bundled them together, and sold them as MBS to investors in the open market. Ostensibly, this scheme increases the amount of money available for mortgage lending. When more mortgages are available, more homes are purchased, and, for the reasons Obama outlined previously, the entire economy prospers as a result.
One of the problems that agitated the late-2000s crisis and brought Fannie Mae and Freddie Mac into the spotlight is that the value of mortgage securitization is ultimately a function of housing prices, and during the crisis, home prices plummeted. Fannie Mae and Freddie Mac, which backed nearly half of the $12 trillion mortgage market in 2008, and (unlike most privately originated mortgage securities) guaranteed the performance of their MBS, accumulated tremendous losses as a result. As quasi-government organizations, these losses were ultimately placed on the shoulders of taxpayers.
While they wound up being part of the problem during the financial crisis, Fannie Mae and Freddie Mac have historically served an essential role in assisting the housing market. But now, in the wake of the crisis, the necessity of the organizations in their current form has been questioned.
In his speech in Arizona, Obama said that part of the strategy to prevent another mortgage crisis from ever happening again involved the winding down of “these companies that are not really government, but not really private sector — they’re known as Freddie Mac and Fannie Mae. For too long, these companies were allowed to make huge profits buying mortgages, knowing that if their bets went bad, taxpayers would be left holding the bag. It was ‘heads we win, tails you lose.’ And it was wrong. And along with what happened on Wall Street, it helped to inflate this bubble in a way that ultimately killed Main Street.”
As part of this process of winding down Fannie Mae and Freddie Mac, The Wall Street Journal reports that the Federal Housing Finance Agency is gearing up to reduce the maximum size of residential mortgages the two organizations are allowed to back. Theoretically, this will help begin the process of detangling the government from the mortgage market and allow the private sector to take a bigger role in the market.
“Private capital should take a bigger role in the mortgage market,” the president said in his speech. “I believe that our housing system should operate where there’s a limited government role and private lending should be the backbone of the housing market.”
As it stands, Fannie Mae and Freddie Mac can typically back mortgages with balances up to $417,00. In certain (i.e., expensive) markets, the caps are higher. In a statement seen by WSJ, FHFA said that a “gradual reduction in loan limits is an appropriate and effective approach to reducing taxpayers’ mortgage-risk exposure … and expanding the role of private capital in mortgage finance.”
However, while reform is necessary, organizations like the National Association of Realtors have some concerns. They outlined some points in an issue analysis:
“NAR’s Statement of Concern — Cutting back significantly on Fannie Mae and Freddie Mac’s involvement in the mortgage market will (1) reduce housing access and affordability for those who are able to become homeowners (2) create higher profits for America’s big banks, (3) create more too big to fail banks, leading to greater consumer risk and taxpayer exposure, and (4) hurt the economy and hinder job creation and growth.”