FANNIE & FREDDIE

The government’s twin housing behemoths—Fannie Mae and Freddie Mac—cannot simply be cut lose from government support. Like animals kept too long in captivity, Fannie and Freddie will not be able to survive in the wild. This is something that supporters of Fannie and Freddie have right - government support is absolutely necessary for their existence. But that doesn’t mean we should continue the government life-support.
In fact, there is good reason to end government support for the agencies and let them wither away. The truth is that there is nothing that Fannie and Freddie do that private companies couldn’t do better—except provide an illusory subsidy for homebuyers. And there are far better ways to subsidize housing than propping up Fannie and Freddie.
Fannie and Freddie are supposed to make housing more affordable by buying up mortgages and providing guarantees for mortgages that conform to the guidelines developed by bureaucrats. Mortgage lenders are willing to make loans at cheaper rates when part of the risk of default is absorbed by someone else.
That’s it. That’s really the only way that Fannie and Freddie save homebuyers money—by taking on the risks of making mortgages that would otherwise sit with the lenders. The lenders then pass on the savings to homebuyers by providing mortgages at slightly lower rates.
But if Fannie and Freddie are just big insurance companies for mortgage lenders, there’s no reason that this couldn’t be done by private markets. Insurance is a huge business in the United States. And mortgage insurance is, in fact, available from private companies.
The main advantage Fannie and Freddie have is access to cheap capital. Even before they were put into government conservatorship, Fannie and Freddie could borrow money from debt investors at rates far cheaper than private competitors because they enjoyed the implicit guarantee of the United States government. Debt investors assumed—correctly, it turns out—that if these companies got in trouble, the U.S. taxpayer would assure that they could pay off their debts.
Now that they have access to government bailout capital, the advantage is even larger. Last quarter, Fannie owed $1.9 billion in dividends to the Treasury. It couldn’t make the payments, so it requested $1.5 billion from the Treasury to pay back the Treasury. For real. That’s what happened.
Access to cheap, government guaranteed debt and equity means that Fannie and Freddie can provide guarantees to mortgage lenders far cheaper than any private company can. And that’s the source of the subsidy for homebuyers: Fannie and Freddie undercut competition by providing mortgage insurance far cheaper than the market allows for private companies.
Absent the government guarantee and attendant cheap funding, there would be no reason for Fannie and Freddie to exist. They’d no longer be able to undercut private competition. In all likelihood, the leaner, more efficient private competitors would clean their clocks.
Fannie and Freddie would die—or be transformed into ordinary companies with no special role to play in the housing market.
Unfortunately, we do not know how to cut Fannie and Freddie off from the government guarantee. Prior to the crisis, government officials often insisted there was no guarantee of Fannie and Freddie—but no one believed them and the officials turned out to be either mistaken or lying.
Now—after the bailout—the government lacks all credibility on Fannie and Freddie. As long as they exist, Fannie and Freddie will enjoy a competition killing advantage that will undermine any attempt to create a healthy mortgage market not dependent on government subsidies. By John Carney, Senior Editor, CNBC.com
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