The Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) buy mortgages from banks and thrifts then securitize them for sale. These mortgage backed securities are more attractive to investors than raw mortgages because they don’t need servicing and are easier to buy and sell. In this way, Fannie Mae and Freddie Mac increase the funds available for investing in mortgages. They earn income from offering mortgage insurance, and from margins earned in securitization.
The Federal government backed Freddie and Fannie for decades, reducing to near zero the risk their lenders face. But government entanglement comes with downsides. Government encouraged Fannie and Freddie to make loans as widely as possible and to lower underwriting standards to levels private mortgage issuers could not tolerate. Willingness to finance those who couldn’t afford to pay and laxity in checking buyer qualifications stoked inflation in house prices. These practices fueled the housing bubble of 2007. For taxpayers, the sobering downside of government backing was that mortgage defaults forced government to cover Fannie’s and Freddie’s asset shortage, $188 billion worth.
In the five years since then, Fannie and Freddie operated under government conservatorship and have repaid most of the $188 billion. The housing sector is beginning a path toward normalcy. Private sector funders are willing to buy the mortgage giants and operate them as mortgage insurers, buyers and securitizers in a manner fully cognizant of market realities – no more looking the other way on risk and no raiding the financial cookie jar as politicians seem compelled to do.
The housing sector represents 18% of GDP, bigger than health care’s 16% (recently seized by controlling politicians). The sale of Freddie and Fannie would reinstate private sector control and efficiency. But some in politics want to keep their tool for controlling who gets a mortgage, who doesn’t, and at what price. Some think a successor to Fannie and Freddie would still need a government guarantee on its finances.
There is a way to make this work for consumers. A government guarantee can be priced in cash instead of in politicians’ control.
Alan Daley is a retired businessman who writes for The American Consumer Institute Center for Citizen Research