Slowly Backing Away From Fannie And Freddie

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There's a nice opinion piece from breakingviews.com in today's edition of the New York Times. Its author, Rob Cyran makes a strong argument for winding down Fannie Mae and Freddie Mac, the two largest government owned companies that purchase mortgages and mortgage-backed securities (MBS), as well as guarantee mortgages. He explains the central problem and the challenge for lawmakers. I think he's right.

First, the problem:

The problem arises from the companies' dual roles. They have a public policy mandate to increase lending to the housing market. And they are supposed to reward shareholders. The conflict between these two goals caused the companies to nearly collapse.


Fannie Mae and Freddie Mac's principal business of guaranteeing mortgages caused economic distortions that helped drive the housing boom. As private mortgage lenders pulled in their horns, the two companies' share of the market grew from under 50 percent to around 80 percent by the end of last year, despite the fact that their aggregate portfolios have only increased by about 3 percent since their conservatorship.

The dual-role issue shouldn't be minimized: I'd argue it's the main cause of all of the problems these companies faced. When you've got the government's backing, investors will feel very, very safe with your products. They consequently felt a little too safe and overheated the mortgage market. The MBS backed by Fannie and Freddie were treated by investors as being almost as safe as Treasuries before the housing bubble popped. That helped to make Fannie and Freedie one of the gravest causes of the bubble.

The solution should be obvious -- get rid of the dual role. Either privatize these companies or eliminate them altogether. After all, there's no reason the government must be involved in the mortgage business.

Yet, despite their vast contribution to the financial crisis, Fannie and Freddie are barely on Washington's radar screen. The Obama administration isn't releasing its recommendations about what to do with them until February 2010. And the Fannie/Freddie debate won't really even begin then if healthcare and cap-and-trade are still being worked out.

That debate about these government-owned mortgage companies, by the way, won't be a quiet one. Shrinking Fannie and Freddie will be politically difficult. Cyran rightly notes:

The firms have the popular support of some lawmakers and play an increasingly dominant role in the mortgage market.

On some level, these companies are Washington's darling. That's why reform will be so hard, and probably impossible. As a result, I wouldn't expect to see any change to these companies any time soon, if ever.

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Daniel Indiviglio was an associate editor at The Atlantic from 2009 through 2011. He is now the Washington, D.C.-based columnist for Reuters Breakingviews. He is also a 2011 Robert Novak Journalism Fellow through the Phillips Foundation. More

Indiviglio has also written for Forbes. Prior to becoming a journalist, he spent several years working as an investment banker and a consultant.
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