Fannie and Freddie: The Mother of All Bailouts

Move over, AIG. Fannie Mae and Freddie Mac, the government-sponsored mortgage giants, could shortly become the most expensive bailout of the Great Recession.

Almost one year ago exactly, in July 2008, Congress passed the Housing and Economic Recovery Act, which gave the Treasury Dept practically unlimited debt space to prop up the failing government-sponsored mortgage giants, Fannie Mae and Freddie Mac. Congress first estimated the cost would be around $25 billion. One mortgage analyst told CNN: "We're assuming they each will cross the $100 billion mark fairly soon. They could be hitting the $200 billion barrier by the end of next year."

How exactly did we get here? In simple terms, Fannie and Freddie made or backed about half of all American home loans. The housing market boom encouraged lenders to be riskier to keep up with the competition. When the market went bust, the FMs went bottoms up, and with the went dozens of billions of taxpayer dollars. Arnold Kling, writing way back in July 2008, seems to have had a cogent take that holds up well:

I used to work at Freddie Mac, in the late 80's and early 90's. Back then, the capital regulations gave the FM's an advantage over banks in holding low-risk mortgages. We understood that, and we stuck to low-risk lending. As times changed, and the market shifted to high-risk loans, it would have been logical for the FM's to say, "This is not our market," and allow their market shares to drop. But top management, at least at Freddie, is pretty green... Between that and government pressure to provide "affordable housing," the FM's decided that they needed to get on the subprime bandwagon rather than stop it.

In related news: existing home sales are up 3.6 percent, but prices are still falling.