That would certainly not be the sentiment of Dr. Edward Glaeser, who is an economics professor at Harvard University. He expresses his rationale in the NY Times Economix Blog on November 9th, 2010. Certainly, Fannie Mae and Freddie Mac contributed to the housing crisis through their ineffective controls and incentivizing irresponsible home purchases by driving down interest rates. However, it would not be prudent to transfer both entities to private hands because that could end up costing taxpayers even more.
Fannie Mae and Freddie Mac are government-sponsored enterprises (GSE) aimed at making home purchases more affordable. They were originally set up to operate in the secondary mortgage market. That means that they do no loan originations, but rather buy a group of mortgages from another party, typically a mortgage servicer or bank. It was thought by pooling mortgages together into a securitized product that investors could benefit from diversification and servicing fees. While there will always be a certain number of homeowners that would default and have to foreclosed on, the GSEs would recover enough fees and repayments to cover any bad mortgages. However beginning in 2003, a significant number of homeowners were defaulting and payouts to the mortgages started to decline and this caused the value of the mortgage securities to fall. This occurred due to a high number of subprime loans collapsing. Subprime loans refer to credit quality and are given to individuals with subpar credit. While they are more risky, it was thought that their defaults could be covered by Gradually, the portfolio of mortgage securities held by Fannie Mae and Freddie Mac became toxic and investors fled both, which affected their viability.
Congress was faced with two choices, which was either to allow both entities to collapse or have the Treasury come in with taxpayer-funded dollars to bail out both Fannie Mae and Freddie Mac. The problem with the first option is what to do with the trillion dollars of unpaid mortgages that cannot find a buyer. That could cause significant turmoil within the housing market and leave many vulnerable. The other option is also not too enticing, but it's actually the course of action taken by Congress. They did this to prevent another more severe crisis, but many are concerned that this is creating a moral hazard, where the U.S. government's implicit guarantee of these mortgages is leading to reckless risk-taking by banks and mortgage servicers. As stated by Dr. Glaeser, this eventually led to the U.S. Treasury assuming 80% stake in the two entities.
Dr. Glaeser's main point was to show that privatizing the mortgage securities market carries implicit costs that are different from other forms of privatizing governmental services. For one, there's the real possibility that there will not be enough investors interested in a group of securitized mortgages that remain toxic. In that scenario, they would demand a bailout and the U.S. government would have to intervene or risk another catastrophe that could leave homeowners vulnerable. Dr. Glaeser contrasted that with trash pickup services that governments subcontract to private industry. When that occurs, there's no risk of the implicit government guarantee because they should always be another firm to assume those services if that firm defaults.
Another alternative not mentioned above comes from Dr. Arnold Kling, an adjunct scholar with the Cato Institute. While his paper was dated on September 8th, 2008, the Fannie Mae and Freddie Mac: An Exit Strategy for the Taxpayer provides another solution that involves the Congress immediately freezing their mortgage purchasing activities. By doing that, he hoped that banks and financial institutions would start buying new mortgages and eventually downsize the influence of both GSEs. In order to encourage the financial institutions to take on these loans, Dr. Kling called for loosening or eliminating capital requirements, so that they would have to capacity to take on additional loans. On the positive side, this would limit the exposure to taxpayers in the case of both GSEs failing. However, the negative side is that lower capital requirements could lead to a less stable financial system, especially during another economic downturn. Another downside is that borrowing costs for many individual home buyers would rise, so an affordable source for home financing would no longer occur.
While it is probably necessary to maintain the current arrangement, it is critical that Congress take steps to stabilize an untenable arrangement. This can be done by instilling more strict underwriting standards to ensure that their portfolio of mortgage securities would be improved. Eventually, it would be ideal if we could wean ourselves away from Fannie Mae and Freddie Mac, but this should be done on a more gradual basis.
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