In the past few weeks we has seen a lot of activity on the housing front, with the White House promising to end Fannie Mae, Freddie and their “failed business model.”
“Traditionally,” said President Obama, “Fannie and Freddie were supposed to be subsidiary to the private marketplace.”
Well, yes, Fannie Mae and Freddie Mac now have a much bigger share of the secondary market than in the past. But is this really so terrible? And do Freddie Mac and Fannie Mae represent a failed business model.
To say that Fannie Mae and Freddie Mac were supposed to provide a backstop to private players in the secondary market is only correct if we can agree that private firms can do the same job at the same price. In fact, what Fannie Mae and Freddie Mac really do is provide an alternative to the private players that would otherwise control the secondary market. Without the competition represented by Fannie Mae and Freddie Mac borrowers would have higher loan costs.
The Secondary Market
The essential question regarding Fannie Mae and Freddie Mac is not how big they are, it is whether they achieve their basic purpose, to assure the availability of low-cost mortgage money nationwide.
Imagine that a local lender makes 50 loans for $100,000 each. The lender has now financed mortgages worth $5 million. If it has $5 million available for mortgage lending it cannot make additional loans. However, with the secondary market it can sell qualifying mortgages to Fannie Mae and Freddie Mac, get new capital, and originate more local loans. In turn, Fannie Mae and Freddie Mac bundle those loans into securities which are then sold to investors worldwide.
The secondary market has not been closed for a single day as a result of the mortgage meltdown. If anything, the existence of Fannie Mae and Freddie Mac prevented a worse financial meltdown while lenders in the private sector were in free-fail — the very reason for a $700 billion bailout from taxpayers.
Market Share & Banks
If market share is an issue with Fannie Mae and Freddie Mac then why is it not an issue with our biggest lenders? The national banking system includes 7,000 lenders and yet a handful hold the vast majority of assets.
“Our six largest bank holding companies,” said MIT professor Simon Johnson in 2011, “currently have assets valued at just over 63 percent of GDP (end of Q4, 2010). This is up from around 55 percent of GDP before the crisis (e.g., 2006) and no more than 17 percent of GDP in 1995.”
The size and scope of the biggest banks is so large that they have a unique position within the American economic system: As Attorney General Eric Holder told the Senate Judiciary Committee in March: “I am concerned that the size of some of these institutions becomes so large that it does become difficult for us to prosecute them when we are hit with indications that if you do prosecute, if you do bring a criminal charge, it will have a negative impact on the national economy, perhaps even the world economy. And I think that is a function of the fact that some of these institutions have become too large.”
And which institutions would naturally fill the secondary market if Fannie Mae and Freddie Mac were downsized by government order? The very same institutions which are today so big they have no realistic fear of the criminal justice system.
Since 2008 when they were nationalized by the federal government, Fannie Mae and Freddie Mac received $187 billion in government assistance. They have also repaid $132 billion. The entire advance will be paid off by 2014 according to Perry Capital — with 10 percent interest.
Should we break-up Fannie Mae and Freddie Mac because of the advances they received from the federal government?
If assistance from the federal government is grounds for nationalizing major corporations, then why is it that the government did not seize the Chrysler Corporation? As President Obama explained: “When my administration took office and began going over Chrysler’s books, the future of this great American car company was uncertain. In fact, it was not clear whether it had any future at all.”
Why did we take over Fannie Mae and Freddie Mac but not General Motors?
The government would bailout GM with taxpayer dollars, said the President in 2009, but the company “will be run by a private board of directors and management team with a track record in American manufacturing that reflects a commitment to innovation and quality. They — and not the government — will call the shots and make the decisions about how to turn this company around.”
Here’s one more: The government loaned $45 billion to Citigroup and the Federal Reserve offered “certain loss protections” for $300 billion in troubled assets and yet Citigroup was not taken over by the federal government.
After The Downsizing
The public interest in Fannie Mae and Freddie Mac is very simple: If they are replaced by private-sector firms will the cost to finance and refinance a home increase?
The answer is plainly yes. In the name of “privatization” we will be exchanging the present system for a higher-cost option, one that will bring billions in new profits to the nation’s largest banks — and billions of new costs for borrowers. As Mark Zandi, the chief economist at Moody’s Analytics told the Associated Press, without Fannie Mae and Freddie Mac the cost of a $200,000 mortgage will increase by $75 to $135 a month — that’s $900 to $1,620 per year.
What extra benefits will borrowers get for such new costs? That’s something no one can quite explain.