The Future of Fannie and Freddie

The current “politically correct” opinion is that Fannie and Freddie, the agencies that purchase most residential mortgages on the secondary market, should be eliminated and their functions transferred to private business. I am not so sure.

The Washington Post published an interesting article by Barry Ritholtz in the Business Section Sunday, November 20. (The article is reproduced and additional data added in his blog for November 20. Click to view article.) He analyzed economic data about our economic crisis and observed that the “vast majority of subprime mortgages – the loans at the heart of the global crisis – were underwritten by unregulated private firms.” He reported that the data also shows that the bulk of these mortgages were sold to Wall Street, not Fannie or Freddie. Finally, he stated that Fannie and Freddie began purchasing subprime loans on the secondary market only because they were losing market share to the unregulated private lenders. On this point he elaborated, in response to a question on his blog, that “in late 2005, having lost so much marketshare to private lenders, Fannie & Freddie petitioned their regulator, OFHEO, to jump into the subprime mortgage market. That was granted, and they ramped up purchases into the peak of the housing boom.”

The take away from this data is that it was not until Fannie and Freddie strayed from their original business model that they became a problem. It seems to me that, until that point in time, they provided the linchpin in the mortgage market, insuring stability and inexpensive mortgages, and enabling millions and millions of people to own homes. That was, and continues to be, a good thing.

The obvious solution is to fix what is broken. It seems clear that the simple “fix” is to return Fannie and Freddie to their original business model. That has already been accomplished.

So, why eliminate them? “Political correctness” tells us that “private” is always better than “public.” Please correct me if I am wrong, but wasn’t it the private market that created the mess that destroyed our economy?

Forget “political correctness.” The biggest problem with governmental regulation is overreaction. In order to fix one problem, five more are created. Smart regulation limits itself to fixing the problem. Smarter regulation fixes the problem and creates a basis for economic progress.

Smart regulation has already happened; Fannie and Freddie have been forcibly returned to their original roles.  Smart regulation stops here.

Smarter regulation is regulation that not only allows, but encourages, the blossoming of a secondary mortgage market while preventing the kinds of abuses which damage the economy and bankrupt individuals. Smarter regulation is really hard, but if we jettison our penchant for distorting facts to fit into our political philosophies, we can do it.

If and when a private secondary mortgage market evolves that is better, Fannie’s and Freddie’s market share will decline. At that time, we should learn from past mistakes and allow it to happen. If and when the private secondary market establishes itself as secure and reliable with a competent consumer protection component (in stark contrast to the recent past) Fannie and Freddie can be allowed to fade away, with minimal disruption to the economy. And if a satisfactory secondary market never does evolve, Fannie and Freddie can continue to serve the functions they capably served prior to losing their direction.

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