No Fannie, no Freddie
Editorial Courtesy of the Los Angeles Times
The Obama administration has offered three options for reducing the government's role in home loans.
Congress created Fannie Mae and Freddie Mac to help lower the cost and increase the availability of home loans. Before the Depression, banks typically required mortgages to be paid off in one lump sum after five years. That's because banks' reliance on short-term sources of money, such as customers' deposits, left them ill prepared for the long-term risks posed by loans that wouldn't be paid back for years.
Launched in 1938, Fannie Mae's original mission was to purchase and hold loans guaranteed by the Federal Housing Administration. By offering banks the chance to sell the loans they issued, Fannie Mae made it possible for them to offer more mortgages and to allow longer payback periods. The eventual result was the wide availability of consumer-friendly 30-year fixed-rate loans. Freddie Mac, which Congress created in 1970, made even more capital available for mortgages by buying, bundling and selling loans to investors.
But Fannie Mae, which became a shareholder-owned company in 1968, and Freddie Mac, which has always been shareholder owned, combine public missions and private ownership in a dangerous way. Because Congress created the two companies and relied on them to promote affordable housing, investors and lenders assumed (correctly) that they wouldn't be allowed to fail. That made it cheaper for Fannie and Freddie to borrow money, giving them an unfair advantage over competitors in the secondary market for home loans.
More important, the implicit federal guarantee encouraged the companies to take excessive risks, which they did by jumping into the market for subprime and other exotic loans late in the housing bubble. After racking up billions in profits for their shareholders and employees, they foundered in 2008, sticking taxpayers with more than $150 billion in losses.