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No Fannie, no Freddie

The Obama administration has offered three options for reducing the government's role in home loans.

February 23, 2011
The Obama administration took its first, tentative step this month toward a future without Fannie Mae and Freddie Mac, the troubled mortgage finance giants. The Treasury Department laid out three options for reducing the government's role in home loans, each of which would phase out Fannie and Freddie and shrink or eliminate federal support for run-of-the-mill mortgages. Such an approach is likely to raise mortgage interest rates, especially for 30-year fixed loans, and could make it harder to get a mortgage during a financial crisis. But it would also greatly reduce the likelihood of taxpayers being stuck covering the cost if a downturn causes foreclosures to mount.
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.

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