Anthony Sanders is a senior scholar at the Mercatus Center and the distinguished professor of Real Estate Finance at George Mason University.
Last week Fannie Mae, one of the two mortgage giants in conservatorship with Freddie Mac, reported a $2.7 billion profit for the first time since the financial crisis. This seemingly good news may actually be a reason to finally do something about Fannie and Freddie rather than pretending that they will be just fine on their own.
Fannie and Freddie have cost U.S. taxpayers over $170 billion to date. As Congress struggles with the decision to perpetuate them in some form or pull the plug on them, losses will continue to mount. Specifically, if the administration's recommendation for principal reduction for borrowers is adopted by the Federal Housing Finance Administration, Fannie and Freddie's regulator, losses to Fannie Mae and Freddie Mac would be in the billions.
As we move through the process, it is important to remember the U.S. housing market was not the only one to have housing bubbles that burst, and Fannie and Freddie are not solely to blame. Spain, Portugal, France, Denmark, Greece, and other European nations had housing bubbles as well (and their housing prices continue to deflate). Japan has had a housing bubble that has been deflating for years. China has experienced a "double bubble" like Australia. Even Canada experienced a housing bubble.
However, Fannie and Freddie did make a huge contribution to the problem. They partnered with the Clinton administration's National Homeownership Strategy to push low-down payment mortgages to lower and middle income families to increase home ownership rates. And this same strategy asked Fannie and Freddie to streamline underwriting standards as well. Both of these recommendations were complicit in forming a housing bubble.
The Clinton strategy of increasing home ownership and building equity for underserved borrowers backfired. It recommended the abandonment of capital gains on housing, and it was "off to the races" for house prices and the home ownership rates, both of which have come down considerably in recent years with a cost of $7.4 trillion to American households in terms of equity in their dwellings.
Serious doubts have been raised about Fannie Mae and Freddie Mac's privatized gains and socialized losses model. When you look at how much the U.S. subsidizes housing, you can see that housing has mutated into a form of entitlement.
Not only does the government guarantee low-down payment loans, and provide the well-known mortgage-interest deduction for federal taxation, the mortgage government-sponsored enterprises (Fannie Mae, Freddie Mac, Federal Housing Administration) have captured more than 90 percent of the residential mortgage market. Fannie and Freddie guarantee multifamily loans, while the Federal Housing Administration guarantees reverse mortgages for seniors.
Regardless of what happens to Fannie Mae and Freddie Mac, we have to come to the realization that housing is heavily subsidized in the United States and that was the ultimate cause of our housing woes. If housing and mortgage subsidies remain the same, someone will offer them to households even if Fannie and Freddie go away. The future of the housing finance industry must include a discussion of how much we want to subsidize housing (and housing finance) and then we can decide how to deliver it.
One suggestion is to convert them to an ownership form where they become cooperatives owned by U.S. banks and lenders. Fannie and Freddie would no longer have retained portfolios where they purchase mortgages and hold as investments.
Alternatively, U.S. lenders could hold the mortgage equivalent of a taxi medallion where the lender can use the government mortgage guarantee. The taxi cab medallion is expensive and gives the cab owner the right to operate a taxi cab; a government mortgage medallion is currently held only by Fannie Mae, Freddie Mac, and the Federal Housing Administration.
Unfortunately, paring back or removing government guarantees and subsidies will be difficult for Congress. Any time cutting the subsidy to housing is mentioned, there is backlash from consumer and trade groups.
While a privatized housing finance system would be ideal, it is likely that we need a government medallion (or backstop) for mortgage lenders. The idea would be to scale down the guarantee over time and let the private market return. A cooperative structure for a national securitization operation would eliminate the "cookie jar" nature of Fannie Mae and Freddie Mac.
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