By Axel Merk
Fannie Mae was founded during the Great Depression as part of the New Deal. Fannie’s mission is to lower the cost of home ownership. Not only has Fannie failed in its mission, it’s delivered us bubbles and crises.
If you are in the market to buy a home, odds are you have budget to allocate. If you receive a loan subsidized by Fannie, you might get excited about getting a great deal. But you are not. To illustrate, think of a government that hands out $10,000 to each of its citizens. You may cheer until you realize handing out checks to everyone does not create wealth, only increases the dollars in circulation, causing the prices of everything to rise.
When it comes to doling out mortgage subsidies, if a family could afford a $1,000 monthly mortgage payment before the subsidy, it is still a $1,000 monthly mortgage payment after receiving a subsidized mortgage. But with the subsidy, the family can afford a larger, nicer home. Until they realize that everyone else can also afford a larger, nicer home.
Pushing up prices
What happens in practice is that subsidized mortgage rates push up home prices. As such, those that first take advantage of the subsidy win. And all of us who are homeowners love to keep the subsidy in place. But isn’t Fannie supposed to help new homebuyers? When Fannie was first founded, it helped some. But these days, Fannie may at best be responsible for making housing less affordable to new homebuyers.
There’s a political argument to be made to subsidize housing for low-income groups. Depending on one’s political convictions, one may be against all subsidies or one may think the most needy 1%, 2%, 5%, possibly 25% of the population should be eligible for such subsidy. But something is wrong with a system where over 80% of mortgages contain a government guarantee, as has been the case in recent years! Even more striking, of late, mortgages without government guarantees have lower interest rates: a 30-year “jumbo loan” at a major U.S. bank is currently available for 4.375%, compared to a 30-year fixed “conforming” (Fannie) loan at 4.5%. Jumbo loans are larger loans and, as such, one would expect them to have less favorable terms. Granted, only those with excellent credit have access to jumbo loans, but isn’t the U.S. government supposed to have the most impeccable credit? Fannie is a rotten deal, in both theory and practice.
There’s plenty of blame to go around for the financial crisis from bankers to consumers and policy makers, but let’s not lose sight of the fact that Fannie played an integral role in fostering the illusion that made housing the one “safe” area to invest in.
There are those that fear, without Fannie, housing would collapse yet again. If that were true, well, homes would become more affordable. The reason lower home prices are not acceptable to policy makers is that homeowners that owe more on their homes than they are worth (that are “under water”) don’t make for good consumers (or happy voters). It’s the key reason the Federal Reserve is working hard to promote higher home prices (we used to call this inflation). More to the point, though, modern history only has communist countries where the government plays as heavy a hand in the housing sector as in the U.S. In the U.S., too, a private mortgage sector can thrive. Fannie should be phased out over, say, 10 years, to allow a transition to a system not dependent on government subsidy. Politicians will find a way to support the needy, but please, don’t consider 80% of the population as in need of subsidy.
To foster a sustainable housing market, we need market-based, not low interest rates. Market-based means that the cost of credit is tailored to the risk profile of the borrower. China is opening up its banking system to encourage just that. Those communists might be beating us at capitalism.