Perspective on Freddie and Fannie

The other essay I have out today offers background on Fannie Mae and Freddie Mac.

As of the late 1970s, most of the mortgage credit in the United States was supplied by savings and loan associations (S&Ls), which are very similar to banks. However, the inflation of the 1970’s wreaked havoc on the highly-regulated S&L industry, leading to its collapse. Fannie Mae and Freddie Mac, with strong encouragement from Congress, stepped in to take mortgage assets off the balance sheets of the S&Ls for a fee. In effect, the GSEs fed off of the carcasses of the S&Ls, and subsequently the GSEs took over the role of being the chief providers of home mortgage credit in the U.S.

If you had it to do over again, you would not allow the GSEs to become more than 50 percent of the mortgage market. Instead, you would create a system that diversifies mortgage finance across many institutions. The “regulatory arbitrage” that the GSEs enjoyed should be replaced by a level playing field, which reduces the capital requirements for banks to hold investment-quality loans while increasing the capital requirements for GSEs should they continue to stray out of the arena of low-risk, high-quality mortgages.

Anyone could see that the GSE dominance of the mortgage market was unhealthy. But the political process was unable to get the job done. What the central planners tend to forget is that political failure is even more entrenched than market failure.

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