Arnold Kling  

Should Freddie and Fannie Come Back?

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Susan Woodward and Robert Hall say "yes." Their history of the mortgage market is correct. Their analysis of the nature of the competition between banks, thrifts, and the GSE's (what some of us call the "duelling guarantee" model) is correct. See my testimony for the same history and analysis.

However, I disagree with their policy recommendations. I take the view that instead we should revert to the pre-Freddie model, in which banks and thrifts originated loans and held them. If Freddie and Fannie were such a good idea, why did they fail? Hall and Woodward say that need to be better regulated. Well, fine. Any institutional structure works if you assume that it is well regulated.

Banks and thrifts are not a piece of cake to regulate, either, but the fact that there are a lot of them helps in a couple of ways. First, they may not all make the same mistakes at the same time, so that there will be times when one or two firms fail without bringing down the entire system. (There will also be times when there are widespread failures.) With Freddie and Fannie, if either one messes up, you've got a disaster on your hands.

Second, I don't think it is an accident that Freddie and Fannie had a weak regulator. When you have giant institutions, the regulator is bound to be intimidated. It's a lot easier to give orders to a firm that represents one percent of the industry than to a firm that represents 25 percent of the industry.

Hall and Woodward make a big deal of the fact that securitization lowered mortgage rates. I don't put much weight on this. First, Hall and Woodward admit that Freddie and Fannie were under-capitalized. If you require the firms to hold sufficient capital, then they will not do as much to reduce mortgage rates. Second, I am not convinced that our goal should be to minimize mortgage rates. I have said many times that while there may be a social purpose in promoting home ownership, it is far from clear that there is a social purpose in promoting mortgage indebtedness. If you're increasing the supply of mortgage credit, you're reducing the supply of credit elsewhere in the economy. It's not clear that we should be aiming for that.


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COMMENTS (4 to date)
KipEsquire writes:

Much like the FDIC, there is still no compelling case whatsoever to suggest that, even if Fannie & Freddie should exist at all, that they should in any way be public bureaucracies (or quasi-public "government-sponsored enterprises").

If there is truly a market for the financial intermediation that FNM/FRE provide, then they (or some subsequent entity) can function privately and profitably, without any coaxing/coercion/subsidization from the government's central planners.

Bill Woolsey writes:

S&Ls held portflioes of 30 year mortgages financed by savings accounts. They were thinly capitalized. That was a disaster waiting to happen. And it happened.

The commerical banking system is invested 40% in real estate loans. That seems too much too me, but it is better than more or less 100%. They are financing too much in the way of long term investments with short term debt. There were better capitalized than the S&Ls of yore.

Investment banks used short term money, up to overnight commercial paper to invest in portfolios of mortgate backed securities. This is almost as bad as the S&Ls. They were capitalized like the S&Ls too. This was "OK" because the mortgages were securitzed and so could be easily sold. No it wasn't.

I think Kling is right that much reaction to the crises is based upon the idea that it should be "OK," and market for mortaged backed securities needs to be fixed so that any such security can be sold at any time for something close to its face value. Like T-bills.

To me, securitization seems great, it is just there there is no reason to beleive that the mortgage backed securites should be treated as quasi-Tbills. Near rsikless, extremely Liquid, near prefect to fiannce with deposits or commercial paper.

Think of them more like thinly traded corporate bonds. Good for insurance companies, pension plans, and the like to hold for income purposes. Or, individuals could hold them for retirement.
Really, more like holding stocks.

Not a place to park money safely because they can always be resold.

I don't want to claim that a bank sholdn't own any of these, or any mortugages on its balance sheet. But that isn't the way homes should be financed. Thirty year loans should be treated way more like equity than money.


Carl The EconGuy writes:

Fannie and Freddy are prime examples of a political will to manipulate private consumption that lacks the courage of its convictions. It's a subsidy program for housing that uses the mortgage market to induce loans to people who otherwise would not buy housing, on the assumption that "housing is good for them". The problem with this approach is that it hides from political view the transactions that are going on. A better model would be Food Stamps, i.e., handing out overt annual subsidy coupons to poor people so they can get and keep mortgages in any financial institution -- and then there would be no need for Fanny and Freddy. That way we would know what's going on, and we would not have to deal with huge political pork machines like Fannie and Freddie, with the unending regulatory problems that come along with that. Kill the beasts, and create a Housing Stamps program instead. Even better, let the stamps be tradeable. That way, qualified people who'd rather have a new car than own a house could get to a better position. Stop this social engineering manipulation of choices in private consumption already! Why do Susie Woodward and Bob Hall think they're experts in how to balance consumption choices of poor people?

Derk writes:

You are making the case for more than no Fannie and Freddie. Your reasoning can easily be extended to no reason to have any large financial institutions -- no Chase, Wells, Bank of America, Goldman Sachs, etc.

Also, you have forgotten about a key reason Fannie and Freddie were set up. Banks are not equipped to hold fixed rate mortgages. Are you also making the case for every consumer to have an adjustable rate mortgage which banks are equipped to hold?

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