On Christmas Eve, when most Americans' minds were on other things, the Treasury Department announced that it was removing the $400 billion cap from what the administration believes will be necessary to keep Fannie Mae and Freddie Mac solvent. This action confirms that the decade-long congressional failure to more closely regulate these two government-sponsored enterprises (GSEs) will rank for U.S. taxpayers as one of the worst policy disasters in our history.
Since August of 2008, I have advocated winding down Freddie and Fannie. Any other policy courts mischief.
For years, U.S. housing policy was to encourage the use of mortgage credit to the maximum extent by as many people as possible. We see the results. The new policy is to encourage as many people to stay in homes that they should not have bought in the first place for as long as possible. The result of this new policy, as I have predicted from its onset, is to perpetuate the crisis.
The significance of the unlimited backing of Freddie Mac and Fannie Mae is that it represents the unwillingness of policymakers to back away either from subsidizing mortgage credit or from trying to keep the wrong people in the wrong housing units with the wrong ownership arrangement. Instead, if they were to let the market work, those who cannot afford their mortgages but who could afford the rent would become renters, and those who cannot afford the rent would move out and rent elsewhere. Again, as a taxpayer I would gladly pay moving expenses for these people rather than pay to keep them in their homes as "owners."
Housing policy today reminds me of Japanese banking policy in the 1990's or U.S. energy policy in the 1970's. Once government puts a market into crisis mode, there is usually no turning back. Ronald Reagan's decision to remove price controls in energy and return to the use of market forces is a remarkable exception. At the time, it was viewed as dangerous and absurd, even crazier than my idea of winding down Freddie Mac and and Fannie Mae and letting the housing market find its own equilibrium.