May 19, 2011, The Guardian Unlimited
A child learns the dangers of fire by getting his hand burned. Washington policy wonks are not as quick learners. This is demonstrated by the reports that the Obama administration is about to come forward with a plan to replace Fannie Mae and Freddie Mac, the two mortgage giants that are now in conservatorship, with five mini Fannie and Freddies.
There are differences in the proposed structure of these new public/private entities and the pre-crisis Fannie/Freddie, but these details are less important. The more basic question is why the government feels the need to create a special financial system to subsidize housing. If there is a good answer, nobody has bothered to bring it up in public debates.
Just to be clear, the claims that Fannie and Freddie were the primary culprits behind the inflation of the housing bubble and the flood of fraudulent mortgages is nonsense. I say this as someone who was sharply critical of these mortgages giants throughout the run-up of the bubble and warned of their collapse as early as 2002.
Fannie and Freddie were not good actors during the bubble. If they had acted responsibly, they would have refused to buy mortgages for homes purchased at bubble-inflated prices, as determined by the price to rent ratio. Had either or both of them taken this position, it likely would have been sufficient to deflate the bubble before it grew large enough to sink the economy when it collapsed.
They deserve blame for failing to recognize and respond to the bubble. Housing is their only business and if they had understood the housing market, they would not be in conservatorship today.
However the worse junk mortgages were not bought and securitized by Fannie and Freddie. These were packaged and sold by the investment banks – Goldman Sachs, Lehman, Citigroup, and the rest. Fannie and Freddie got into junk mortgages late in the game, and even then their primary motive was to regain lost market share. It had little to do with a desire to promote homeownership among moderate-income households.
But even if Fannie and Freddie were not the primary culprits, the crisis and their collapse gives us a serious opportunity to rethink housing policy. Fannie Mae, when it was originally created in the depression, served a useful purpose. It created a secondary market in mortgages, allowing banks to sell their mortgages and get the capital necessary to issue new mortgages. This reduced the disparity in interest rates across regions, ensuring that homebuyers had access to mortgages at a reasonable price.
Given the development of the national banking system over the last 75 years, the same concerns no longer exist today. There are plenty of mechanisms for transferring funds across regions. Therefore we no longer have to worry about parts of the country being denied access to housing credit.
The question is whether there is any reason to provide some sort of government guarantee in order to subsidize home mortgages. And more specifically, is there a reason to subsidize the securitization of mortgages, which is what the Obama administration proposal would do.
There is an argument for subsidizing homeownership, which we already do through the mortgage interest deduction. This benefit could be restructured to be more generous to moderate income homeowners and less so to the higher income people who derive most of the benefit from the deduction in its current form. It is difficult to see why taxpayers should give Bill Gates $25,000 a year to help pay for his mansion on Lake Washington.
Since we can use tax policy to make homeownership subsidies as generous as we want, why should the government also subsidize homeownership through a second channel in the financial system? Furthermore, even if the government were going to subsidize housing finance, why have the subsidy only apply to mortgage-backed securities?
The policy being considered by the Obama administration, which would guarantee the mortgage-backed securities issued by mini Fannie and Freddies, is effectively handing taxpayer dollars to the intermediaries in the housing finance process. That’s a good policy if the point is to give taxpayer money to financial intermediaries. It makes zero sense as housing policy.
The incompetence of economic policymakers in the last decade has given us the worst downturn since the Great Depression. Tens of millions of people are going to be suffering ill effects from this crisis for many years to come.
The folks who brought us this disaster should have been fired, but almost all of them are still on the job. That’s the way things work in Washington.
As a second best solution, we should expect that these policymakers have at least learned something from their failure. But in Washington, no one in a position of power ever seems to learn from mistakes, which is why we seem destined to repeat them.