November 16, 2015
Robert Samuelson devoted his column this morning to discussing the fate of Fannie Mae and Freddie Mac (F&F). He notes that both are still effectively owned by the government even though almost everyone agreed years ago that they should be wound down and eliminated.
The complaint against leaving F&F public is that it leaves the government exposed to the sort of liabilities that led us to spend more than $180 billion bailing out F&F in 2008–2009. This badly misunderstands the dynamics of housing finance.
First, on the money used to bail out F&F, we ended up making a profit using the standard accounting that the media employs for bank bailouts. The government collected more money from F&F than it loaned it. This is of course a silly criterion, since the government is among the world’s lowest cost borrowers, so it can generally make money by lending at interest rates between its cost of borrowing and the cost of borrowing for the businesses to which it is lending money. (This is the story of how the Export-Import Bank is profitable.)
The issue here is that the government is allocating capital by making subsidized loans available to favored companies in the case of the Export-Import Bank or the housing sector in the case of F&F. This has a cost in the form of higher priced capital to other borrowers, even if this does not appear as a budget item. Anyhow, the issue should be less the bailout money than whether F&F helped fuel the housing bubble, and if there is an alternative structure that would make such irrational exuberance less likely.
On the first question, there can be no doubt that F&F contributed to the bubble (they did finance 40 percent of new loans), but they were followers rather than leaders. The worst loans were financed by the investment banks that bundled them into their own mortgage backed securities. The business press derided F&F at the time for losing market share to more nimble private sector competitors. When F&F did start to move more aggressively into the subprime market it was for pursuit of profit (they were privately-held profit-making companies at the time), not because they were trying to serve the public good.
This raises the question of what would be accomplished by eliminating F&F. While there are some who would like to see the government get out of housing finance altogether, the most likely alternative would be a mixed model, such as proposed in the Johnson-Crapo bill, that would allow private banks to issue mortgage backed securities with government guarantees.
It is difficult to see how this would improve matters from the bubble period. Private issuers would have the same incentive as before to package bad mortgages, but they would now be able to do it with a government guarantee for most of the principal. This seems like a recipe for more bad loans.
Furthermore, it would substantially increase the cost of mortgages, since homebuyers would have to cover the profit of the private issuers. Estimates of the increased cost range from 25 basis points to as much as 100 basis points. It is difficult to see how this helps to promote homeownership compared with the current situation of leaving F&F as public companies.
It is worth noting in this respect that there is a widely held, but wrong, view that the housing market remains depressed compared with a scenario in which housing finance was working profitably. In fact, house sale prices are well above their long-term trend for the country as a whole, with some markets, like San Francisco, likely entering a bubble.
While the piece cites Mark Zandi as saying house sales are about 8 percent below normal, they arguably are actually above normal. In the years from 1993–1995 existing home sales averaged just over 3.5 million annually. These were post-recession pre-bubble years in which the economy was relatively healthy. Adjusting upward by 20 percent for population growth would give us sales of around 4.2 million. This is well below the current rate that is close to 5 million. While new home sales remain depressed, existing home sales are actually quite high relative to trend.
In short, the effort to reform F&F seems intended to fix a problem that is not there, with the main “fix” on the agenda likely to be a huge cash cow for Wall Street.
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