The Fannie/Freddie conversation begins

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Yesterday, Fannie Mae said that it would need another $8.4 billion to cover losses on the home loans it backs, and today the head of the Federal Housing Finance Agency, which oversees both Fannie and sibling Freddie Mac, said that the ultimate taxpayer tab of supporting the two housing giants is still unclear.

That’s the sort of news that might make a person even more interested in figuring out what we’re going to do with these two agencies. As the Senate debates financial reform this week, Senators McCain, Shelby and Gregg are pushing their amendment to wind down Fan and Fred over the next 15 years—although all the commentary I read says that there’s little chance that amendment will pass.

Nonetheless, it seems the Fannie/Freddie conversation is finally starting to get moving. As this much-awaited moment arrives, let’s keep in mind that though we may currently loathe the amount of taxpayer money we’re plowing into these companies, we did get many, many years of upside in return, through home loans that were a lot cheaper than they would have been otherwise. Reforming Fannie and Freddie is surely a good idea, but one likely consequence is higher-priced mortgages.

Last week Ezra Klein did a fantastic job of summing up why that is:

The right way to think about Fannie Mae and Freddie Mac is to think about the widespread availability — at least before the crisis — of 30-year, fixed-rate mortgages with no prepayment penalty. That is not a financial product that flourishes in the state of nature, and for obvious reasons. If you’re a bank, why do you want those mortgages? If interest rates go down, people refinance and pay the loan back early. If they go up, you might be losing money on the loan.

So you get Fannie and Freddie to buy up those mortgages, prompting banks to lend more. Fan and Fred finance their mortgage purchases by borrowing on the cheap—which they can do since they carry the U.S. government’s imprimatur. That helps keep ordinary homeowner costs lower, too. As Klein writes:

What you’re talking about, essentially, is a massive subsidy for home ownership. That is to say, a massive subsidy for the middle class.

Now remove Fannie and Freddie. If private companies rush in to fill the void (a big “if,” at least in the short-term), their borrowing costs will be higher. In turn, so will home loans. Even just removing Fan and Fred’s government-affiliation by fully privatizing them will make mortgages more expensive.

That is not necessarily a bad thing. In recent decades, overly cheap consumer credit (of all stripes) encouraged excessive household debt and helped cause the financial crisis. As we now know, if mortgages are artificially inexpensive for a period of time, we will just wind up paying for it later.

But that does ignore the potentially useful social function of Fannie and Freddie—spreading homeownership, which is seen as a way to keep communities stable and give families a leg-up on asset building. If we take away Fan and Fred, then it might be nice to articulate what will work to achieve those goals instead. The current proposal to wind down Fannie and Freddie notably doesn’t do that.

Surely there are other ways to promote stability and asset building. I just hope that will be part of the conversation, too.