Posts Tagged ‘bailout’

The end of Fannie and Freddie?

August 19, 2013

Since the housing market crashed in 2008, the government has gone back and forth over whether or not to close down Fannie Mae and Freddie Mac. The argument is this – why should the government pay (which really means tax payers pay) to bail out Fannie and Freddie in the future if something like this were to happen again?

It is a great point considering how much money was poured into Fannie Mae and Freddie Mac. Instead of considering whether or not to close Fannie and Freddie, this should really be evaluated from the point of view of what happens if there isn’t a Fannie Mae or Freddie Mac.

To get an idea of exactly what Fannie Mae and Freddie Mac does for the housing market, you have to go back to when these two entities originated. Ironically, these two institutions were born out of the Great Depression.

During the Great Depression, private lending all but dried up. The government created Fannie Mae and Freddie Mac in order to purchase loans from banks. This freed up capital for the banks to turn around and make the next loan. This helped the housing market to recover and was one of the factors that helped the country get out of the Great Depression – again, the irony.

What happened?

During the housing boom, Wall Street was making a lot of money off of non-conforming loans. “Non-confirming” is another way of saying a loan doesn’t meet Fannie Mae and Freddie Mac guidelines. Not wanting to miss out on the action, Fannie and Freddie (with government oversight) lowered their guidelines to take on these risky loans. They were exposed when the bubble burst.

Now the call is to get rid of them entirely to avoid a future bailout. What happens if Fannie Mae and Freddie Mac do go away:

1. There would have to be some entity out there to keep money available for banks to lend. If there isn’t a place to sell mortgages on the secondary market to free up more money to lend, the county winds up with another liquidity crisis. We’d be back into another slowed housing market.
2. Private lending would need to be re-introduced to the market to compensate for the loss of Fannie Mae and Freddie Mac. As of this moment, there isn’t an infrastructure from private lending that would be able to handle the scope of the US housing market.
3. Mortgages would be more expensive. As previous posts on this blog describe, interest rates are based on market movements. In order for private lending to begin again, investors would have to feel the risk of losing money is less than the amount of money they can make by lending it out… in other words, gone are the days of historically low interest rates based on market conditions. Interest rates would now be based on levels of risk investors are willing to take.

Back to some more irony. While Fannie Mae and Freddie Mac were part of the system that helped push the U.S. into the Great Recession, they are now aiding in the recovery. Money stopped going from the government into Fannie Mae and Freddie Mac back in 2011. With the housing market recovering, money is flowing the other way. Freddie Mac just posted its second largest quarterly profit ever. Would we even want to change anything at this particular moment? If there were a change, at least initially, you’d see a slowing in the housing market, which will hurt the country’s economic recovery.

Since Congressional representatives are elected every two years (with an election year just over a year away), it is doubtful anyone would want to attach their name to a piece of legislation that could hurt the economic recovery. For now, like it or not, it seems Fannie Mae and Freddie Mac will be continuing to do what they were designed to do originally – keeping liquidity available for banks to lend and the housing market moving along.