Home > Solution-Problem > Fannie Mae and Freddie Mac illustrate two chronic problems with interventionism

Fannie Mae and Freddie Mac illustrate two chronic problems with interventionism

Robert Samuelson at Real Clear Markets has an article today about everyone’s two favorite wards of the state, Fannie Mae and Freddie Mac.  Tacitly implied, but not fully explained, are two very important principles of interventionist government.  First, if you attempt to prevent market downturns, you will inevitably make the ultimate crash bigger than it otherwise could have been.  Second, intervention to encourage certain practices will fail when those practices are organically unsustainable.

Historically, the mortgage market has been relatively steady, with a stable rate of home ownership and traditional lending standards that offered good protection to capital providers.  The market changed when Fannie and Freddie entered the picture.  Under government direction, these GSEs pumped up the housing market with artifically low interest rates, then they moved in on the subprime market, offering the benefits of implicit government backing to the non-creditworthy.  Of course, if the practice of giving mortgages to people who can’t afford mortgages were to expand under normal market conditions, one would expect a near-term correction, and the resulting money loss would suggest a probable curtailment of the suspect practices.  But this is no normal market.

Fannie and Freddie, in the interest of propping up the housing market, doubled down on its bad bets.  Abhorrent lending practices proliferated.  House prices went through the roof.  Toxic mortgages were repackaged into securities generously rated by the institutionalized conflicts of interest that we call “ratings agencies.”  And then came the bust.

We all remember what happened next, but here’s a brief recap:

It seemed a perfect marriage: The GSEs would do well by doing good. They’d earn profits and pass along the benefits of cheaper credit by financing or guaranteeing mortgage loans. Congress could promote homeownership outside budget constraints. By 2009, Fannie and Freddie had lent or guaranteed almost $5.5 trillion in home mortgages, roughly half of the U.S. total. But the marriage between private profit and public purpose failed. In September 2008, the Bush administration took over Fannie and Freddie, which faced huge losses from bad mortgages.

Fannie and Freddie have us at least $145 billion in the red and counting.  But why was the crash of such magnitude?  Simply because the market was propped up for so long.  Buyers can’t afford the down payment?  Lower it!  Mortgage rates are rising?  Cheapen credit!  Banks won’t hold these mortgages?  Make them into CDOs!  (Note that this phenomenon has not stopped.  “Homeowners” have negative equity?  Modify their mortgages!)

The point is, markets can only be propped up for so long.  And when more and more “solutions” are added to the mix, the ultimate problem just gets bigger.  In our government’s irrational fear of any market downturn, no matter how slight, they set up the market for crashes that are ultimately worse than otherwise possible.  And it’s the taxpayers who eat the cost when the ultimate correction comes.

Which segues into my next point.  The correction will come.  No matter how well-intentioned the interventionist is, and no matter how many letters the experts have behind their names, unsustainable practices are, perhaps shockingly to elected officials, unsustainable! 

Robert Samuelson again:

The irony is that, in failure, the GSEs have become more important than ever. Private lenders, which once regarded a mortgage secured by a home as a highly safe investment, now see it as highly risky. Few new mortgages are made without government guarantees. The GSEs continue to operate and, along with other government agencies, guaranteed about 95 percent of new mortgages made in 2009, reports Inside Mortgage Finance, an industry newsletter. Since 1990, the government guarantee share had fluctuated between 30 and 50 percent.

The single-minded promotion of homeownership failed and, paradoxically, undermined the American dream. It contributed to the housing “bubble” and favors housing investment over new industries and technologies.

Ironic, yes.  Paradoxical, absolutely not.  I’ve said it before, and sadly I’m sure I’ll have to say it again, the solution is the problem!

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