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One of President Bush’s main goals when he became president was to build an “ownership society,” characterized by, among other things, more people owning their own homes. It was a laudable goal. The US government would facilitate this goal through the creative use of two major “government-sponsored enterprises” (GSEs) established by federal law, which means that, although they are private companies with stockholders and profits, they do receive special privileges. These two GSEs are the Federal National Mortgage Association (now known as Fannie Mae) created in the 1930s as a part of the New Deal and its cousin now known as Freddie Mac.
How do they work? Overall, they own over $5.2 trillion in mortgages in the US, nearly half of all outstanding mortgages in this nation. These two giants are simply too important to fail and they are backed up by the US government, which cannot permit them to fail. Simply put, both Fannie Mae and Freddie Mac would buy mortgages from banks with funds it borrowed at a much lower rate because it is a GSE. This would then give the banks more money with which they could make more loans. They would then bundle these mortgages together and sell them as securities and/or bonds on the open market. The mortgage-based investments continued to rise in value and in tandem so did the value of real estate. As real estate values continued to soar, so did expanded home ownership. The nation’s banks then relied on these investments to raise more money for a whole new wave of loans. This complicated system worked as long as lenders could keep selling their mortgages and as long as someone would guarantee most of the debts. Here is where Fannie Mae and Freddie Mac came in because they would guarantee the loans. That is why they together now own nearly half of all mortgages in the US.
With this relatively easy method of financing, more and more people bought homes and it seemed that real estate prices would keep rising forever. Therefore, some banks made more and more risky loans (aka sub-prime loans), which were the first to default when home prices started falling. As lending became more conservative, the speculative bubble burst. With housing prices plummeting, the ugly reality emerged that many banks did not understand the details of these mortgage-backed investments. That ignorance was expensive! With huge losses being recorded, the only major player left in the market is Fannie Mae and Freddie Mac. So, that being the case, the US government simply cannot allow them to fail. Peter Goodman has written: “For a generation, American policy makers have lectured the world on the need to unleash the animal instincts of the market. China’s rickety banks should stop lending to protect state factory jobs, Americans said, and focus on the bottom line. Now the Bush administration is reluctantly concluding that Fannie and Freddie might need to be propped up to protect the American homeowner. . . Yet here, in the aftermath of a financial crisis brought on by what were once called American virtues—financial engineering and risk management—Washington may bail out Fannie and Freddie for the simple reason that they are too big to fail.” The current, brutal reality is that the US government is now playing the dominant role in assuring that Americans can purchase a home—and that is not a good idea!
Not too long ago, critics of Fannie Mae and Freddie Mac were arguing that they should be required to report to the Securities and Exchange Commission like other corporations, that they should pay state and local taxes like other corporations, and that they should increase their capital reserves like other regulated financial entities. But in each case, their corporate officers would unleash their lobbying machines in Congress and thwart such actions. They both used their position as GSEs to an unfair advantage in the market place and when times were good they raked in huge profits. Now that times are bad, they are running to the US government for salvation. And the US taxpayer will foot the bill! This is a colossal mess, one of the unintended consequences of fostering, through an agency of the US government, a good and worthy goal—an ownership society. But this ownership society was not to be achieved in the normal manner—through the market. It was to be achieved through an unfair GSE. When it comes to the US government, one is beginning to wonder who is really minding the store right now! This will not be quickly fixed and we will be living with this for some years to come.
See Peter Goodman’s most helpful analysis in the New York Times (14 July 2008) and the USA Today editorial (15 July 2008). |
