The Fannie/Freddie Dilemma, Cont.

No Government-Sponsored Entity (“GSE”) can serve two masters.

–New Testament

OK, so that’s not exactly how the Biblical quote goes.

But it’s an apt description of the conundrum facing would-be reformers of Fannie Mae and Freddie Mac, the two now-state wards that buy or guarantee a stunning 96% of all U.S. mortgages.

The philosophically pure solution — dissolve them — risks throwing the housing market into disarray (or worse) by creating a financial vacuum.

Meanwhile, the clean, business solution — spin them out as for-profit’s and sever their government guaranties — likewise means no more government “sugar daddy” for the housing market.

The result has been a muddle: keep them alive, quarter-to-quarter, until the political will to tackle the problem head-on reaches critical mass.

Here’s another take on the two, mutually exclusive missions assigned to Fannie and Freddie:

America may want a private mortgage market, or it might want the security of a subsidized market. What every administration since L.B.J.’s has coveted and what has always been a lie is that we can get a subsidized market free.

–Roger Lowenstein, “Cracked Foundation“; The NY Times Magazine (4/25/10)

Read the rest of Lowenstein’s article for the complete (conflicted) history of Fannie and Freddie.

About the author

Ross Kaplan has 19+ years experience selling real estate all over the Twin Cities. He is also a 12-time consecutive "Super Real Estate Agent," as determined by Mpls. - St. Paul Magazine and Twin Cities Business Magazine. Prior to becoming a Realtor, Ross was an attorney (corporate law), CPA, and entrepreneur. He holds an economics degree from Stanford.
4 Responses
  1. TIb

    I'm a little confused about Fanny and Freddie. I thought their creation was the foundation for the housing boom, and they didn't get into trouble until unqualified loans were "pawned" to Fanny and Freddie as AAA.

    I thought the intent and system worked fairly well until unscrupulous lenders and unqualified buyers flooded the system.

    Am I completely off base?

  2. Ross Kaplan

    It is confusing.

    To simplify (a bit), imagine that instead of banks and mortgage loans we're dealing with manufacturers and widgets.

    Once a manufacturer makes the widget, it becomes inventory until they can sell it.

    That's where Fannie and Freddie come in.

    They either buy the widgets outright, or, guaranty them so that third parties will buy them.

    Either way, the widget manufacturer books a sale, gets paid — and can make more widgets.

    So, in today's housing market Fannie and Freddie are what keep the pipeline moving (vs. clogged).

    The process broke down, in my opinion, due to: 1) the Fed dropping interest rates too low, for too long, to help a weak economy recover from the busted stock market bubble; 2) investors starved for yield were receptive to
    increasingly aggressive securities marketed and sold by Wall Street — which they did by the trillions.

    Voila! Bubble #2.

    The difference between a mortgage-backed security and a widget is, a defective widget explodes right away.

    Simple, huh?

  3. Ned

    I think I've got it. Thank you. It still seems to me that although Fannie and Freddie are not blameless; they should have been more prudent and cautious in their assessment of mortgages; Fannie and Freddies didn't "manufacture defective widgets" knowing the widgets were defective.

    I'm curious, what happens to all those "defective widgets" (properties) Fannie and Freddie (a.k.a. taxpayers) own?

  4. Ross Kaplan

    Yes, Fannie and Freddie are blameworthy — but I put them 5th or 6th on the list, after Wall Street, The Fed, the credit ratings agencies, regulatory capture, etc.

    They were latecomers to the party, and got burned.

    But the party was very much in high gear by the time they piled in.

    Regarding who gets the defective widgets:

    with mortgage-backed securities, if the borrowers default, the lenders get the keys (eventually).

    So, whoever the mortgage-holder(s)
    is/are, gets the house back.

    With derivatives, there's a different outcome; the parties to a different contract are ultimately just betting on whether the price of something goes up or down.

    So, the side that bet houses would tank won big, the other side lost big. But none of it is connected to the underlying real estate.

    Making derivatives even dicier: huges amounts of leverage, on top of bets that reportedly were many magnitudes the size of the actual housing market.


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