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dbucfan

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: May 20, 2010, 10:06:20 PM

What’s big, risky, and losing billions?
Mortgage giants Fannie Mae and Freddie Mac need to go away — but slowly
By Edward L. Glaeser  |  May 20, 2010
THIS WEEK, the Senate rejected a $400 billion cap on the taxpayer bailout of the Federal Home Loan Mortgage Corporation and the Federal National Mortgage Association, better known as Freddie Mac and Fannie Mae. The decision may ensure that the two firms’ collapse will be the most costly event of the economic downturn. Their old model — private companies with an implicit public guarantee — created behemoths that gambled trillions of dollars and lost billions in taxpayers’ money.

This old system was unacceptable, but what shall we put in its place?

Let’s start with the basic question: Why should Fannie and Freddie exist at all? Supporters made two standard arguments. The simpler one is that Freddie and Fannie increase homeownership by making borrowing cheaper. It is surely true that if the federal government guarantees mortgages against default without charging enough for that guarantee — which is what happened — then this underpriced guarantee is yet another implicit subsidy for home borrowing and homeownership.

But a policy isn’t wise just because it promotes homeownership. There are more transparent ways of doing so, such as a direct annual homeownership tax credit. Besides, how much promotion does homeownership need? The home mortgage-interest deduction already encourages people to overborrow to bet on the housing market.

The more complicated argument for Fannie and Freddie is that, by guaranteeing mortgages and packaging them into securities, the two firms make a secondary mortgage market possible. The secondary market is important because it allows banks that write mortgages to share their risk with investors. Indeed, the current crisis might have been worse, not better, had banks been holding all of the nation’s mortgages in their own portfolios. Americans are lucky that their mortgage losses were borne by investors worldwide — not just by banks that were ultimately backstopped by the US government.

Defenders of Freddie and Fannie have argued that, without the two firms as intermediaries, banks would keep their good mortgages in their own portfolios and sell only the worst loans to secondary investors. Investors would wise up and avoid the securities, and the secondary market would break down — making new mortgages more expensive.

But is this argument right? In fact, there are several securitized debt markets that exist without any federal guarantee. Securities backed by credit-card debt and corporate obligations, for instance, trade in a global market. Even jumbo mortgages were securitized without help from Fannie and Freddie. If anything, there was too much of a market for subprime securities without a federal guarantee.

But despite my skepticism about the mission of Fannie and Freddie, we won’t and shouldn’t get rid of them overnight. They still hold vast portfolios. The housing market is still fragile. We should reform them and gradually reduce their role in the markets, moving slowly to avoid panic and dislocation.

One option is to reconfigure Freddie and Fannie as a purely public agency — one that is slow and risk-averse. For-profit entities are good at taking risks and making money, neither of which is wise if the public is ultimately paying the bill. The reformed agency would be forbidden to innovate or to hold loans in their own portfolios. Its job would be to guarantee, bundle, and securitize standard, moderate-sized mortgages to borrowers with good credit scores and sizable down payments.

The new entity’s primary obligation would be to avoid costing taxpayers — not to promote homeownership or any other ill-defined social aims. The entity should be isolated from legislators pushing broader objectives, and should charge fees hefty enough to cover its own costs under almost any circumstances.

Some governmental entities err by doing too much — as Fannie and Freddie did before the fall — while others are terrified of overreaching and do very little. This mortgage-selling entity should be a model of conservative inaction.

If the new entity’s fees are sufficiently high, and its due diligence is sufficiently onerous, then banks and borrowers will bypass it altogether. That’s the dream. We’ve seen what happens when government-guaranteed entities aggressively dominate the mortgage market. Let’s see what happens when the government gradually prices itself out of business.

Edward L. Glaeser, a professor of economics at Harvard, is director of the Rappaport Institute for Greater Boston. 


WHAT A GRAND IDEA

\"A Great Coach has to have a Patient Wife, A Loyal Dog, and a Great Quarterback. . . . but not necessarily in that order\" ~ Coach Bud Grant

doobiedoright

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#1 : May 21, 2010, 11:44:24 AM

Barney Frank and chriss dodd should be investigated and charged for what they have done!
Frank in particular should be looking at a very long stay in the pookie,then again odds are he would love that!


John Galt?

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#2 : May 21, 2010, 02:07:42 PM

I'm all for liquidating Fannie and Freddie. Let's just take our lumps on this failed experiment now because those lumps are just going to get bigger. Better to take a couple hundred Billion dollar loss now than to pump another $400 Billion in, then another $400 B, then another, only to have it collapse anyway.

The truth is Fannie and Freddie are actually preventing private businesses from entering a huge market. Without F&F running with subsidized, below market value pricing, dozens of private firms could profitably enter the secondary Mortgage market and diversify the risk out among dozens of companies instead of just 2. F&F are preventing risk diversification and preventing competition. Get rid of them and let private firms find a way to make it work. The key is to insure that there are lots of firms in it and that no one firm dominates.


Biggs3535

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#3 : May 21, 2010, 02:17:55 PM

Get rid of them and let private firms find a way to make it work.

Agreed.

I'm pretty sure the gov't doesn't want to start testing out those waters, though.


kevabuc

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#4 : May 21, 2010, 02:24:10 PM

I thought collateral was supposed to be the one of the main guarantees against risk for mortgage companies, not government backing.

\"The budget should be balanced; the treasury should be refilled; public debt should be reduced; and the arrogance of public officials should be controlled.\" -Cicero. 106-43 B.C.

John Galt?

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#5 : May 21, 2010, 02:35:25 PM

I thought collateral was supposed to be the one of the main guarantees against risk for mortgage companies, not government backing.

You mean the system that worked fine for 500+ years?

That's no good because there isn't enough control of the system. See if the government backs the mortgages then they can have better control and government control is always better because the government is perfect and never makes mistakes.

Surely you wouldn't want us to go back to the way things were in the 90s and 80s and earlier. things are so much rosier now. It's for our own good, all that economic growth and jobs and stable prices were holding people down.


dbucfan

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#6 : May 21, 2010, 10:00:55 PM

I'm all for liquidating Fannie and Freddie. Let's just take our lumps on this failed experiment now because those lumps are just going to get bigger. Better to take a couple hundred Billion dollar loss now than to pump another $400 Billion in, then another $400 B, then another, only to have it collapse anyway.

The truth is Fannie and Freddie are actually preventing private businesses from entering a huge market. Without F&F running with subsidized, below market value pricing, dozens of private firms could profitably enter the secondary Mortgage market and diversify the risk out among dozens of companies instead of just 2. F&F are preventing risk diversification and preventing competition. Get rid of them and let private firms find a way to make it work. The key is to insure that there are lots of firms in it and that no one firm dominates.

That is my feeling as well. 

\"A Great Coach has to have a Patient Wife, A Loyal Dog, and a Great Quarterback. . . . but not necessarily in that order\" ~ Coach Bud Grant

FortMyersDave

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#7 : May 21, 2010, 10:40:19 PM

And on top of what y'all said; wasn't Senator Dodd caught in taking some damn good loans in finance which would normally land a simple citizen in jail????  I believe that is the main reason that the old fart is leaving his senate seat open for the Tea Party Candidate (wife of Vince McMahon) and the @-hole Demo who lied about serving in Vietnam....       
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