Economists' Outlook

Housing stats and analysis from NAR's research experts.

Fannie Mae and Freddie Mac: the mere mention of them arouses passionate anger in many people.  Rightly so.  These two entities, which had taxpayer guarantees, ran their businesses as if they were privately owned.  Fannie and Freddie made huge bets on the housing market.  If it had been their money and their loss, then there would be no problem.  But their mistakes took taxpayers down as well.

What went wrong and what needs to happen?  Fannie Mae was born from the Great Depression in the 1930s to help bring mortgages to the ailing housing market of the time.  Fannie was a government corporation (not a private corporation) with the single mission of increasing liquidity by buying up soundly underwritten mortgages.  Because of Fannie and its government status, 30-year fixed rate mortgages became widely available.  Canada and Britain, for example, do not have long-term mortgages, or least not at low cost, because they do not have a Fannie equivalent with government guarantees.

Fannie, as a government corporation, like the current the Federal Reserve for example, never needed taxpayer funding because its revenue always covered its cost of operation.  Fannie was a very boring entity with very boring business model, always playing behind the scene of the housing market.

Then around 1970, Fannie was privatized.  Freddie was introduced as a government sponsored enterprise at around this time to add some competition to Fannie.  Even though the companies were private – with the right to pursue profits for shareholders – both still carried an implicit government backing in the marketplace, which we know in retrospect to have been an explicit government backing.  But the mangers of Fannie and Freddie, even though they had easy borrowing costs because of their government ties, thought of themselves as profit-maximizers and were slowly and increasingly gambling with taxpayers’ money.  During the good years, huge multi-million dollar bonus checks were paid out to managers.  For many years, the Washingtonian magazine, which carries light local news about local events and restaurant recommendations, named Fannie and Freddie as two of the best places to work in the Washington D.C. area, evidently suggesting great perks to employees.

Then the housing market crash happened.  And lo and behold – taxpayers were on the hook for massive losses.  Such entities, with perverse incentives and the ability to mete out private profits during good times and taxpayer losses during bad times, should never have been permitted.

Currently the discussion is now over the reform, restructuring or even elimination of Fannie and Freddie.  We should very mindful of what worked and what did not. What worked is the pre-1970s model as a government corporation that took a behind-the-scenes role.  What did not is the strange model of private profit with taxpayer backing.

If the eventual goal is to make Fannie and Freddie into pure private companies then we should expect higher mortgage rates, more short-term mortgages, and the occurrence of total market freezes in times of a financial market crisis.  Ask any commercial real estate practitioner about commercial mortgages in the past few years, mortgages which do not carry government backing.  Ask jumbo loan borrowers about the mortgage rate they pay because of the purely private jumbo mortgage market.  In addition, large ‘purely private’ financial institutions will always be considered too-big-to-fail and taxpayers will be asked to come to the rescue at some point in the future.

If the restructuring is to return these entities to their status as a government corporation then we will have steady mortgage liquidity, continuing availability of 30-year fixed rate mortgages, and probably no taxpayer bailout (as happened prior to the 1970s and like the Federal Reserve today).

It is my view that government can never produce interesting consumer products.  A government bureaucratic culture is too stifling for entrepreneurs and innovators.  The Apple iPhone, for example, simply could not be produced out of Washington.  However, there is something that government may be good at and that is producing a boring product.  There is next to nothing as boring as a 30-year fixed rate mortgage.  It requires no innovation.  If consumers have demonstrated good credit and are willing to stay well within their budget, then the 30-year fixed rate mortgage is one of the safest financial products on the market.  And because of the government corporation status, consumers will be able to tap mortgages at a lower rate than would be possible under a pure privatization model.  If the 30-year fixed rate mortgage was good for grandpa then it will be good for our grandkids in the future.

Though Fannie and Freddie still report headline financial losses because of legacy assets on the books from the housing bubble years, they have been raking in good internal profits on new mortgages underwritten for taxpayers since being taken over by the government in 2008.  Fannie and Freddie, in other words, have in essence acted as if they are a government corporation and good bottom-line results have been flowing out for both consumers and taxpayers.  That is why NAR is opposed to the pure privatization of Fannie and Freddie.

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