Could Frannie Have Prevented the Housing Bubble?

Dean Baker is right that the failure of Fannie and Freddie was due to the incentives that being private corporations gave them to take excess risk.

In the future, Fannie and Freddie can best serve their role of providing the stable anchor of the secondary mortgage market by being boring government corporations.

But I think he goes too far when he blames the whole bubble on Frannie.

If Fannie and Freddie had begun to tighten credit five or six years ago, when house prices were already clearly out of line, they could have stopped the growth of the bubble before it reached such dangerous proportions.

I'm not sure what he means by "tighten credit" here, but he certainly seems to imply that sans Fannie and Freddie the bubble wouldn't have expanded so far:

Perhaps the private sector would have created a secondary mortgage market on its own, but it didn't. Furthermore, private issue mortgage backed securities have performed far more poorly in the current crisis than the securities issued by Fannie and Freddie.

The problem with this argument is that the property bubbles in countries without Fannie and Freddie -- Ireland, UK, Spain, South Africa, you name it -- were even bigger than the property bubble in the US. Given US monetary policy, global liquidity conditions, and a society obsessed by home ownership, a bubble was going to happen, Frannie or not.

Comments

[freemarkets...:]

There are so many ways in which our public policies funnel too much investment into what is, really, consumption. Tax policy tells individuals they would be utter fools not to buy a bigger house than they really need, given the deduction for mortgage interest and real estate taxes and the exemption for capital gains on houses. Many other local and federal programs funnel even more money, directly and indirectly, into housing, and not just for those who cannot afford to pay for their own housing. It is little wonder the country became drunk on subsidies for housing and that we are all enduring the hangover now.

Fannie and Freddie did exactly what any profit-maximizing business with an implicit government guarantee that reduced its borrowing costs would do. They expanded their market share so long as there was money to be made doing so, ultimately squeezing out everyone else, for all practical purposes, in their very important part of the housing finance market. The government facilitated that expansion by allowing them to buy up ever larger mortgages and of ever weakening credit quality. Those homeowners who financed homes with "conforming" mortgages instead of "jumbo" mortgages received a benefit in the form of a significantly lower interest rate. Past investors and officers received a lot of benefit. They and everyone else will now pay the costs through tax increases, inflation to pay off the debt the government has now explicitly assumed, and the squeezing out of other opportunities by allocating resources to clean up this mess.

So no, Fannie and Freddie didn't create this mess. But their existence made the problem far more accute than it otherwise would have been, with a private market of a number of Fannies and Freddies.

2008 Sep 08 04:48 PM

[MarvinMBA:]

It was obvious a few years ago to any beginning student of economics that housing inflation was out of control and monetary/policy was nessasary to prevent additional abuse but this administration thought they could make everyone wealthy with a housing market ponzy scheme....yes take a loan on your house you just bought last week and buy a new car or a resort home with the one month appreciation you just received from your new home...its obvious it could not last and did not but where were the so called experts or were they listening to the Administration trying to keep things going to help the war effort and social programs..

2008 Sep 08 05:15 PM

[madasiwannabe:]

Fannie and Freddie were not alone in this. How about the friends of Anthony that got incentives for keeping the backdoor at Fannie open. It amazes me how the ones responsible for guarding the hen house (i.e OFEHO, treasury, Congress...) get a pass on taking responsibility. Mr. Syron told the world he understood the risk and ignored the Risk Officer because he has many more masters than the shareholders. Who do you think they are? Probably the same people that had the GSE's take on more risk so the banks could write more toxic loans. Someon other than the CEO's lowered the GSE's congressionally mandated capital requirements from 30 to 15%. To figure out how they got so big, one only needs to look at FHA right now. They are growing very quickly to keep the market moving.

Plain and simple... Fannie and Freddie got thrown under the bus to keep the spotlight off the administration.

2008 Sep 08 05:34 PM

[SilverLeaf:]

madasiwannabe: Sadly, I think there is potentially great truth in your conclusion.

2008 Sep 08 06:53 PM

[Ice:]

IMO the main reason we had a housing bubble beside Wall Street greed was the non-recourse mortgage system. This allowed speculators to enter the market with a free put. This made every family a speculator which did not carry its own downside risk. This create jingle mail, this creates people running away from spec' houses.

I am surprised how little attention this aspect of the credit crunch gets in the general media, in the blogs and by the opinion leaders (like yourself)

2008 Sep 08 08:26 PM

[fatcat:]

Mr.Salmon,you are submitting far too many subpar articles here...

2008 Sep 08 08:51 PM

[johnthebear:]

DID YOU KNOW THAT FANNIE AND FREDDIE GAVE $174,000,000 SINCE 1998 TO CONGRESS SO THEY WILL LOOK THE OTHER WAY?

THEY (f&f) KNEW WHAT THEY WERE BUYING,

THEY KNEW THE APPRAISALS WERE PHONY

THEY KNEW THE BORROWERS WERE LIARS

THEY KNEW THE BANKS GOT HUGE FEES

TO MAKE BAD LOANS!

THEY ALL HAD THEIR HAND IN THE PURSE.

CONGRESS GOT IT'S PAYOFF AND THE

AMERICAN PEOPLE ARE THE LOSERS.

THE BEST DAYS OF OUR COUNTRY MAY BE BEHIND US BECAUSE THE LIBERALS REFUSED TO ALLOW US TO DRILL FOR OIL, REFUSED NUKES AND INSISTED ON DECLARING THE WAR LOST (HARRY REID) AND DID EVERYTHING THEY COULD TO LOSE THE WAR BY CUTTING FUNDING FOR THE WAR (J. KERRY), JUST LIKE THEY DID IN VIETNAM.
WE HAD THAT WAR WON, BUT REFUSED TO WIN.

LIBERALS ARE THE DOWNFALL OF AMERICAN.

PLEASE PRAY THAT GOD WILL HELP US, BECAUSE NOT EVERYONE IS A GODLESS SINNER. WE ARE ALL BEING PUNISHED FOR LIBERALS SIN, AND THEY REFUSE TO REPENT!

2008 Sep 11 01:23 PM