An Interview with Matthew Richardson, one of the authors of Guaranteed to Fail
What role did Fannie Mae and Freddie Mac play in precipitating the
Fannie and Freddie contributed to the Great Recession through both of the economic functions that they play in mortgage finance. In their portfolio or investment business, they increasingly held high-risk mortgages with very high loan-to-value ratios (and securitized assets backed by such mortgages), especially from 2003 to 2007. In their guarantee business too, they expanded their activities by substantially lowering their underwriting standards. This expansion was financed largely with debt that was implicitly backed by the U.S. government and supported with inadequate capital for the increasing risk of their mortgages and guarantees. Fannie and Freddie's expansion contributed to the housing price bubble, and the subsequent deflation resulted in massive losses, which had to be backstopped since the two enterprises were too big and too interconnected to fail. As of now, the losses for U.S. taxpayers have accumulated to $150 billion.
Don't Fannie and Freddie play an important role in making home ownership affordable to people who might otherwise be shut out of owning a home?
There is little evidence that Fannie and Freddie increased U.S. home ownership rates. Their primary effect has been to lower mortgage rates across the board, from which high-income households profited disproportionately. Internationally, countries that do not have Fannie and Freddie equivalents--and even have restrictions on the minimum quality of mortgages, such as a maximum loan-to-value ratio--exhibit home ownership rates similar to those in the United States.
Why has it been so difficult to reform Fannie and Freddie?
Fannie and Freddie have been a political football, tossed between the left and the right of American politics. They were the key tool for successive administrations to fight rising income inequality. During the recession, they were used to prop up the housing market and modify mortgages. Fannie and Freddie's activities, while enjoying the implicit and later explicit support of the government, were never explicitly recognized on the government's balance sheet. Absent such recognition, their enormous growth has allowed each successive government--under the ostensible purpose of supporting home ownership--to indirectly support housing-related borrowing and spending by households. Due to the unsustainable nature of such borrowing and spending, the housing markets have collapsed, and the costs have now materialized as the government honors the guarantees to Fannie and Freddie.
If policymakers could implement only one of your suggestions, which one should that be?
That would be to close Fannie and Freddie in the long run, starting with shutting down their portfolio or investment operation. There is no room for a government-sponsored multi-trillion-dollar hedge fund that is allowed to bet against economic catastrophes.
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File created: 10/13/2010