If you realize just how big a role Fannie Mae and Freddie Mac played in the Great Recession, you’ll likely find Shawn Tully’s latest Fortune magazine article disturbing.
On the morning of Feb. 11, 2011, Treasury Secretary Timothy Geithner gave a speech at the Brookings Institution near DuPont Circle in Washington, D.C., addressing the future of Fannie Mae and Freddie Mac. “We need to wind down Fannie and Freddie and substantially reduce the government’s footprint in the housing market,” he declared.
Geithner’s position enjoyed remarkably wide support from lawmakers, regulators, and economists across the political spectrum. The prevailing — virtually universal — view was, and still is, that the twin colossi of housing finance that stuck taxpayers with a $189 billion bailout bill after their collapse in 2008, that inflated the real estate bubble with artificially cheap credit and hence helped sink the U.S. economy, should never, ever be allowed to regain their former dominance.
Today, 2 1/2 years after Geithner’s principled pronouncement, Fannie and Freddie are bigger and more powerful than ever. Real estate is roaring back, and so are the players that, as much as any other, caused its crash. In fact, almost all the policy decisions that have been made since the government took control of Fannie and Freddie have failed miserably in the mission to de-emphasize their role in the economy — instead giving the pair unintended but powerful advantages and squeezing out private competitors. The two institutions, now essentially owned by the government, are virtually the whole show in the mortgage market, guaranteeing 80% of all new home loans in America. That’s almost double their market share before the credit crisis. In one of the strangest turns of events in the annals of business, Fannie and Freddie have rapidly morphed from epic money losers into unprecedented money machines. …
… [T]he housing market is now hooked, more than ever, on artificially cheap credit furnished by Fannie and Freddie.
The ultracheap mortgages Fannie and Freddie enable pose two towering problems. First, they’re almost totally squeezing out private lenders, which need to price their home loans for true credit risk. Despite its roaring comeback, real estate isn’t yet in a bubble again. But subsidized credit threatens to create a new one. Second, the new Fannie and Freddie still pose a huge risk to taxpayers. They are bizarre financial creations, designed to carry both practically zero capital and gigantic balance sheets supporting trillions in home loans — a recipe for another bailout in the future if there’s a new housing downturn.
To appreciate the extent of the threat, it helps to understand how government policy has empowered Fannie and Freddie at the expense of potential competitors. As we’ll see, everything from the Federal Reserve’s preferential purchases of Fannie’s and Freddie’s bonds to new regulations under the Dodd-Frank financial reform bill has penalized private lenders — and boosted the mortgage giants. A well-intentioned move to raise the rates they charge and thus even the playing field has instead helped create their profit windfall. Even as they boom, it’s unclear whether anyone in Washington has the will or the leverage to control the newly reborn Fannie and Freddie. Perhaps no quandary poses a graver threat to America’s economic future.
