America Doesn’t Need Government Sponsored Businesses

Members of Congress and the mortgage industry say they are baffled by the administration’s recent statements about Fannie Mae and Freddie Mac. But given the administration’s chaotic economic policy, it’s surprising that these conflicting comments have baffled anyone.

The main source of confusion is that the administration seems to want to end the companies’ conservatorship while keeping them under government control. Obviously, that approach borders on an incoherent policy. However, the administration hasn’t yet released a plan, so it might be worthwhile to wait and see what they come up with.

On the other hand, the administration does seem to revel in this kind of incoherence. For instance, it is true that the administration has espoused some free market economic principles. But it’s hard to see where they’ve applied those principles. At best, the administration has used those principles very unevenly.

If, for example, the administration really is against “a dictatorial government that tells certain industries they’re not allowed to do what they need to do,” then getting the government out of housing finance is the way to go. But the first Trump administration failed to end the conservatorship, so there’s even less reason to think they’ll really get the government out of the housing finance system.

Private Profit with Socialized Loss is Not Free Market

Unfortunately, that means the administration will ultimately leave the core of the government-sponsored enterprise problem completely unchanged. That is, Americans will still have a government-driven system that privatizes profits and socializes losses. Put differently, Americans will be left with the same highly flawed system that imploded in 2008.

Neither the administration nor Congress is likely to correct the mistake, but the federal government should never have become so involved in housing in the first place. There was only one direction that involvement would go, and the difficulty in ending the conservatorship is just further proof.

The GSEs’ roots go back to the New Deal era, when Congress authorized the creation of privately funded “national mortgage associations” to buy federally insured (by the newly created Federal Housing Administration) mortgages. Just like with many other programs during that time, the idea was to bolster the banking and construction industries, creating more jobs.

But when nobody formed any of these associations, the Reconstruction Finance Corporation (created by the Hoover administration) did it. The RFC chartered the National Mortgage Association of Washington, and then promptly changed its name to the Federal National Mortgage Association, giving birth to Fannie Mae (using the letters FNMA).

Federal Policy has Liberalized Credit Terms for Decades

At first, the many different players in the housing industry were against more government involvement, but eventually everyone got on board. Having a steady flow of funds, it turns out, is great for business.

Until World War II was over, Fannie remained something of a bit player in the housing market, but by 1953 it had a $2.5 billion portfolio. (Total federal expenditures were $72 billion.) Some in the Eisenhower administration wanted a smaller role for the federal government in housing, but by this time the government was entrenched. The only question was exactly what that involvement would look like going forward.

Even though the Housing Act of 1954, signed by President Eisenhower, allowed Fannie to raise private capital, the law contained vague language on privatization. The law failed to set any kind of deadline or outline a process, so Fannie was never privatized.

More importantly, by this time, the federal government and the financial industry were fully invested in “growing availability of mortgage funds on more liberal credit terms.” While only about 8 percent of U.S. Department of Veterans Affairs loans in 1953 were made with no downpayment, that figure shot up to more than 28 percent in 1954, with a similar rise in maturities.

The 1954 Act also permitted the FHA to insure larger loans with smaller downpayments and longer terms. After signing the bill, Eisenhower predicted the changes would “raise the housing standards of our people, help our communities get rid of slums…strengthen our mortgage credit system…[and] also strongly stimulate the nation’s construction industry and our country’s entire economy.”

In 1958, President Eisenhower signed an “anti-slump” bill that gave $550 million to Fannie Mae to buy mortgages for urban renewal projects, as well as another $300 million for direct Veterans Affairs housing loans. It included “up to $1.85 billion” in government funds to help build “another 100,000 houses, create 500,000 new jobs…and lay a solid floor under those sagging industries that lean heavily on home construction.” Urban renewal was in full swing.

Fannie and Freddie Were Always Sponsored by the Government

By 1968, the federal budget was such a big problem that President Johnson reorganized Fannie Mae again. This change did not privatize Fannie and, if anything, it cemented the GSE model.

The newly reorganized company still had a $2.25 billion line of credit with the U.S. Treasury, an exemption from state and local income taxes, and an exemption from Securities and Exchange Commission registration. The law also allowed the U.S. president to fire its directors and let federally regulated banks buy unlimited amounts of Fannie’s debt, giving it equal regulatory treatment with U.S. Treasury securities.

Bond markets, faced with the obvious truth that Fannie was not really a private company, referred to its debt as “agency” debt, with a subtle difference from Treasury debt.

In 1970, President Nixon signed the Emergency Home Finance Act of 1970, allowing Fannie Mae to buy conventional mortgages (those not insured by the federal government). The law also created Freddie Mac, a whole new GSE designed just for the Federal Home Loan Banks.

By the end of the 1970s, the question of the GSEs’ public purpose versus private profit was as cloudy as ever, and the vested interest groups had successfully walled off the GSEs from privatization.

Limited Government Trumps Public-private Cooperation

It should surprise nobody that the companies were able to avoid full receivership and liquidation after they failed in 2008. Everyone with an interest in keeping money flowing into the housing industry, especially with some kind of government backing, had been getting rich and wanted more. As the administration moves closer to some kind of release from conservatorship, those voices will only get louder.

It’s critical, though, that Americans remember how they got to this point—a toxic mix of public-private cooperation that increasingly privatized profits while saddling taxpayers with more risk and the resulting losses. The losses that taxpayers were forced to pick up after 2008 are very easy to see.

By 2009, Fannie had reported 10 straight quarterly losses. The cumulative losses for 2009 were $72 billion, the size of the entire federal budget when Eisenhower reorganized Fannie. By 2012, the U.S. Treasury had lent nearly $450 billion to the two failed GSEs.

Separately, between 2008 and 2010, the Fed purchased $175 billion in GSE bonds and $1.25 trillion in GSE mortgage backed securities. The $1.25 trillion accounted for between 50 percent and 70 percent of the GSEs’ monthly originations.

The social costs of the GSE system have been huge—without a comparable benefit—because elected officials have repeatedly failed to stick to the principles of limited government and free enterprise. The costs will continue to climb if they keep making the same mistake, and it shouldn’t baffle anyone.