Personal Finance: Time to euthanize Fannie and Freddie

Personal Finance: Time to euthanize Fannie and Freddie

August 21st, 2013 Chris Hopkins in Business Diary

Chris Hopkins

Photo by Patrick Smith/Times Free Press.

Fannie Mae and Freddie Mac played a central (but by no means exclusive) role in the financial crisis. Through a combination of misguided policy, political cronyism, greed, and good old-fashioned mismanagement, these two massive government-sponsored enterprises nearly collapsed under the weight of subprime loan defaults and excessive leverage. The entities required a $189 billion taxpayer bailout and were taken over by the government in an effort to head off a total collapse of mortgage lending in the United States.

But the most damaging consequence has been the near annihilation of private lending in the U.S. housing sector. The outsized role of Fannie and Freddie (in conjunction with other well-intentioned but detrimental government interventions) is impeding the orderly functioning of a large chunk of the economy. Five years after the meltdown, the time has come to phase out the GSEs and allow the market to operate.

Economic forces in the U.S. housing market are more distorted by federal interference than in practically any other sector except healthcare. Half of all outstanding home mortgages are either held or guaranteed by Uncle Sam's new wards, Fannie Mae and Freddie Mac. Since the financial crisis, something approaching 90 percent of all new loans have been bankrolled by these same two entities. But mortgage finance is just one of the many ways in which government support for home ownership impedes healthy functioning.

The mortgage interest deduction is a tax subsidy awarded to home owners, at the expense of renters who do not benefit from the deduction. Property taxes are also deductible, as is interest on home improvement loans and some real estate transaction fees. And capital gains on the sale of a primary residence are exempt from taxation up to $500,000 for a married couple every two years. These perks to homeowners accrue disproportionately to higher-income households with larger loans. But more importantly, they distort the behavior of both buyers and lenders and ultimately reinforce the type of boom and bust cycle that culminated so explosively in the 2008 crisis.

It has often been alleged that the Great Recession was the inevitable consequence of unrestrained free market excesses. To the contrary, the seeds of the collapse were sown in the ubiquitous government suppression of economic forces (including the Federal Reserve's pro-housing interest rate policy) that encouraged over-investment in residential real estate and under-pricing of risk. Artificial stimulus kept the party going for a while, but once it blew, the damage was widespread and abiding.

At last, it seems the opportunity for necessary reform may be at hand. President Obama has voiced agreement in principle with Republican lawmakers seeking to systematically eliminate the role of Fannie and Freddie. The devil is in the details, but the objective of wrestling these behemoths to the ground and reinvigorating private lending is crucial to restoring a robust and sustainable housing market.

Home ownership can be a worthy goal for some families, depending upon their specific circumstances and the expected length of their occupancy. But if there is anything we have learned from the financial crisis, it is that excessive intervention by policymakers in the housing market led to massive economic distortions and ultimately to catastrophic financial consequences for millions of households. Winding down the GSEs and restoring critical market discipline to mortgage lending is an essential step.

Next week, we look at proposals to phase out Fannie and Freddie.

Christopher A. Hopkins, CFA, is a vice president for Barnett & Co. Investmet Counsel in Chattanooga.