Life Without Fannie and Freddie

Life Without Fannie and Freddie

A new study shows only a modest effect on the housing market.

In the Wall Street Journal

The housing-industrial complex spends so much money lobbying to maintain federal mortgage subsidies that it’s easy to forget how little they matter to the average borrower. A recent report from the Congressional Budget Office does a public service in showing how easily the U.S. could transition to a free market that doesn’t threaten taxpayers.

Last week CBO released a paper exploring various options for reform of mortgage financing. One alternative CBO studied is to allow private companies to replace Fannie Mae and Freddie Mac , the two government-created monsters that guarantee mortgage-backed securities and contributed so much to the 2008 credit crisis.

Under this scenario, Fan and Fred would gradually increase the fees they charge to provide these guarantees, and gradually reduce the number of loans that qualify. By the end of a decade, Fan and Fred’s market share of new mortgage guarantees would be zero. And most consumers would barely notice the difference.

According to CBO, borrowers who took out Fannie- or Freddie-backed loans early in the transition “would pay interest rates that were 20 basis points higher than they would pay under current policy. That differential would continue to increase, so by 2024, borrowers who took out federally backed mortgages would face rates that were 60 basis points higher than they would be under current policy.” And that’s about the increase that borrowers would pay in the private market, too.

In other words, shutting down the two firms and letting taxpayers off the hook would add much less than a percentage point to rates for borrowers. As CBO notes, such rate increases would be “smaller than the fluctuations in market interest rates that occur in most years. For example, rates on conforming 30-year fixed rate mortgages rose from less than 3.5 percent in January 2013 to 4.5 percent in July of that year, or more than 100 basis points. Mortgage rates moved a little less during the first 11 months of 2014, when they stayed between 3.9 percent and 4.5 percent, a range of 60 basis points.”

But what about home values? Would the end of subsidies channeled through Fan and Fred cause home values to crack? CBO’s analysis says that house prices might be “2.5 percent lower than they would be under current policy.” If that’s a catastrophe for a mortgage customer, it’s probably because he put too little down and borrowed too much. And lower home prices would make housing marginally more affordable for renters and first-time buyers, which is supposed to be the point of the federal subsidy scheme.

CBO points out other benefits to getting rid of Fan and Fred, notably that “privatization would probably provide the strongest incentive for financial institutions to be prudent in their lending and securitizing because private investors, rather than taxpayers, would bear all losses.” Bravo to that one. CBO also notes that competition would mean less reliance on any one entity in a market and greater innovation.

Under the scenario sketched out by CBO, as the toxic twins disappear, private investors could once again take a leading role in the market. But the Federal Housing Administration would still exist to subsidize first-time home buyers and CBO figures they would soak up a portion of the business that used to belong to Fan and Fred. So the taxpayer wouldn’t be entirely out of the woods.

CBO estimates that, under current policy, FHA loan volume over the next decade will be more than $2.2 trillion for single-family mortgages, and more than $3 trillion if Fan and Fred are phased out. But if that transition succeeds, why couldn’t private investors also replace taxpayers in the FHA market segment?

The housing lobby likes to pretend that 30-year fixed-rate mortgages would hardly exist without a federal guarantee, or would only be available to borrowers at extremely high prices. CBO’s report makes it much tougher to sell that fairy tale.

This could be helpful to Rep. Jeb Hensarling and other Republicans who want to put Fan and Fred out of our misery in the new Congress. Such an effort will be difficult given the housing lobby’s hooks into both political parties, but the reformers have the evidence on their side. Even the Keynesian economists who run CBO recognize that the U.S. can have a vibrant, affordable housing market that better protects taxpayers against the systemic risks known as Fannie and Freddie.