Fannie and Freddie: Homeownership at whose expense?(Read article summary)
Fannie and Freddie are stimulating the creation of credit and indebting homebuyers at the expense of the highest-income-earning taxpayers.
Manuel Balce Ceneta/AP Photo/File
Baltimore, Maryland â€” The original mission of Fannie Mae when it was created in 1938 was to stabilize the badly battered home mortgage market of the Depression with a focus on first-time homebuyers.
The idea was that banks could create loans and sell them to Fannie Mae, freeing up balance sheet capacity. Like many government programs, initially success may be evident, but as in the â€śopen-ended fallacyâ€ť that economist Thomas Sowell exposes, monstrous results can emerge as momentum for more subsidization builds.
Yes, the new agencyâ€™s presence created more loans. But the cash had to come from somewhere, and that somewhere was the federal government and its tax revenue, which under Roosevelt saw income tax rates raised overall and sharply boosted for high brackets.
The combined result would be smaller private sector consumption and expanded government take, and a more indebted consumer. After the economy emerged from the Depression era, this and the tax deductibility of interest continued to increase leverage and homeownership.
Home ownership increased as the innovation of the long-term fixed-rate mortgage caught on in the postwar housing boom, which was partly kickâ€“started by the release of accumulated savings of soldiers returning from the battlefront (and reduced down payment requirements).
From 1940 to 1965, homeownership expanded from 44 to 63 percent. Note that its good intentions were hardly felt in the 1930s when the effect was needed, but its ill effects have now reverberated generations later.
Since the secular trend towards the democratization of credit began decades before the depression, it is arguable whether Fannie Mae was necessary for continuance of the trend. However, even if that is assumed to be so, what occurred after Fannie Mae was privatized in 1969 and Freddie Mac was chartered a year later, to provide competition, is instructive.
The new face of Fannie Mae and its clone turbocharged growth. These institutions enjoyed the access to capital from the public equity market, but their special status (line of credit with the government, no SEC oversight, and a government guarantee that gave these entities a lower cost of funds than their private market rivals) was preserved.
Armed with these advantages, GSEs increased their book of business from $13 billion in 1965 to $1 trillion by 1990 and $3.4 trillion in 2003. Once the great real estate bubble had concluded by year-end 2007, Freddie and Fannie combined had purchased $4.9 trillion of mortgages, repackaging 70 percent of these into guaranteed securities for the secondary market.
This (along with Ginnie Mae) gave the GSEs roughly half of the $11 trillion mortgage market, but their share of new originations has become near dominant.
Many sources peg this at 70 percent, but an interesting take from TIME magazine business and economics columnist Justin Fox takes into account the impact of refinancings into GSE-backed loans. Juxtaposing GSE total volume ($ 539 billion) against new originations ($313 billion), GSE market share was 172 percent for the first quarter of 2008.
Just as in the Depression, the GSEs are stimulating the creation of credit and indebting homebuyers at the expense of the highest-income-earning taxpayers. Homeownership topped out at 69 percent in 2004 and stood at 68.4 percent in September 2007, not having increased much from its 63 percent level nearly 50 years ago when the government restructured the agencies to promote their growth.
Citizens know that owning real estate in an environment when credit expansion under a fiat currency has devalued the purchasing power of the dollar by over 60 percent since 1980 has made real estate an enticing investment, particularly if it can be leveraged 4:1 with low interest rate fixed debt.
The increase in primary mortgage credit, rather than promoting homeownership, wound up escalating prices beyond the reach of many of the firstâ€“time homebuyers it was intended to subsidize.
Moreover, the credit availability made itself felt through higher loan-to-value ratios and diversion into consumption. When house prices ran up sharply between 2001 and 2007, homeowners extracted a staggering $8 trillion of equity from their homes, all a tax-free stream of cash, which is now quite material relative to the overall value of residential real estate ($20 trillion). $8 trillion is a lot, more than half a yearâ€™s GDP, and it distorted signals to businesses, which expanded and repurchased shares.
Individuals saw the rising fortunes and bullishly invested in the stock market. Sadly this withdrawal closes the gap between financing and the now reduced value of properties.
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