Do We Need Fannie and Freddie?

Fannie Mae and Freddie Mac back more than 90 percent of home loans today, but do we need them to?


The United States doesn't need government-sponsored enterprises such as Fannie Mae and Freddie Mac to sustain the housing market. At least that's what Anthony Sanders, professor of real estate finance at George Mason University, told the House Subcommittee on Capital Markets and Government Sponsored Enterprises last week.

Because government-sponsored enterprises (GSEs) back more than 90 percent of all home loans today, they have crowded out private sector lending and distorted the housing-finance landscape, he says. "Fannie and Freddie will not be missed, nor will their absence make a difference to the housing market or the economy, particularly if taxpayers are no longer on the hook for further losses," Sanders testified.

Since the housing bubble burst, the government has spent more than $160 billion of taxpayer money to shore up the mangled finances of the two federal mortgage giants. The Obama administration has said it plans to wind down the influence of Fannie and Freddie to trim the government's role in the housing market, and Congress has invited several housing market experts to offer opinions on the best ways to limit government involvement. Sanders presented seven proposals to the House subcommittee to facilitate the transition, including requiring Fannie and Freddie to dispose of assets not critical to their mission and capping bailout funds to the distressed duo at $200 billion.

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U.S. News recently spoke with Sanders about the outlook for Fannie Mae and Freddie Mac. Excerpts:

What do the next few years look like for GSEs?

Over the next few years, there is much to be done with the GSEs. I recommended a five-year wind-down period. It will be slow to start, simply because the housing market—in part because of the GSEs—is in such fragile shape right now.

The concern from both sides of the aisle is that any massive disruption would be bad for the housing market and consumers. I don't agree with that. There's enough concern from the Democrats and some Republicans about removing the government subsidies to the housing market. Even HUD [U.S. Department of Housing and Urban Development] has acknowledged that we've oversubsidized the housing market and we really should be withdrawing that.

Does that mean there's no place for government subsidies in the housing market at all?

We have the FHA, which is primarily for first-time home buyers, but everyone forgets that HUD has Section 8 and has a big multifamily support mission. It's not as narrowly defined as some people say it is.

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What's the problem with a GSE-dominated mortgage market?

Fannie and Freddie used to be the gold standard for mortgage lending. They're not lenders, but they would buy high down-payment, high credit-score loans. Why does the government need to be in that market? The private sector can purchase high down-payment, high credit-score loans with private mortgage insurance or other types of credit enhancements.

Here's the problem. When the government is in that space, they crowd out and drive away the private market. As a matter of fact, they drove them into the risky mortgages. So we sit here today and the private market is not functioning in terms of securitization. We stuck them in the risky space and it blew up.

How do we encourage private-sector lending?

Right now, Fannie and Freddie buy very high-quality loans, they have very tight underwriting standards, and then they apply the guarantee. We don't know yet how the world economy is going to receive mortgages without a guarantee.

There could be a very simple way to get the private sector back in. Why don't we have Fannie and Freddie do an experiment? Why don't they take those same high-quality mortgages that they're underwriting or purchasing and put them into new mortgage-backed securities without a guarantee? Put it up for bid and see what people bid on it.

Here are the two outcomes. If the premium paid by investors is, for instance, 1 percent. That's not really big in the general scheme of things. So that means the private market is ready to come back. [There have been] estimates that it's 3 percent. If that's true, that shows you how much government intervention in the housing market has done. [Investors] are going to want much bigger yields because they don't trust us anymore. That experiment would do the trick.