By Alan White
Die-hard free market advocates are responding to the nationalization of Fannie Mae and Freddie Mac by calling for them to be gradually shrunk out of existence, to unleash the private market to meet our housing finance needs. This appalling proposal completely ignores the clear lessons of the crisis unfolding all around us.
Fannie and Freddie have provided American homeowners with low-interest, safe, fixed-rate long-term mortgages for the past seventy years. In the last decade their share of the mortgage market did not grow too big, indeed it shrank. Why? Because the private securitization market grew dramatically, offering high-interest subprime and alt-A loans. The advocates of eliminating the public role in mortgage finance are thus advocating that we rely solely on a private mortgage finance system that lately brought us 2/28’s, NINJA loans (no income no job no assets) and Payment-Option ARMs.
Why did the private label securitization market produce such unsustainable and unsuitable mortgage products? Yield. While Fannie and Freddie were able to make modest profits buying safe affordable mortgages at interest rates as low as 6% and selling them to investors with yields just slightly lower, the appetite of private capital for higher yields and yield spreads stimulated mortgage originators to sell more expensive loans. The higher interest rates of alt-A and subprime loans were pushed on American homeowners by telling them higher rates were required by their weak credit, or in return for the convenience of not making a down payment or documenting income. In other cases higher rates were sold to homeowners through deception and fraud.
Why did Fannie and Freddie become destabilized? It was because of their private nature, not because of their implicit public nature. As servants of shareholders, the GSE’s sought higher yields, by, among other things, investing in subprime mortgage-backed securities, something a truly public mortgage finance agency should never have done. Of course, Fannie and Freddie’s portfolio of safe conventional and FHA loans has also been eroded by the decline in home values, but that alone would not have pushed them to the brink of collapse.
While it is clearly not necessary to have the GSE's buying $700,000 mortgages (the result of the recent increase in their loan cap) they are essential to provide home financing for the low end of the market. Americans need to understand that affordable homeownership has been the product of public programs, including the Homeowners Loan Corporation, the F.H.A., and the creation of mortgage-backed securities markets by Fannie Mae and Freddie Mac as government institutions. The private mortgage finance market has brought us the subprime collapse. If we had to rely solely on the private market for mortgage capital right now, there would be no mortgages in America. The private-label mortgage securitization market has been out of business for nearly a year. The private capital markets have not funded American homes by themselves since the 1920s. The way out of the crisis requires strong public housing finance agencies, properly regulated to focus their mission on providing safe affordable mortgages, not ideological fantasies about unleashing the free market.
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