The Real Shame About Fannie & Freddie
Credit given by dealers to unproductive consumers is never an addition, but always a detriment, to the sources of public wealth. – John Stuart Mill, Principles of Political Economy
Solvency questions at government-sponsored mortgage firms Fannie Mae and Freddie Mac have roiled the markets in recent weeks. Due to the massive exposure banks and financial institutions the world over have to the formerly safe shares issued by the mortgage giants, there has existed the fear that Fannie and Freddie’s federal minders would “nationalize” them a la Bear Stearns with equity holders left holding very little. The debt issued by both was never really a question, and sure enough the government’s implicit backing was made explicit as expected.
For the above alone, Fannie and Freddie’s problems are a major shame. Thanks to the guarantees that are part and parcel of institutions chartered by the federal government, they were able to overextend themselves in the mortgage market, and in the process they’ve helped discredit capitalism. Even though their activities had nothing to do with true capitalism, this hasn’t kept the E.J. Dionne’s of the world from proclaiming that today’s problems are rooted in too much economic freedom, as opposed to the reality that capitalism today is increasingly of the big-government variety.
But the bigger shame when it comes to Fannie and Freddie involves the longer-term economic harm that results from too much capital flowing into the ground. Founded to increase mortgage-market liquidity in the U.S., Fannie and then Freddie were supposed to foster greater “community” in the United States given the broadly held view that homeowners are better, more invested citizens. If we ignore the extra-Constitutional nature of such government activity, not to mention that equity holdings presumably “invest” us just as much in the U.S., we can then address the problems that result from government doing what it should not.
On the capital front, even though anyone with a pulse always knew that taxpayers would be on the hook if problems arose at Fannie and Freddie, their bonds were always a great investment for offering more yield than government-backed Treasuries of the same maturity. Thanks to their presumed government guarantee, Fannie and Freddie bonds have logically attracted far more investment than they would have in a free economy.
The above was and is problematic considering that we live in a world of limited capital. Fannie and Freddie themselves pull in a great deal of investment, plus private banks have greater incentives to make loans in the housing space with full knowledge that our government-sponsored institutions will be there to provide massive liquidity in the secondary mortgage market.
Taking nothing away from the necessity that is shelter, the extra subsidies have given us an unseen economic retardant. Indeed, when subsidies drive increased capital flows to certain sectors, others go wanting. What will never be known is how many Microsofts and Googles were strangled at infancy due to capital that was consumed in the housing market as opposed to making its way to job-creating businesses and entrepreneurs.
Simply put, subsidies distort investment flows, and with housing a heavily subsidized sector, capital that might have found its way to entrepreneurs in an economy not muddled by government intrusion found its way to the unproductive sector that is housing. When John Stuart Mill wrote about unproductive consumption, housing was at or near the top of his list.
Sadly, the story gets worse. With U.S. residential property worth just south of $21 trillion (easily exceeding the total stock-market worth of all public companies) as of last year thanks to land-use rules, its preferred status among our leaders in Washington, and the ever weakening dollar, it is increasingly the main source of wealth for most households. This is problematic from an asset diversification standpoint, particularly during times of housing uncertainty, but it’s most enervating for keeping many Americans stationary in an economy that is not.
Sure enough, with some Americans logically reluctant or unable to unload what might be their best investment, many feel the need to stay in one place despite the fact that capital moves at lightning speed, and with very little regard for the past residential choices of most Americans. No doubt many residents of Michigan and Ohio would like to move where economic opportunity is greater, but home ownership has become the proverbial ball-and-chain that makes following capital and opportunities difficult.
So not only is the housing subsidy that Fannie and Freddie represent unfortunate for distorting capital flows, it’s probably most harmful for discouraging the more robust migratory patterns that would enable our economy to grow in the most optimal way. Indeed, that Fannie and Freddie are effectively insolvent is almost beside the point. We should expect that from institutions whose successes are private, but whose losses are shared by the public.
Going forward, once the bailout of what’s been a government-created mistake is complete, Fannie and Freddie should be sold in order to shed any ties to the federal behemoth that created them. Additionally, the subsidies that are mortgage-interest deductions and tax-free sales should be normalized so as to make them no more enticing than that offered by equity investment.
As for our political class, here’s hoping the bi-partisan and politically correct notion suggesting everyone should own a home goes the way of Prohibition, “stimulus” and other bad ideas foisted on us by Washington throughout history. While housing is an essential good, government efforts to make ownership universal have redirected money away from the productive economy, all the while slowing the necessary movement of human capital in a world of fast-moving financial capital.