Why Fannie Mae and Freddie Mac Survived

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One of the most interesting and uncovered stories these days is the survival of Fannie Mae and Freddie Mac - the giant housing entities created by the government and known collectively as the GSEs (government-sponsored enterprises). On Sept. 6, 2008, nine days before the Lehman Brothers bankruptcy, Treasury Secretary Henry Paulson put the GSEs into "conservatorship." This meant that the government would cover their costs because they were bankrupt. The government's aid ultimately totaled $187 billion.

Even in Washington, that's serious money, and it fostered an informal consensus: Fannie and Freddie had to go; taxpayers' exposure was too great. "This is an opportunity to get rid of institutions that shouldn't exist," former Federal Reserve chairman Paul Volcker said. The GSEs had been - it was widely assumed - "consigned to the dustbin of history," as financial writer Bethany McLean says in her new book, "Shaky Ground: The Strange Saga of the U.S. Mortgage Giants."

Well, not yet - and possibly never.

Remarkably, their importance today is unparalleled. In 2013, President Obama said that "our housing system should operate where there's a limited government role and private lending should be the backbone." Just the opposite applies now: Government dominates housing finance.

Here are the numbers. Fannie and Freddie provide government mortgage guarantees (i.e., if homeowners default, the GSEs repay mortgage investors in full). In 2015, GSE guarantees cover about half of new mortgages for home purchases; including other agencies - the Federal Housing Administration, which caters to lower-income borrowers, and Veterans Affairs - the government guarantees three-quarters of new mortgages. By contrast, the government's share in 2006 was slightly more than 30 percent, with the GSEs representing most of that.

We have effectively nationalized housing finance. Private money retreated, and the GSEs have returned to profitability - with all the profits going to the U.S. treasury. So far, these amount to $241 billion.

To be sure, some profits reflected one-time increases, says housing expert Jim Parrott of the Urban Institute. During the financial crisis, the GSEs overestimated their losses, resulting in huge write-offs. As the economy revived, it became clear that the GSEs had been too pessimistic. When some write-offs were reversed, profits temporarily surged. In 2013, they totaled $133 billion. But these profit bonanzas won't likely be repeated, says Parrott.

Still, the GSEs' underlying profitability has improved, though more modestly. Losses on loans made in the early 2000s have faded, while tighter lending standards have made new loans less risky. And guarantee fees - what borrowers pay to cover losses - have increased. Nevertheless, taxpayers could face billions of losses in another crisis. Doesn't this suggest that the GSEs should be eased out of backstopping the $9 trillion mortgage market?

Apparently not. Two obstacles arose.

One is pragmatic: fear for the housing recovery. All the real estate agents, builders, carpenters, mortgage bankers and others who depend on home buying worry that dismantling the GSEs would push interest rates up and housing activity down.

"Without GSE backing, banks have shown very little interest in lending to American homeowners, even ones with very high credit scores," writes McLean. Even with the GSEs, housing's recovery has been sluggish. Annualized sales are about 8 percent below a normal level of 6.5 million, notes Mark Zandi of Moody's Analytics. Housing starts are weaker at about 1.1 million annually, well below a more normal level of 1.7 million, he says.

The second obstacle is philosophical: protecting the 30-year fixed-rate mortgage, which Americans prefer. It's said that, without government guarantees, institutional investors won't hold loans with such long maturities. The danger of huge losses is too great. If government guarantees end, mortgage maturities will shorten and adjustable interest rates will become more common, the argument goes.

What's wrong with that?, asks Peter Wallison of the American Enterprise Institute. Subsidized long-term mortgages encourage overinvestment in big homes. Shorter maturities would favor smaller homes. Borrowers would also earn equity in their homes faster than with 30-year fixed loans, where early payments go mostly to interest.

These are important choices. The GSEs are part of a larger agenda that McLean rightly calls "the cult of homeownership": that it's an essential marker of social success. We should be discussing whether this approach still serves our interests. But that's a debate we've evaded.

There's a wild card in all this: suits by private investors, who still own about 20 percent of the GSEs. They allege that the government has mistreated them. A legal victory could compel change. Meanwhile, the safest course for the White House and Congress has been to save the GSEs and enlist them in the housing recovery. So that's what they did - and that's how Fannie and Freddie survived.


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