Taxpayers have already spent more than $111 billion bailing out mortgage giants Freddie Mac and Fannie Mae, and that's going to be just the tip of the iceberg. Instead of limiting Fannie's and Freddie's bailouts to $400 billion as first planned, the Treasury quietly announced (on Christmas Eve, no less) that it would offer the two firms unlimited bailouts. This puts taxpayers on the hook for any losses the two firms suffer. And there will be lots of losses.
Last week, Fannie announced it lost $15.3 billion in just the fourth quarter of 2009, bringing its 2009 losses to $74.4 billion. The Congressional Budget Office expects Fannie and Freddie to cost taxpayers a whopping $290 billion this year alone. Collectively, the two firms hold or guarantee more than $5 trillion in debt. In December, 3.8 percent of Freddie's mortgages were at least 90 days late and 5.2 percent of Fannie's mortgages were delinquent. Those numbers will continue to rise as the economy rights itself.
Since their founding, Fannie and Freddie have been used by politicians to distort the housing industry. They were technically privatized but had a tacit promise that the government (read taxpayers) would pick up any major financial losses. Fannie and Freddie used this silent guarantee to borrow against the credit of the U.S. government. At one point, they were leveraged as high as 100-to-1 by some estimates. And you thought AIG was bad.
Congress manipulated the mortgage market, and helped the housing bubble, by pursuing a political goal: home loans for everyone. When it comes to congressional exploitation of the housing market, few could be considered more culpable than Rep. Barney Frank, Massachusetts Democrat. For the past two decades, Frank and others have encouraged Fannie and Freddie to lend to risky borrowers who did not meet traditional requirements. As recently as last summer, Frank wrote a letter demanding that Fannie and Freddie further reduce loan-qualifying standards for condo buyers. This excessive risk-taking gave more families access to homeownership, a political boon. Unfortunately, it also meant a massive buildup of subprime debt.
At a hearing in February, Frank changed his tune, calling for "abolishing Fannie Mae and Freddie Mac in their current form and coming up with a whole new system of housing finance."
He's half-right. The answer is to abolish Fannie and Freddie. But the government should stop there. We don't need a "whole new system of housing finance." The federal government doesn't need to be involved in the mortgage business at all. Plenty of healthy, viable banks are willing to do that.
The central role that Fannie Mae and Freddie Mac played in the financial crisis shouldn't be ignored. Without the lowered lending standards at Fannie and Freddie, mortgage originators would have paid more attention to the loans they were issuing, because the risk wouldn't have been shifted onto taxpayers so easily. And without the failure of Fannie and Freddie in September 2008, the market might not have destabilized, leading to the bankruptcy of Lehman Brothers, the quasi-nationalization of AIG and, eventually, the bailout of the financial industry.
The process of eliminating Fannie and Freddie is going to be complicated and hotly debated. They cannot be shut down right now because virtually the entire mortgage market is dependent on them as a wastebasket for toxic mortgage debt. But a long-term strategy for dissolving Fannie Mae and Freddie Mac can and should be created now. The ideal plan would break them up and sell their assets over five to 10 years, with any remaining government activities related to housing consolidated in another agency.
Fannie and Freddie have hurt the economy and distorted the housing market long enough. As the losses pile up, it is time for the government to start getting itself out of the mortgage business.