December 9, 2008

Collapse of Fannie Mae and Freddie Mac

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Arnold Kling, a member of Mercatus's Financial Markets Working Group, testified on the role of Fannie Mae and Freddie Mac in the current financial crisis before the House Committee on Oversight and Government Reform on December 9, 2008.

In his testimony, Dr. Kling offered a series of lessons from the collapse of the secondary mortgage market:

  1. Capital requirements matter. Details that are easily overlooked by regulators can turn out to cause major distortions.
  2. Securitization is not necessary for mortgage lending. On a level regulatory playing field, traditional mortgage lending by depository institutions probably would prevail over securitized lending. Rather than try to revive Freddie Mac and Fannie Mae, I would recommend that Congress encourage a mortgage lending system based on 30-year mortgages originated and held by old-fashioned banks and savings and loans. This would require instructing the regulators of Freddie Mac, Fannie Mae, banks, and savings and loans to all use the same capital standard for mortgages, one that is based on a stress test methodology.
  3. Subsidized mortgage credit is an inefficient tool for promoting home ownership. Unless what you want is home buyers who are buried in debt and speculating on house price appreciation, I recommend that Congress not try to create cheap mortgages and instead use other means to encourage home ownership.
  4. Recent financial innovations, particularly credit default swaps, have changed our financial system in ways that current policymakers fail to recognize. Bailouts and rescues are counterproductive in today's financial crisis. Within the financial sector, de-leveraging needs to slow down and the process of shutting down failed institutions needs to speed up. Relative to these necessities, handouts from the taxpayers are a hindrance, not a help.

Click here to view the Committee's Web page for the hearing.