April 26, 2011

Reforming GSE's - Fannie, Freddie, and the Future

Arnold Kling

Senior Affiliated Scholar

Dr. Arnold Kling discusses two ways to look at GSE’s. One approach, the “devil you know” strategy, would restore the status quo ante, meaning that Freddie Mac and Fannie Mae would be returned to the investing public as private corporations with government backing, able to purchase loans for securities and able to hold securities in portfolio, subject to limits on loan amounts and subject to safety-and-soundness regulation. The other approach, the “Jimmy Stewart banker” strategy, would get the government out of the mortgage-guarantee business and let the mortgage market evolve in a decentralized way. In this system, mortgage lending would return to local banks, which would retain the loans that they originate.

Dr. Anthony Sanders asks “can the private sector offer a less costly alternative to Fannie and Freddie, with far less government involvement in the housing and mortgage market?” What is unique about Fannie/Freddie that the private sector could not provide? Both Fannie/Freddie and the private sector have loan-underwriting models; both can purchase loans and create mortgage-backed securities (MBS); both the private and public sector can offer mortgage insurance.

The one thing that Fannie and Freddie have that the private sector does not is an explicit guarantee from the federal government. If the private sector can replicate Fannie and Freddie’s only defining “virtue”—a federal-government guarantee—then there is no justification for keeping Fannie and Freddie around either in conservatorship or in their pre-conservatorship forms. Is that possible? What are the potential consequences?