William F. Shughart II
Urbana Daily Citizen
Readers of a certain age might remember the old newspaper cartoon of a man so down on his luck that he resorts to wearing an empty barrel held in place by suspenders. If Fannie Mae and Freddie Mac continue on their present course, barrels may again become fashionable for US taxpayers.
Criticized last week as “fatally flawed” by Alan Greenspan, the two so-called mortgage giants are at the center of the current financial crisis. Owned by private investors but chartered by Congress for the purpose of supplying liquidity to mortgage lenders, thereby putting home ownership within the reach of more Americans, Fannie and Freddie aggressively participated in the booming housing market of the early 21st century. By the end of the third quarter of 2007, the two were guaranteeing—or had purchased outright—roughly half of the nation’s home mortgages, accumulating in the process $5.2 trillion worth of debt, nearly $4 trillion more than on their books in 2003.
The roof then fell in. Real estate prices plummeted, mortgage default rates soared, and the market value of Fannie and Freddie’s asset portfolios—primarily consisting of the income expected from the mortgages they owned and the mortgage-backed securities they sold to investors—went into freefall. Crisis might have been averted had the two companies kept reserves adequate for meeting such a contingency, but Fannie and Freddie’s regulator, the Department of Housing and Urban Development’s Office of Federal Housing Oversight, demanded reserves of just 3 percent, a figure much lower than required of banks and other financial institutions and one that in hindsight was utterly irresponsible.
Last month, as Fannie and Freddie’s losses mounted and concerns grew that their collapse might cause meltdowns in financial markets both at home and abroad, Congress enacted rescue legislation. Among other provisions, July’s housing-relief bill allows the Treasury to extend unlimited lines of credit to Fannie and Freddie and, if necessary, to buy their stock. Undercutting the common perception that the housing crisis was precipitated by “predatory” lending to low-income, subprime borrowers who did not qualify for conventional loans, the new law also authorizes Fannie and Freddie to buy mortgages worth up to $625,000.