Don't Replace Fannie and Freddie - End Them. Period

By Steve Stanek | May 15, 2014 | 5:52 PM EDT

For every 100 mortgages being sold in the United States these days, at least 95 of them have government backing. We're told America has a free-market economy? Not judging by the government's involvement in housing, arguably the most important market there is. Most people can go years without needing health care. A healthy adult can go weeks without food. We cannot go one day without needing shelter.

The housing market was nearly ruined several years ago, and the government's involvement is a big reason. A bill moving through the Senate would do away with the main government players-Fannie Mae and Freddie Mac-but it might worsen the market manipulation problems Fannie and Freddie caused.

Before the collapse, Fannie Mae and Freddie Mac were bundling mortgages into mortgage-backed securities and selling them to investors, thus lending implied government backing to the securities and artificially lowering mortgage interest rates. Fannie and Freddie further manipulated the market by imposing "affordable housing" standards that required lenders to loan money to riskier borrowers. The effects of these policies were to put more buyers into the market, which drove up housing prices, and to increase the number of borrowers who could not or would not pay back their loans.

Implied government backing became explicit after the housing bubble popped in 2008 and the federal government put Fannie and Freddie into conservatorship and handed them $188 billion to stay afloat. Since then, government backing of mortgages has gone from little more than half to nearly all new mortgages.

Now Senators Tim Johnson (D-SD) and Mike Crapo (R-ID) have agreed on a bill to wind down Fannie and Freddie. This is good. But they want to replace those organizations with private mortgage bond issuers who would each have government guarantees backed by a new entity called the Federal Mortgage Insurance Corporation. This is bad.

Their FMIC would be highly politicized. The bill calls for "equitable access" to mortgages and describes an "eligible borrower" as someone who meets standards set by the Consumer Financial Protection Bureau under the Dodd-Frank financial regulation law. As former Sen. Phil Gramm and American Enterprise Institute Fellow Peter Wallison recently noted in The Wall Street Journal, "six federal agencies [in 2013] noted that mortgages meeting the qualified-mortgage standard had a 23% default or serious delinquency rate between 2005 and 2008. Even Fannie and Freddie were never forced to set their mortgage standards that low."

The FMIC also would charge fees to the private mortgage bond issuers-fees that would be based partly on how many people in "underserved" demographic groups receive mortgages. The more people in the "underserved" category who receive loans, the lower the fees. This would penalize borrowers with strong credit, benefit borrowers with weak credit, and lead to more of the subprime lending that played such a big role in the most recent housing market collapse.

The bill smacks of the income redistribution in Obamacare, which has young, healthy persons paying higher health insurance premiums so older, sickly people can pay less. It is in fact an assault on the very concept of insurance, in which persons who pose high risks are supposed to pay high premiums and vice versa. We're doing it under Obamacare and would extend it to housing under the Johnson-Crapo bill.

Johnson and Crapo should have stopped at agreeing to wind down Fannie and Freddie. Period. Replace them with nothing. Let borrowers and lenders strike their own deals without government meddling. In that way, mortgage interest rates would better reflect true risk, there'd be almost no way for legislators to inject corruption and cronyism into the system, and taxpayers would not be at risk of shelling out more hundreds of billions of dollars.

Editor's Note: Steve Stanek ( is a research fellow at The Heartland Institute in Chicago.