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Freddie Mac and Fannie Mae

An Exit Strategy for the Taxpayer

by Arnold Kling

No. 106

September 8, 2008

Executive Summary

Regulators should contemplate freezing the

The Fannie Mae-Freddie Mac crisis may have

mortgage purchase activities of the GSEs while

been the most avoidable financial crisis in histo-

at the same time loosening the capital require-

ry. Economists have long complained that the

ments for banks to hold low-risk mortgages.

risks posed by the government-sponsored enter-

The result would almost surely be an industry

prises were large relative to any social benefits.

much less concentrated than the current duop-

We now realize that the overall policy of pro-

oly. A housing finance system that does not rely

moting home ownership was carried to excess.

so heavily on Freddie Mac and Fannie Mae will

Even taking as given the goal of expanding home

be more robust.

ownership, the public policy case for subsidizing

We have to assume that sooner or later some

mortgage finance was weak. The case for using

of the institutions involved in mortgage finance

the GSEs as a vehicle to subsidize mortgage

will fail. The policy should be to promote a hous-

finance was weaker still. The GSE structure serves

ing finance system where mortgage risk is spread

to privatize profits and socialize losses. And even

among dozens of institutions. That way, the fail-

if one thought that home ownership was worth

ure of some firms can be resolved through merg-

encouraging, mortgage debt was worth subsidiz-

ers and orderly restructuring, without exposing

ing, and the GSE structure was viable, allowing

the financial system to the sort of catastrophic

the GSEs to assume a dominant role in mortgage

risk that is represented by Fannie Mae and

finance was a mistake. The larger they grew, the

Freddie Mac.

more precarious our financial markets became.

Arnold Kling is an adjunct scholar with the Cato Institute. After receiving his Ph.D. in economics from the Massachusetts

Institute of Technology, he worked as an economist at the Federal Reserve Board for six years and then at Freddie Mac for about

10 years in the 1980s and 1990s. He blogs at econlog.econlib.org.

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