Cato Policy Analysis No. 528 October 7, 2004

Policy Analysis

Fannie Mae, Freddie Mac, and Housing Finance: Why True Privatization Is Good Public Policy

by Lawrence J. White

Lawrence J. White is the Arthur E. Imperatore Professor of Economics at the New York University Stern School of Business. During 1986-1989 he was a member of the Federal Home Loan Bank Board and a board member of Freddie Mac.


Executive Summary

The Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) are the two dominant entities in the secondary residential mortgage markets of the United States. They are an important and prominent part of a larger mosaic of extensive efforts by governments at all levels to encourage the production and consumption of housing.

Fannie Mae and Freddie Mac are a unique part of this effort. Though they appear to be "normal" corporations, each with shares that trade on the New York Stock Exchange, they in fact have federal government origins and entanglements that make them quite special. Their specialness is a double-edged sword, however. On one side, they cause interest rates on many residential mortgages to be lower than would otherwise be the case; on the other, their size and mode of operation have created a significant contingent liability for the federal government and, ultimately, for taxpayers. In addition, their size and prominence has recently led to concerns about the larger consequences for the U.S. economy if either were to experience financial difficulties.

There is strong evidence that home ownership has positive spillover effects for society. However, the broad policies that encourage home ownership simply encourage the consumption of more housing—at the expense of other things—by those who would have bought anyway, with the consequence that our society's resources are less efficiently allocated than would otherwise be the case.

The special governmental links that apply to Fannie Mae and Freddie Mac yield little that is socially beneficial, while creating significant potential social costs. The best policy would be to privatize them completely—that is, to sever all governmental links and convert them to truly "normal" corporations—as well as to pursue other measures that would better address the positive externality of home ownership and efficiently reduce the cost of housing. In the event that true privatization does not occur, suitable "secondbest" policies would include stronger statements by Treasury officials that the federal government has no intention of supporting the two companies, improved safety-and-soundness regulation of the two companies, limits on the amounts of their debt that can be held by regulated depository institutions, and increased efforts to focus Fannie Mae and Freddie Mac on the segment of the housing market where their social benefits would be greatest.

Full Text of Policy Analysis No. 528 (PDF, 24 pgs, 320 Kb)

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