Freddie Mac and Fannie Mae: Corporate Welfare King & Queen

November 17, 1997 • Commentary
By Vern McKinley

They are two of the largest financial institutions in the nation, with more than half a trillion dollars in assets between them: Freddie Mac and Fannie Mae. But few people can explain exactly what function those financial giants serve.

Freddie Mac and Fannie Mae indirectly assist homebuyers by purchasing mortgages from lenders, such as commercial banks, savings and loans and mortgage banks. Freddie and Fannie, in turn, generally get those loans off their books by creating securities that are eventually paid off as the underlying mortgages are paid off. Homeowners are happy because they are aided in borrowing money for a home. Lenders are happy because they don’t have to hold mortgages for several years. Investors in the securities are happy because they have a reliable investment, and Freddie Mac and Fannie Mae are happy because they make a handsome profit. Sound like capitalism at its finest? Not exactly.

Although Freddie and Fannie are privately owned, they are what is known as government‐​sponsored enterprises (GSEs). GSEs don’t have to follow all the rules that true privately owned companies do: they don’t have to register their securities with the government, their securities receive special treatment for investment purposes, they don’t have to pay state and local income taxes and–most important–their government sponsorship gives them the aura of a fully guaranteed government entity. That final benefit means they save billions in borrowing costs, just as lenders are willing to offer low‐​interest student loans that are guaranteed by the government. That savings alone allows the GSEs to pocket about $2 billion per year, according to estimates by the Congressional Budget Office and the Treasury Department.

Allowing Congress to grant such special privileges is a bad idea. Those privileges, which are granted solely to Freddie and Fannie, crowd out other potential competitors in their market. Privately owned companies should not receive such preferred borrowing status, because it redirects investor funds into the middle‐ and upper‐​income housing market at the expense of other potential investments. Finally, the failure of either Freddie or Fannie could saddle taxpayers with a huge liability.

Throughout 1996, a number of reports mandated by recent legislation were issued by the General Accounting Office, the Congressional Budget Office, the Department of Housing and the Treasury Department. Those reports scrutinized the system under which Freddie and Fannie operate. Congressional hearings were also held on the subject. Critical commentators argued that the $2 billion in benefits received by the GSEs is a blatant form of corporate welfare. They further argued that Freddie and Fannie constitute a duopoly, a fancy term to indicate that the two GSEs share above‐​average profits in a noncompetitive market. It’s no wonder that with the many benefits of their special status, Freddie and Fannie have no direct competition. They have even begun to move into new markets.

A clear sign of how much Freddie and Fannie value their government sponsorship is the great effort they expend to maintain it. They have used a portion of their billions of dollars in benefits to fund a high‐​powered public relations and lobbying machine with the sole purpose of maintaining their current status. Their efforts have involved spending millions on full‐​time lobbyists, paying millions to politically connected executive officers, and making “soft money” political contributions of three‐​quarters of a billion dollars, evenly split between Democrats and Republicans, during the last election cycle.

One would think that the scrutiny of last year’s reports and hearings would have prompted the GSEs to lie low for a while, but that has not been the case. They have continued to squeeze competitors who do not enjoy their borrowing and tax advantages by entering or increasing their presence in the insurance, reverse mortgage, home equity and subprime mortgage markets. They have contributed nearly $400,000 in soft money in just the first six months of this year. Finally, Fannie Mae brought on board a new political hired gun: Jamie Gorelick, Janet Reno’s second‐​in‐​command at the Justice Department. She will be compensated millions to, as the American Banker put it, “fight for Fannie Mae on Capitol Hill.”

The GSE structure is a classic case of a special legislative benefit that its recipients will fight to the death to maintain. Congress should immediately revoke all the benefits of government sponsorship: clearly, Freddie and Fannie can be profitable without them. Eliminating special privileges will force mortgage markets to be truly competitive and will eliminate the possibility that the current system of government sponsorship will someday lead to yet another taxpayer‐​funded bailout.

About the Author
Vern McKinley