This reveals a fundamental misunderstanding of how private markets work — one that needs to be exorcised before we can move to better policies. The Administration’s statement assumes that private lenders’ business decisions and risk‐taking activities occur in a vacuum. On the contrary, the very existence of Fannie and Freddie to subsidize and support home lending probably triggered private risk taking at the margin in that sector.
The long‐standing and profitable operation of housing GSEs — their purchases of home‐loans financed out of bond sales to the public at cheap rates because of the implicit government backing they enjoyed — generated a long‐sustained upward spiral in home prices, reduced aggregate risk perceptions in home finance among private lenders, and attracted capital including foreign savings. That made Fannie and Freddie a part of the constellation of government policies that promoted a steep home price bubble — that eventually burst to deliver the Great Recession.
The correct policy prescription under a buoyant housing market would have been to withdraw the GSEs from the market, and transition to a self sustaining home finance sector. Such a policy, had it commenced during the early 2000s, could have injected caution and countered the growing perception of a risk‐free bonanza in home lending that fed the housing price bubble. Instead, Fannie and Freddie’s appetite to preserve market share and profits was only whetted — as the historical record of their massive portfolio expansion by purchasing subprime loans clearly shows.
The Administration is now proposing to “wind down Fannie and Freddie on a responsible timeline,” (that is, remove the old names), to “address fundamental flaws in the mortgage market to protect borrowers, help ensure transparency for investors, and increase the role of private capital,” (that is, increase lending regulations that stifle the private market), and “target the government’s vital support for affordable housing in a more effective and transparent manner” (that is, create new government sponsored home‐lending institutions and increase its role in home‐finance).
Instead of admitting that the lesson of the housing debacle is that some segments of the population do not deserve and cannot sustain home purchases financed through government subsidized mortgages, the Obama administration’s proposals, including this latest one, seek to “serve the needs of families, lenders, and investors” (but not taxpayers, of course) to “makes us all better off” (again, taxpayers excluded).
Sometimes, when a company fails for reasons unconnected to its business model, its operators attempt to preserve it via cosmetic changes — a new name, new location, or different front‐office personnel. Accenture, the business consulting firm — formerly a part of Arthur Andersen that was tainted in the Enron scandal — is now thriving. So is “Sunshine Financial,” the formerly failed “People’s First” home lending business in Florida. Look for something similar to happen to Fannie and Freddie — even though that “business model” has clearly failed.