The Fannie Mae‐Freddie Mac crisis may havebeen the most avoidable financial crisis in history.Economists have long complained that therisks posed by the government‐sponsored enterpriseswere large relative to any social benefits.
We now realize that the overall policy of promotinghome ownership was carried to excess.Even taking as given the goal of expanding homeownership, the public policy case for subsidizingmortgage finance was weak. The case for usingthe GSEs as a vehicle to subsidize mortgagefinance was weaker still. The GSE structure servesto privatize profits and socialize losses. And evenif one thought that home ownership was worthencouraging, mortgage debt was worth subsidizing,and the GSE structure was viable, allowingthe GSEs to assume a dominant role in mortgagefinance was a mistake. The larger they grew, themore precarious our financial markets became.
Regulators should contemplate freezing themortgage purchase activities of the GSEs whileat the same time loosening the capital requirementsfor banks to hold low‐risk mortgages.The result would almost surely be an industrymuch less concentrated than the current duopoly.A housing finance system that does not relyso heavily on Freddie Mac and Fannie Mae willbe more robust.
We have to assume that sooner or later someof the institutions involved in mortgage financewill fail. The policy should be to promote a housingfinance system where mortgage risk is spreadamong dozens of institutions. That way, the failureof some firms can be resolved through mergersand orderly restructuring, without exposingthe financial system to the sort of catastrophicrisk that is represented by Fannie Mae andFreddie Mac.