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

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The Federal National Mortgage Association(Fannie Mae) and the Federal Home LoanMortgage 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 adouble-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 havecreated 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 experiencefinancial 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 thosewho 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 othermeasures 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 statementsby 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 depositoryinstitutions, and increased efforts to focusFannie Mae and Freddie Mac on the segment ofthe housing market where their social benefits would be greatest.

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.