Since the credit meltdown hit in September 2008, a question has loomed: What to do with Fannie Mae and Freddie Mac?

The Dodd-Frank financial regulatory bill that was signed into law by President Obama in July of last year was unprecedented for its intrusiveness into the marketplace. But it failed to deal with Fannie and Freddie.

On February 11, though, the Obama administration offered its plans for Fannie and Freddie. Well, actually, a decisive plan was lacking. Instead, the Treasury and Housing and Urban Development departments put forth a set of options for Congress to consider.

Recall that Fannie Mae and Freddie Mac are “government-sponsored enterprises” (GSEs). Fannie was set up under FDR in 1938, and converted to a GSE in 1968, with Freddie coming along in 1970. As GSEs, they have private shareholders, but wind up being used for political ends, with the implicit backing of the taxpayers.

That backing became painfully clear in 2008 when the federal government officially took over, i.e., bailed them out. Fannie and Freddie have hit the taxpayers up for $150 billion, and no cap exists as to how high that tab might climb.

The privatizing of gains and socializing of losses always lurked as problems with Fannie and Freddie. But a perfect storm began gathering in the early 1990s with Congress mandating a so-called “affordable housing” agenda, and HUD expanding Fannie and Freddie loans going to low and moderate-income buyers. Mandates for smaller down payments and bigger mortgages came later in the decade, along with changes to the Community Reinvestment Act requiring banks to expand lending to “underserved” communities.

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The effect was to create a disconnect between economic fundamentals, and borrowing for home ownership. As designed by our elected officials, taxpayers were on the hook for subprime, risky mortgages — with various estimates pointing to half of all mortgages in 2008 falling into this dicey camp. And the you-know-what finally hit the fan.

Today, more than 90 percent of all mortgages being issued are somehow backed by the government, with about half of all mortgages outstanding guaranteed through Fannie and Freddie.

What does the President suggest? According to a Treasury Department release, “The Administration’s plan will wind down Fannie Mae and Freddie Mac and shrink the government’s current footprint in housing finance on a responsible timeline.” That’s certainly encouraging. But where the administration actually stands is murky.

Three options for long-term reform were presented. The first would privatize the entire housing mortgage system, leaving the federal government to provide limited financial assistance to targeted borrowers. This makes the most economic sense.

The Treasury-HUD report correctly noted: “The strength of this option is that it would minimize distortions in capital allocation across sectors, reduce moral hazard in mortgage lending and drastically reduce direct taxpayer exposure to private lenders’ losses. With less incentive to invest in housing, more capital will flow into other areas of the economy, potentially leading to more long-run economic growth and reducing the inflationary pressure on housing assets. Risk throughout the system may also be reduced, as private actors will not be as inclined to take on excessive risk without the assurance of a government guarantee behind them.”

That’s a nearly perfect summation of why government should stay out of the mortgage business, leaving it to the private sector. Unfortunately, the report goes on to talk down this option, saying that credit could be more costly and the government would be limited in its ability to step in during crises. In reality, though, the creditworthy would still get mortgages, and the moral hazard and costs related to government bailouts need to be eliminated, not continued.

The second option, unfortunately, would institutionalize the government’s bailout role. That is, a government backstop would be created only for use during a housing crisis. But given the incentives at work in government, including special-interest influences, the pressure to expand this so-called limited role would be intense, and little reason exists to believe that politicians would somehow resist.

Option number three is the worst. The Fannie-Freddie model that worked so poorly would be re-established, just under another name, including private profits and tossing losses onto the taxpayers. As explained, “a group of private mortgage guarantor companies that meet stringent capital and oversight requirements would provide guarantees for securities backed by mortgages” and a “government reinsurer would then provide reinsurance to the holders of these securities.” Even the Treasury-HUD report warns, however, that “the reinsurance of private-lending activity, by its nature, exposes the government to risk and moral hazard,” and given certain political incentives, “private actors in the market may take on excessive risk and the taxpayer could again bear the cost.”

The grim lessons of politicizing the housing and mortgage markets apparently have not been fully learned. Acknowledgement by the Obama White House that the government’s housing footprint needs to be smaller should be grabbed by Congress, and pushed farther to create the only housing policies that make economic sense: Getting government out of the mortgage business altogether, and letting the private market allocate credit to its most productive and efficient uses, and accordingly bear any risks.

Raymond J. Keating, chief economist for the Small Business & Entrepreneurship Council, can be reached at His new book is titled Warrior Monk: A Pastor Stephen Grant Novel.