What to do with Fannie and Freddie

The Fannie Mae building in Washington, D.C.

Bob Moon: House Republicans have taken first steps to reduce the roles of Fannie Mae and Freddie Mac in the residential mortgage market. They've also moved to cut the pay of the top executives who run those government-created businesses.

This is one of those "hot potato" issues on Capitol Hill. Some politicians say Fannie and Freddie have served those who couldn't otherwise afford a home. Others say that they've grown too large. But, little has been done to undo them.

Lawrence White teaches economics at New York University. He's written a book with three of his colleagues called, "Guaranteed to Fail: Fannie Mae, Freddie Mac and the debacle of Mortgage Finance." I spoke to him about the reluctance to tackle Fannie and Freddie as Congress works on financial reform.

Lawrence White: Dodd-Frank said nary a word about Fannie and Freddie. It only said the administration must come up with a report, which the Obama administration finally did. It laid out three alternatives, but I would guess we won't see anything really happen until the spring of 2013 when either the Obama administration will have been reelected or there will be a new administration, which will feel that it has a mandate.

Moon: Well what action would you suggest? The book posits some ideas, right?

White: Despite the fact that I don't think we're going to get any action, there is a fair amount of consensus that Fannie and Freddie will be phased out.

Moon: Necessary to replace them with something else? What would that be?

White: Well there is some consensus, which is if we're going to be subsidizing housing and housing finance, it ought to be with a more focused, on budget, targeted, smaller program that focuses on low/moderate-income households. For the rest of the mortgage market, our vision is really that the private sector -- a combination of banks, private securitizers -- really can handle these markets and do a good job figuring out who's a credit-worthy borrower, who is not; being able to decide are these mortgages suitable for depository institutions, like banks or savings institutions, to hold in their portfolios. That's all something that private markets really can handle.

Moon: Well Democrats and Republicans both say this is an important part of the American Dream. Fannie Mae's slogan for a time was, "We're building the American Dream." Is it necessary to have any government involvement at all? Maybe just take them out of the equation?

White: I think there is a good story for government involvement to encourage people who would not otherwise become home owners as a way of strengthening communities. Where that idea has gone wrong is extending that help to basically everybody -- middle class, upper middle class, upper class -- so people who would otherwise buy anyway are just being encouraged through the subsidies to buy larger homes on bigger lots. Where's the social benefit in that?

Moon: So if you and your colleagues have concluded that these agencies just aren't necessary, does that mean that the consumer would not lose out if we wind them down?

White: It's clear mortgage rates would be a little bit higher -- a quarter percentage point than they otherwise would be. Grass is not going to grow in the streets of America over a quarter of a percentage point differential. It would be only a modest effect, but we would have a more robust mortgage system where the private sector is there doing what it does best. We could get innovation that way, and we wouldn't have the government having to absorb the large losses at the moment -- $150 billion so far lost, and at least $200 billion in aggregate, possibly as much as $400 billion.

Moon: Lawrence White is a professor of economics at New York University. Thanks for joining us.

White: Thank you.

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