The Truth About Fannie and Freddie’s Role in the Housing Crisis

This is from Veronique de Rugy at Reason. Excerpts:

Myth 1: The government-sponsored housing finance companies Fannie Mae and Freddie Mac had nothing to do with the housing crisis. They were simply innocent bystanders caught in the crossfire. Economist and New York Times columnist Paul Krugman, for instance, has argued that Fannie and Freddie’s role in the housing market was insignificant between 2004 and 2006 because “they pulled back sharply after 2003, just when housing really got crazy.” According to Krugman, Fannie and Freddie “largely faded from the scene during the height of the housing bubble.”

Fact 1: Fannie and Freddie contributed to the housing crisis by making it easier for more people to take out loans for houses they could not afford. Beginning in 2000, Fannie and Freddie took on loans with low FICO scores, loans with low down payments, and loans with little or no documentation.

Myth 2: Fannie and Freddie’s role in the housing market increased homeownership, especially for first-time buyers and lower income earners.

Fact 2: The small increase in homeownership rates were temporary and artificial, driven by unsustainable incentives. In the best case scenario, Fannie and Freddie may have increased the homeownership rate from 63 percent to 69 percent, but the rate has now fallen back to 66 percent. Moreover, Fannie and Freddie did not make housing more affordable and even priced many first-time buyers out of the market.

As business journalist Bill Bonner explains in The Christian Science Monitor:

Armed with these advantages, GSEs increased their book of business from $13 billion in 1965 to $1 trillion by 1990 and $3.4 trillion in 2003. Once the great real estate bubble had concluded by year-end 2007, Freddie and Fannie combined had purchased $4.9 trillion of mortgages, repackaging 70 percent of these into guaranteed securities for the secondary market.

This (along with Ginnie Mae) gave the GSEs roughly half of the $11 trillion mortgage market, but their share of new originations has become near dominant.

Many sources peg this at 70 percent, but an interesting take from TIME magazine business and economics columnist Justin Fox takes into account the impact of refinancing into GSE-backed loans. Juxtaposing GSE total volume ($ 539 billion) against new originations ($313 billion), GSE market share was 172 percent for the first quarter of 2008.

Myth 3: Fannie and Freddie are essential for maintaining a working mortgage market. Without them, interest rates will increase and homeownership will plummet as more people are priced out of the housing market.

Fact 3: Interest rates are likely to go up. Yet it is not clear what impact this will have on homeownership rates. In the 1980s, interest rates on the average 30-year mortgage were significantly higher, yet homeownership rates were almost the same as they are today. Besides, the alternative to homeownership is not living on the street.