by Richard Morrison
December 9, 2008

Washington, D.C., December 9, 2008—Today, the House Oversight and Government Reform Committee is finally holding a hearing on the failures of the government-sponsored housing enterprises Fannie Mae and Freddie Mac. John Berlau, Director of the Competitive Enterprise Institute’s Center for Entrepreneurship, applauds the committee for grilling former Fannie and Freddie executives, but he disputes Chairman Henry Waxman's assertions that the GSEs were not a “catalyst” of the mortgage crisis and were simply “following the market.” 

“Fannie and Freddie were indeed among the biggest catalysts of the crisis, as banks knew they had a willing buyer for many questionable mortgages,” Berlau said. “They guaranteed or invested in $717 billion of subprime or near-subprime Alt-A mortgages, according to the New York Times. Even more importantly, through their market power generated by their quasi-government status, they lowered standards even for prime or ‘conforming’ mortgages. Without the existence of Fannie and Freddie as buyers of lower-quality mortgages, many of the loans that have cause so much of the current turmoil would not have been made.”

Below is an excerpt on Fannie and Freddie from a new article by Berlau in Stocks, Futures & Options magazine looking at the causes of the credit crisis. Read the full article here.

Rushing to Regulate: Which Way Is Wise?

The mortgage giants Fannie Mae and Freddie Mac had the peculiar designation as government-sponsored enterprises. Although owned by private shareholders since Fannie’s reorganization and Freddie’s creation approximately 40 years ago, they were chartered by Congress and maintained special privileges from the government. They were exempt from state and local taxes and, unlike every other public company, they were exempt from SEC regulation. Also, they each had a $2 billion line of credit with the United States Treasury Department.

Critics, including my boss, Competitive Enterprise Institute President Fred L. Smith, had long warned that this hybrid structure—with “privatization of profits” and “socialization of losses” through implied government guarantees—held dangers. In 2000, Smith testified to the House Financial Service Committee that “no one is quite sure how these entities should be evaluated or held accountable.” On the line of credit with the government, he argued that “as long as the pipeline is there…it is very expandable” and added that “it is only $2 billion today. It could be $200 billion tomorrow.” Eight years later, it turns out he may have underestimated the amount Fannie and Freddie may cost taxpayers after the government took them over.

During the past 15 years, Fannie’s and Freddie’s portfolios were allowed to grow to approximately $6 trillion in mortgages. Fannie and Freddie became ready buyers for mortgages that may not have been issued in the absence of their existence. By the end of 2007, they had guaranteed or invested in $717 billion of subprime or near-subprime Alt-A mortgages, according to the New York Times.

But even aside from that, they had lowered the standards for a prime mortgage. A 2004 article in the Fannie Mae publication Housing Matters notes, “Lenders now classify some mortgage products that were traditionally B or C as A- because Fannie Mae and Freddie Mac are willing to purchase these mortgages.”

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