An End to Fannie and Freddie?

As has become tradition after a chamber or two changes hands, Congress is currently grappling over the extent of proposed budget cuts with the threat of a government shutdown looming. Now wouldn’t that be fun?

While congress continues to bicker and bargain their way toward a budget, many programs have been laid out on the chopping block. And — dare we be so hopeful — the massive, government-sponsored entities Fannie Mae and Freddie Mac might finally be targeted for cuts. Should their elimination actually come to fruition, it is a change that has long been overdue.

According to The Wall Street Journal, the House Subcommittee on Capital Markets could produce legislation to this end as early as today. Although the Obama administration’s “Reforming America’s Housing Finance Market” report stated support to “wind down” Fannie and Freddie, it is yet to be seen if the administration will endorse any GOP proposal.

Peter Wallison, former Reagan Treasury official and one of the foremost analysts of the distortions that such government-sponsored enterprises have created for global capital markets, has recommended a plan of action to phase out these entities in his Wall Street Journal op-ed, “Moving Beyond Fannie and Freddie.”

Privatization or elimination of Fan and Fred is necessary to revive the securitization market, which cannot compete with the GSEs’ subsidized rates. But as long as the GSEs are controlled by the government, the size of the mortgages they are able to buy can gradually be reduced. This can be done in, say, $50,000 increments every six months. As the GSEs are slowly removed from a portion of the market, securitization will take their place. When the GSEs’ permitted level of mortgage acquisitions has been sufficiently reduced so that they are no longer important market factors, they can be closed down or privatized.

Fred Smith, president of the Competitive Enterprise Institute, in testimony to Congress back in 2000 argued that we must phase these entities out because they’d been allowed to grow too large. Smith suggested the agencies be broken up into smaller entities with the requirement that the size of their portfolios be legislatively decreased each year over a brief time period, until they disappeared. It is a valid proposal still, though notably more difficult given that those entities have grown much larger in the interim and constitute a much larger sector of the housing finance industry. It will also require much diligence.

Simply reforming Fannie and Freddie will solve nothing, because a trimmed weed will simply become a healthier weed!

Dramatic action must be taken to bring about their end.