Policy Documents

Privatization of Fannie and Freddie

Ryan Krause –
July 21, 2008

Fannie Mae and Freddie Mac are in dire straits. With their stock prices at record lows, their assets dwindling, and multiple federal agencies scratching their heads over how to prop up the mortgage giants, now is an opportune time to advocate Fannie and Freddie's privatization.

Fannie Mae and Freddie Mac are government-sponsored enterprises (GSEs), which means they carry an implicit government guarantee in the event of their default or failure. For the first time, it is looking like this guarantee will be put to the test.

Since last August, Fannie and Freddie's stocks have lost more than 80 percent of their value. The two mortgage giants' continued existence depends on a dramatic increase in capital. The Federal Reserve and the Treasury Department have woven several stop-gap measures together -- including expanding Fannie and Freddie's credit line at the Treasury, opening the Federal Reserve's discount window to them, and injecting taxpayer funds directly into the companies -- with the hope that combined, they will bolster confidence in the foundering behemoths and restore them to health. This is a fantasy.

Political commentators are now arguing over which of two paths -- a bailout or nationalization -- the government should pursue. The former would create an even greater moral hazard than already exists, and the latter would transfer half the nation's mortgages -- valued at more than $5 trillion -- to the federal government. The Treasury plan greatly resembles a bailout, with the added risk of inflation that accompanies an increase in the Federal Reserve's lending power.

Even more troubling, however, is that the plan offered to Congress makes explicit the long-implicit government guarantee of Fannie and Freddie's fate. This new precedent will increase the subsidy the companies already receive in the form of discounted cost of debt and will only embolden their shareholders and managers to take greater risks at taxpayer expense.

An alternative to the options of expanded government power is beginning to garner meaningful attention: privatization. Removing Fannie and Freddie's status as government-sponsored entities would relieve the taxpayers of the present "private profit, public risk" problem. It would force Fannie and Freddie to compete as equals in the secondary mortgage market, rather than as anointed duopolists. It would eliminate the special regulator that oversees the two firms, leaving them open to the market's guidance and justice. Most importantly, it would eliminate the incentive for reckless lending at the two firms, as they would bear the full burden of their decisions going forward.

The following articles offer justifications for the privatization of Fannie Mae and Freddie Mac and outline possible plans for its implementation. They provide evidence that government intervention in the mortgage market caused the current crisis and show that less government involvement, not more, will alleviate it.


Privatize Fannie Mae
http://www.csmonitor.com/2005/0110/p08s02-comv.html
In this 2005 editorial, the Christian Science Monitor suggests privatizing Fannie Mae as a solution to the organization's unchecked growth and irresponsibility.

The Case for Privatizing Fannie Mae and Freddie Mac Grows Stronger
http://www.aei.org/publications/pubID.20395/pub_detail.asp
American Enterprise Institute Resident Fellow Peter J. Wallison discusses the treatment of Fannie and Freddie in the media and government. He proposes his own privatization plan to alleviate the mortgage giants' woes.

It's Time to Privatize Fannie Mae and Freddie Mac
http://www.somc.rochester.edu/Nov03/hess.pdf
Claremont McKenna College Economics Prof. Gregory D. Hess explains that stop-gap regulatory changes will not fundamentally alter the taxpayers' risk, but removing the government's implicit guarantee will.

The Government Did It
http://www.forbes.com/opinions/2008/07/18/fannie-freddie-regulation-oped-cx_yb_0718brook.html
Ayn Rand Institute Executive Director Yaron Brook illuminates the government's role in Fannie Mae and Freddie Mac's downfall and suggests we remove the government from the housing market.
http://www.heritage.org/Research/GovernmentReform/bg1861.cfm
Ronald D. Utt, Ph.D., a senior research fellow at The Heritage Foundation's Roe Institute for Economic Policy Studies, identifies the limited value that Fannie and Freddie add to the mortgage market and offers a plan for an ordered privatization.

Time to Reform Fannie Mae and Freddie Mac

Downsize Fannie Mae and Freddie Mac
http://www.csmonitor.com/2008/0714/p08s01-comv.html
In response to recent events, the Christian Science Monitor proposes shrinking Fannie and Freddie to limit their effect on the housing market. This is a step back from the newspaper's earlier call for privatization, but it is perhaps a more plausible recommendation at this time.

How to Privatize Fannie Mae and Freddie Mac
http://www.chicagofed.org/news_and_conferences/conferences_and_events/files/2004_bank_structure_how_to_privatize_fannie_mae.pdf
Cato Institute Adjunct Scholar Bert Ely lays out his blueprint for Fannie Mae and Freddie Mac and explains why mortgage housing subsidiaries should replace them.

Freddie, Fannie, and Curses on FDR
http://mises.org/story/3045
Mises Institute President Llewellyn Rockwell provides a brief history of Fannie and Freddie to show that the mortgage giants' collapse is government failure, not market failure, and that the solution is to remove government from the equation.

End the Mortgage Duopoly
http://online.wsj.com/article/SB121607820954752561.html?mod=opinion_main_commentaries
Cato Institute Senior Fellow Gerald P. O'Driscoll, Jr. advocates removing Fannie and Freddie's protected status and fully exposing them to market competition.

Testimony of Chairman Alan Greenspan: Government-Sponsored Enterprises
http://www.federalreserve.gov/boarddocs/testimony/2004/20040224/default.htm
Former Federal Reserve Chairman Alan Greenspan testifies to Congress about the substantial problems with maintaining Fannie and Freddie's status as government-sponsored entities.


Nothing in this document is intended to influence the passage of legislation, and it does not necessarily represent the views of The Heartland Institute. For further information on this and other topics, visit The Heartland Institute's Web site at http://www.heartland.org and PolicyBot, Heartland's free online research database.

If you have any questions about this issue or The Heartland Institute, contact Heartland Legislative Specialist Intern Ryan Krause at 312/377-4000 or rkrause@heartland.org.