The Role of Fannie Mae and Freddie Mac in the Crisis
Many experts are of the opinion that Fannie Mae and Freddie Mac played a leading role in the financial crisis. These two fall under the GSE category of Government Sponsored Enterprises. This group of financial services enhances credit flow to certain focused economic sectors to make them more transparent and efficient – agriculture, education and home.
The Federal National Mortgage Association that later came to be Fannie Mae was set up in the 30’s to buy mortgages from the banks to help growth in home ownership. Freddie Mac operates along the same line and was created later on to prevent Fannie Mae from becoming an unwieldy monopoly.
Both enjoy a peculiar position. They are private firms having stockholders and enjoying profits but they are sponsored by the government that allows them to enjoy special facilities. The most important of these is the tacit belief of consumers that the government would guarantee their deposits in case of bank failure. It means losses are socialized while profits are privatized. The stockholders will benefit from profits but the government would have to pay for the losses. This one way traffic encourages dangerous risk taking and this is exactly what happened leading up to the sub-prime crisis.
By the end of 2007 the two mortgage giants had in their hands $4.9 trillion of defaulting mortgages. 70% of these had been made into packaged and sold to investors with the guarantee tag. The balance Fannie Mae and Freddie Mac kept in their own bags. The proportion of the mortgage debt under the cover of these two increased from 6% in 1971 to 53% in 2003. This establishes the case for saying that Fannie and Freddie contributed largely to the foreclosure crisis that followed.
What Fannie Mae and Freddie Mac had ventured into made the bungling of S&L into a dwarf. From 1990 the swelling of Fannie and Freddie made S&L fade from the scene. These two rode on the crest of the housing bubble.
But many have argued that these two cannot be blamed because they only guaranteed the loans but did not issue these. Fannie and Freddie are restrained by HUD to serve only those with low income in similar localities where people with low earnings reside. They bought the securities that had been created by the sub-prime lenders and can be taken to be their obligation towards the borrowers.
Rather it can be argued that the private players of the game knowing that ultimately the government would have to give the backing to Fannie and Freddie drew them forcibly into the risky game, while they played it safe; heads we win and tails you lose.
Some feel that it is HUD that is more to be blamed for the crisis. In 2004 the regulators had given out warnings that the sub-prime lenders were selling more mortgages to people who could ill afford the same. But HUD did not take note – rather stoked the flames.
HUD was over keen to put families coming from modest and low income backgrounds into their own houses. For this HUD required the help of these two government sponsored agencies, Fannie Mae and Freddie Mac to buy more of these affordable loans. HUD pointed to an anachronistic policy that permitted Fannie and Freddie to calculate the billions invested to guarantee sub-prime loans as something done good for the general good of the public as it would encourage quick growth of the affordable housing sector.
