Statement on the Bailout of Fannie Mae and Freddie Mac

by Dollars and Sense

The collapse of the housing bubble has put the survival of Fannie Mae and Freddie Mac in jeopardy, as those of us who warned of the bubble have long predicted. While there can be no question of supporting these mortgage giants at such a critical moment for the housing market, the public should place serious conditions on this support. These companies face bankruptcy because of the incompetence of their management. They should not be given unlimited access to taxpayer dollars without any strings attached.

Before delving into the terms and conditions of the bailout, it is important to be clear on why Fannie Mae and Freddie Mac are in crisis. Last week’s downturn may be attributable to a sudden change in sentiments in financial markets, but the underlying problem is not investor confidence. The underlying problem is that Fannie and Freddie either own or guarantee a large number of mortgages that are in default or will be in default in the very near future. This is due to the collapse of the housing bubble.

In ordinary times, the prime mortgages that fill the bulk of Fannie and Freddie’s portfolios go bad at very low rates. And when they do default, most of the debt is covered, since the value of the house is typically close to the value of the mortgage.

The collapse of the housing bubble, however, has created extraordinary circumstances where even prime mortgages are going bad at very high rates. As many mortgages in former bubble markets sink further underwater, Fannie and Freddie now own or guarantee mortgages on homes that will lose in the neighborhood of 50 percent of their value.

Fannie and Freddie both contributed to the bubble and created the financial crisis that they now face. These mortgage giants continued to make loans in bubble-inflated markets, thereby supporting purchases at bubble-inflated prices. Their top economists insisted that there was no bubble, assuring others in the market that everything was fine.

If Fannie and Freddie had constrained their loans, and tied their price to multiples of rent (e.g., a maximum loan value of 15 times appraised annual market rent for an area), they could have done much to stem the growth of the housing bubble and protected themselves from the bankruptcy they now face.

Labels: affordable housing, Center for Economic and Policy Research, Dean Baker, Fannie Mae, Fredddie Mac, housing bubble

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7/17/2008 04:53:00 AM