Consider the recent turmoil engulfing mortgage giants Fannie Mae and Freddie Mac, and the would-be bailout orchestrated by the U.S. Treasury and Federal Reserve.
The proposed bailout, which would make the implicit financial backing of Fannie and Freddie by the federal government explicit, has inspired a lot of caterwauling about moral hazard and the near-nationalization of the housing industry.
To be sure, this is a big deal. Fannie and Freddie combined own or guarantee about $5.2 trillion in mortgages — about half of the nation’s housing debt. They have become too big to fail.
Fannie and Freddie dwell in a particularly odd space. Both enterprises were originally created by the federal government to provide liquidity in the mortgage market. They do this primarily by purchasing conforming loans from originating lenders, and either holding them or bundling them to back securities that are then resold to investors. Those securities are parked in balance sheets all over the globe.
Although created by the government, Fannie and Freddie also are publicly traded corporations owned by shareholders. Even so, the markets treat their debt and the securities they issue as having the backing of the government.
This has been a sweet deal for Fannie and Freddie managers and their shareholders. They essentially got to use the government’s creditworthiness to greatly enhance private profits. What a great gig.
Unfortunately, Fannie’s and Freddie’s portfolio grew much faster than their capital base, thanks largely to lax regulation. So when the real estate bubble popped nationwide, the underlying value of their mortgages — even though they were not loaded with the toxic subprime sort — declined in value, threatening the companies with collapse.
So the world quaked. And the feds came running to the rescue.
This, understandably, irks Fannie’s and Freddie’s many critics. Why in tarnation, argue the critics, should the American taxpayers bail out a bunch of executives who mismanaged the companies, and the shareholders who own them?
The simple, albeit unfortunate, answer is that the alternative would be worse for all of us. A seizure in the mortgage market at this particular juncture would send housing prices spiraling even lower.
Critics of Fannie and Freddie make many fine points, particularly when it comes to how lax oversight fostered by some cozy political relationships put us all in this pickle.
But critics overstep when they say the feds now are effectively nationalizing the housing industry. That’s where a little longer view is in order.
My observation is that the federal government has been inextricably intertwined with the real estate market for more than 150 years. Consider the following:
•In 1862, President Abraham Lincoln signed the Homestead Act, which allowed any American to claim title to 160 acres of undeveloped land outside of the original colonies. Ultimately, 1.6 million homestead claims were granted over the next 25 years, affecting about 10 percent of all the land in the United States.
•In 1913, when the federal income tax was enacted, it allowed for the deductibility of interest. While that decision wasn’t specifically made to support housing, imagine how it would affect your cash flow and the value of your home if mortgage interest were not deductible.
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