Wednesday, July 21, 2010

Economists Weigh In: "What should be done with Fannie Mae and Freddie Mac?" (FNMA.OB; FMCC.OB)

I'm still having a bit of cognitive dissonance when I type the new stock symbols.
From The Economist:

Laurence Kotlikoff our guest wrote on Jul 16th 2010, 14:54 GMT
FANNIE and Freddie are here to connect lenders and borrowers.  They aren't here to borrow money, promise to repay, and then make mortgages that are highly risky and require taxpayers to cover potential losses. Such casino banking just brought the global economy to its knees.
Like all incorporated financial intermediaries, Fannie and Freddie need to be limited to their legitimate purpose—financial intermediation.

Phillip Swagel our guest wrote on Jul 17th 2010, 16:43 GMT
A PLAN for Fannie and Freddie should distinguish between the appropriate roles for the private sector and the government, ensure that the benefits of government action go to homeowners rather than to the firms’ private shareholders and management, and remove the systemic risk created under the old GSE model. It is unrealistic to have no public role in housing finance—it is inevitable that the government will intervene to ensure that mortgages are available in the next crisis. It is thus better to have the government role explicit and fully transparent rather than implicit and obscured.

Donald Marron and I have put forward a plan in which the GSEs are privatised and the government provides a backstop against a catastrophic decline in the housing market to ensure that housing finance is available in a crisis (see this).

Tom Gallagher our guest wrote on Jul 19th 2010, 13:37 GMT
I START by assuming that the answer has to be set in something close to current conditions, by which I mean weak housing and mortgage finance markets and some degree of government support for housing.
The latter assumption is important.  Support for one future path for the GSEs—total privatization—can be based on the notion that the government should just stop providing so much support for home ownership. That’s a defensible argument, but I take it that’s not the point of this question. The current degree of support for housing makes many economists cringe, but there aren’t many successful politicians who are going to run on a platform of reduced policy support for housing. Economic policy has many higher priorities than trying to persuade voters to lower government support for this sector. Most, though not all, analysts believe these supports were not a principal reason for the housing and credit bubble.

Under current conditions, and under conditions likely to prevail for some time, there are real reasons to doubt there will be much of a private market to provide mortgages without guarantees or government-supported securitisation. Once recent excesses have been worked out, no doubt private markets would suffice in “normal” times, but privatisation would make housing finance more cyclical.