ML Editorial: What Everyone's Missing On Fannie and Freddie

By Aaron Krowne, ML-Implode.com founder.

You probably think nothing new can be added to the debate on the fate of the GSEs Fannie Mae and Freddie Mac, but I'm going to try anyway.

At this late point in what passes for the discourse on the matter, it seems basically a foregone conclusion that some sort of bail-out is needed. The main questions are whether the support should come from the Federal government or whether shareholders should be required to raise capital in the private markets (to their own detriment). To those that think the Federal government should be a part of the bailout, the questions are merely whether the backing should be limited or unlimited, and whether the shareholders should be forced to take the brunt or be made whole (because after all, lots of "public welfare" institutions like pension funds own these shares).

All of these perspectives make one gigantic presumption: that Fannie and Freddie are good for the country, or at least critical for the survival of our housing market. Bolstering the latter more existential view is the fact that nearly all of the housing market activity now flows through the GSEs since the private side of the market virtually collapsed last year (as we know well here at the Implode-o-Meter, being the lead chroniclers of that phenomenon).

But just because heavy use of the GSEs is now being made, it does not follow that this role should be made permanent by bailouts or "props" of other forms. By way of analogy, a drug addict should not be permanently given access to the drug he is abusing simply because taking that drug away abruptly will kill him. A transition plan away from the dysfunction must be made as soon as possible. Everyone knows this intuitively.

So why doesn't it hold for the GSEs? Probably because most people don't really understand what the dysfunction is: price fixing. Fannie and Freddie are and always have been gigantic schemes to fix the prices of mortgages lower than their natural, market rate. Until now this price fixing has been acheived by pretending there is a government backing but providing no such contractual guarantee, giving investors the impression of a solid backing but allowing the government to keep the GSE's obligations "off its books". It is a grand case of "having your cake and eating it too."

Now that fake guarantee is transitioning to an explicit one -- apparently with the government no longer having much concern over how horrible its books are or how many present and future taxpayers it enslaves into debt serfdom.

But the fact remains that this is all to keep the collossal price fixing scheme in place. The ultimate imperative seems to be that we must keep mortgage rates in the ballpark of 6-7%, even though interest rates virtually nowhere else in the economy match this low level. Credit card rates, applied to the same set of consumers, are in the range of 10-30%. Major banks raising capital are having to do it in the range of 8-12%. The only other area of low interest rates is very limited Fed financing -- the 2% funds rate provided to various banking entities, which is itself another artificial price fixing scheme to help temporarily keep them afloat.

Has the mortgage price fixing policy really ever helped anyone? Not really. We have seen that fixing mortgage rates low for a wide swathe of the market simply results in home prices rising to the point where there is no overall benefit conferred to homeowners. The first ones in the scheme get a benefit, of course, but it doesn't take long until the next round of buyers are back where they started. While this phenomenon has been most starkly demonstrated in recent years by private "affordability" loans with teaser rates, the same facts hold for price fixing through the GSEs, though over longer periods of time. The presence of the GSEs is exactly why the prevailing fixed rate mortgage now is 30-year instead of 15-year, as it once used to be. And it's exactly why prices for homes are high and will stay obscenely high, even moreso in areas that have been deemed "high cost areas" (which is simply a statement that the government has resolved to support irrationally high prices in areas with limited supply, thus perpetuating the problem)

My point: the GSEs are not worth saving because they do not serve a purpose that can even theoretically lead to any good for society. All they can do is distort the market, transfer wealth through price fixing from "late receivers" to "early receivers," put our country deeper in debt, and provide more bureaus for politicians to use as plum patronage vehicles.

Yes, the GSEs are now doing most of this country's housing business, and if we were to dismantle them, it would be quite painful. But it only follows then that we "must" bail them out if you believe all pain should be avoided. Keeping in mind that the outcome would be to alleviate all the above long-term ills, and lower home prices to a natural level so more people (including perhaps your children or grandchildren) can once again afford them without government aid, perhaps it is time for all of us to swallow that pill.