Privatize Fannie Mae and Freddie Mac: the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation make mortgage markets inefficient, choke off competition, and help only the affluent.

• Author: McKinley, Vern

The Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation make mortgage markets inefficient, choke off competition, and help only the affluent.

Freddie Mac (the Federal Home Loan Mortgage Corporation) and Fannie Mae (the Federal National Mortgage Association) are two of the largest financial institutions in the nation, with more than half a trillion dollars in assets between them. Yet, few people can explain exactly what function these two financial giants serve. Their names are recognizable from the glowing discussions of their profitability in the financial section of the newspaper. They may sound familiar because of the commercials run nationwide that promote their foundations, generally focusing on Americans purchasing their first home. The ads do not discuss explicitly the role these financial institutions play regarding the home purchase, but they leave viewers with the warm and fuzzy feeling that, were it not for Freddie Mac and Fannie Mae, these people would not have been able to buy their first home.

Freddie Mac and Fannie Mae indirectly assist homebuyers by purchasing mortgages from lenders, such as commercial banks, savings and loans, and mortgage banks. Freddie Mac and Fannie Mae, in turn, generally get these loans off their books by creating securities (a process called securitization) that eventually are paid off as the underlying mortgages are paid off. So, homeowners are happy because they are aided in borrowing money for their home purchase. Lenders are happy because they don't have to hold on to mortgages for several years. Investors in the securities backed by mortgage payments are happy because they have a reliable investment product. Of course, Freddie Mac and Fannie Mae are happy because they make a handsome profit on the whole process. This sounds like capitalism at its finest, but the facts belie that rosy picture.

Although Freddie Mac and Fannie Mae are privately owned, they are government-sponsored enterprises (GSEs). This means they don't have to follow the same set of rules other privately owned companies do. They don't have to register their securities with the government; their securities receive special treatment for investment purposes; they don't have to pay state and local income taxes; and--most importantly--their government sponsorship gives them the aura of a fully guaranteed government entity. This final benefit means the markets think that, even though they are privately owned, the full faith and credit of the government stands behind the debt of these two enterprises--what is referred to as an implied or implicit guarantee. Thus, they save billions in borrowing costs, just as lenders are willing to offer low-interest student loans if they are guaranteed by the government...