Blackadder’s Lair

The home of many a cunning plan

What About Fannie and Freddie?

Aside from the Community Reinvestment Act, the main culprits fingered by conservatives in their attempts to acquit the free market from charges of causing the current credit mess are Fannie Mae and Freddie Mac. Fannie and Freddie are rather curious creatures. Started as government entities, about forty years ago they were spun off into private, profit making institutions. This privatization was not complete, however, as the two Fs were subject to a different regulatory regime than other lending institutions, and held an implicit guarantee that their debts would be backed by the federal government if they ever got into trouble. I’d imagine that if you had asked your typical economist prior to the current crisis whether this was a desirable institutional set-up, the answer would have been a resounding “No!” And, unlike the Community Reinvestment Act, Fannie and Freddie do seem to have been deeply involved in the subprime mortgage mess.

To say that Fannie and Freddie were involved in the housing bubble, however, is not the same as saying that they caused the housing bubble or the resulting crash. From what I can tell, the claim that Fannie and Freddie played a major role in causing the crisis is not very plausible. For example, as this anti-F&F article notes, almost all of Fannie and Freddie’s involvement with subprime loans between 2005 and 2007, long after the housing bubble had gotten underway.

Further, even to the extent that the Fs did play a crucial role in exacerbating the crisis to come, this does not necessarily exonerate the free market. Fannie and Freddie, after all, were themselves profit making ventures. True, they had a number of government granted advantages which gave them a somewhat different incentive structure than totally private firms, but this does not, of itself, prove that it was these government advantages that led them to behave as they did (and induce private firms without these advantages to behave similarly). The question to ask is not whether Fannie and Freddie played a role in the current mess. Rather, it is this: supposing that Fannie and Freddie had been totally private institutions, would the housing bubble and resulting crisis have been averted?

I would say no. While Fannie and Freddie may have got caught up in the “irrational exuberance” in the housing market, they were in this respect no different from private firms, many of which bought into the same bogus theories about the inevitable rise of house prices. As with the CRA, if there is a government scapegoat to be had in the housing market mess, one will have to find it elsewhere.

One final point. To the extent one believes the problem with Fannie and Freddie was their status as government sponsored entities whose debts are implicitly backed up by the federal government, it should be noted that all the major banks are now operating under the same sort of implicit guarantee. If one is going to blame Fannie and Freddie for the current mess, then one had better be 100% against the recent actions by the Fed and the Treasury, since the government has, functionally, made Fannie and Freddie the model for the entire banking industry.


October 25, 2008 - Posted by | Economics, Economy, Government

1 Comment »

  1. I think it’s necessary to take another step in this analysis. If the question is, did the government play a large role in the crisis, and the answer is no. The next question is, well, could the government have prevented it? An a priori towards regulation, any regulation, many times makes things worse (see, e.g., Sarbanes-Oxley). At the very least, that is one of the questions raised by the implosion of the European markets:

    “All of this seems like a pretty stinging rejoinder to the notion that the problem is simply a failure of regulatory stringence. The problems have spread across regulatory regimes, currencies, and banking systems; besides Canada, not a single large economy has escaped. Perhaps the problem is Basel II–having a unified standard may have left us more vulnerable. But there’s something here deeper and more frightening than a lack of adequate rules.

    Update: Tyler Cowen has more on the problems European banks have with emerging market exposure, and adds:

    By the way, this is further evidence that the driving force behind the earlier boom was the global savings glut, and sheer giddiness, not the excessively loose monetary policy of Greenspan’s Fed. The ECB has pursued a relatively tight monetary policy since its origin. It also will be interesting to see what trouble arises in Spain, since Spanish banking regulation has been considered a model of how to keep these problems under control.”

    Comment by fus01 | October 27, 2008 | Reply

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