The bailout of the two large housing mortgage companies, Fannie Mae and Freddie Mac has attracted conservative criticism that these companies contributed to the sub-prime crisis. This is a standard conservative tactic of shifting the blame. Fannie and Freddie were caught in the negative externality of the housing bubble created by Wall Street. The true moral of the Fannie and Freddie story is that there is a case for nationalisation and greater regulation of financial markets.

Many progressives in the west now believe the age of Milton Friedman may be drawing to a close. Their hope is the current financial crisis has shown the costs and dangers of inadequate market regulation, thereby discrediting the anti-regulation philosophy of Milton Friedman and his Chicago School colleagues.

Evidence of the changing times is supposedly provided by treasury secretary Hank Paulson's and Federal Reserve chairman Ben Bernanke's public admissions about the need for regulatory change.

Yet the reality is far more complex, and economic conservative will not roll over and surrender just because of a financial crisis. Instead, if history is a guide, they will blame regulation for the crisis. That was Milton Friedman’s modus operandi when he launched the modern era of deregulation and animus to government with his false claim that the Fed caused the Great Depression.

Blaming Fannie Mae, Freddie Mac

This tried and tested conservative tactic is already surfacing in the debate surrounding Fannie Mae and Freddie Mac, the giant mortgage financing companies. The conservative argument: is government's provision of an implicit guarantee to Fannie and Freddie distorted the market by giving them subsidised finance. The implication is that this enabled them to pump up the housing bubble, while simultaneously making them the dominant players in the securitised mortgage market.

This conservative tactic scapegoats Fannie and Freddie, making them the fall guys for the bubble's financial excesses, when the true cause was inadequate regulation of mortgage lending and failed macroeconomic policy.

Fannie Mae (formally the Federal National Mortgage Association) was set up in 1938 as a New Deal measure to help the housing market, and it was privatized in 1968. Freddie Mac (formally the Federal Home Loan Mortgage Company) was set up as a private company in 1970

to provide competition against Fannie.

Both companies carry an implicit government guarantee of their debt. Hence the reason they are also known as the government sponsored enterprises or GSES. However, a condition of that guarantee is they limit the riskiness of the mortgages they invest in.

The mission of Fannie and Freddie is to facilitate home ownership. They do this by buying mortgages from private lenders, bundling those mortgages as securitized debt, and then selling those securitized obligations on the open market to financial investors. They also retain some of the mortgages they buy as investments that benefit their own shareholders.

 Fannie and Freddie help increase home ownership by increasing the volume of mortgage finance and decreasing its price. They increase the volume by buying mortgages from banks, thereby providing banks with fresh finance to make additional loans. They lower the price in two ways. First, by buying and bundling mortgages for resale as securitized debt, they create a highly liquid market that makes mortgage loans a more attractive portfolio investment.

That increases investor demand for mortgages, which lowers the interest rate mortgage borrowers pay. Second, the fact that they have a government guarantee means Fannie and Freddie have a lower cost of capital, which enables them to buy even more mortgages.

Part of an article by & views of: Thomas I Palley (mail@thomaspalley.com), an economist based in Washington, runs the project ‘Economics for Democratic and Open Societies’

Quoting from [qianshou]:


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