Down with Fannie and Freddie?

With the US bailing out Fannie and Freddie in 2008 to the tune of some $250 billion, adding to the $40 trillion+ net worth of the country, many would like to see these quasi government entities done away with all together.  But what consequences and repercussions would that have on the housing market, and the American way of life for that matter?

What do Freddie Mac and Fannie Mae actually do?  Their purpose lies in creating a secondary mortgage market, in its simplest terms, so that that loan originators do not have to carry loans on their own books, freeing them up to extend loans to others.

In a recent Fortune magazine article entitled Fixing the Mortgage Mess, Wells Fargo CEO John Stumpf articulates that if we were to do away with Fannie and Freddie, we’d be transported back to to 1976 when he first purchased a home, struggling to find a mortgage because banks did not have ample deposits on hand to provide loans.    There are approximately 76 million homes in the US today, and of those, 51 million have mortgages, which aggregates to approximately $11 trillion.  Banks simply don’t have the ability to burden that level of debt on their own, and therein lies the need for a secondary market facilitated by Fannie and Freddie.

While it’s a fact that a secondary mortgage market must exist for borrowing to be feasible and somewhat affordable for the masses (granted, it could be argued that lending to the masses is not an ideal we should strive for), that shouldn’t come without reasonable boundaries put in place to protect us from the same meltdown that occurred several years ago.  That is where Stumpf inserts what appear to be reasonable guidelines that might help right the ship so to speak.

First, all parties having financial skin the game.  With loan originators often not holding loans on their own books and exploiting the secondary market, this leaves the overall lending system exposed.  Some consequences of this may be higher down payments, and minimums for how much of a loan should be maintained in a lender’s portfolio.  Second, additional transparency and explicit clarity is needed in how any quasi government agencies operate, which would in turn lead to bolstered confidence and market liquidity.  And the third guideline that Stumpf highlights is uniform and consistent underwriting standard across the industry.  This latter point seems terribly obvious should we want to maintain any sort of health in the system on a long term basis as over time constituency groups tend to shirk responsibilities and test the boundaries.

So, should we aim to down Fannie and Freddie?  To support home ownership for a large percentage of the population, a secondary mortgage market in some form must exist, is it in Fannie and Freddie, that’s to be debated.