Should Freddie and Fannie Come Back?
By Arnold Kling
Susan Woodward and Robert Hall say “yes.” Their history of the mortgage market is correct. Their analysis of the nature of the competition between banks, thrifts, and the GSE’s (what some of us call the “duelling guarantee” model) is correct. See my testimony for the same history and analysis.
However, I disagree with their policy recommendations. I take the view that instead we should revert to the pre-Freddie model, in which banks and thrifts originated loans and held them. If Freddie and Fannie were such a good idea, why did they fail? Hall and Woodward say that need to be better regulated. Well, fine. Any institutional structure works if you assume that it is well regulated.
Banks and thrifts are not a piece of cake to regulate, either, but the fact that there are a lot of them helps in a couple of ways. First, they may not all make the same mistakes at the same time, so that there will be times when one or two firms fail without bringing down the entire system. (There will also be times when there are widespread failures.) With Freddie and Fannie, if either one messes up, you’ve got a disaster on your hands.
Second, I don’t think it is an accident that Freddie and Fannie had a weak regulator. When you have giant institutions, the regulator is bound to be intimidated. It’s a lot easier to give orders to a firm that represents one percent of the industry than to a firm that represents 25 percent of the industry.
Hall and Woodward make a big deal of the fact that securitization lowered mortgage rates. I don’t put much weight on this. First, Hall and Woodward admit that Freddie and Fannie were under-capitalized. If you require the firms to hold sufficient capital, then they will not do as much to reduce mortgage rates. Second, I am not convinced that our goal should be to minimize mortgage rates. I have said many times that while there may be a social purpose in promoting home ownership, it is far from clear that there is a social purpose in promoting mortgage indebtedness. If you’re increasing the supply of mortgage credit, you’re reducing the supply of credit elsewhere in the economy. It’s not clear that we should be aiming for that.