The Role Of Fannie And Freddie In The US Housing Market In One Chart
Once upon a time, US thrift institutions were the primary provider of credit to keep the American housing market humming along. Then the great Savings and Loan crisis happened, and by and large thrifts disappeared from the housing credit landscape. The result was the advent of Fannie and Freddie (i.e., the GSEs) as the "rug" that tied the US housing market room together. The chart below shows the dramatic increase in the role that the GSEs started playing following the S&L crisis, and which culminated with the great financial crisis, or rather the failure of the GSEs a month ahead of the Lehman bankruptcy.
As the WSJ's Nick Timiraos explains:
The government plays an unusually large role in the U.S. mortgage market because banks don't like holding 30-year mortgages. During the 1980s, many savings-and-loan associations failed when rates jumped because the interest they had to pay to depositors soared above the payments they received on those 30-year mortgages. This is known as "interest-rate risk."
Enter Fannie and Freddie. They don't make loans. Instead, they buy them from lenders, package them into securities, and sell those to investors. They promise to make investors whole when mortgages default. In other words, they take the credit risk.
Then August 2008 happened and the GSEs - that so important source of shadow credit - were effectively nationalized (even if their trillions in debt, inexplicably, never made it on the sovereign balance sheet much to Peter Orszag's chagrin). Which is usually what happens when a third party takes on indefinite interest-rate risk, and when the interest rate punchbowl resulting from three decades of "Great moderation" is finally pulled away.
Since then nobody has come up with any actionable proposal how to maintain housing storming along, while concurrently pushing Fannie and Freddie off of the taxpayer's tab, despite numerous attempts to "resolve" this sticking issue resulting not from the blow up of one but two financial crises. The WSJ has some further clarity:
Those who want the government out of the mortgage business say the 30-year fixed isn't all it's cracked up to be. Because borrowers pay a lot of interest during the first few years of the loan, it's hard to quickly build equity. This makes the loan less practical in an era where people move, switch jobs, and get divorced more often than in the past.
Defenders, however, say it's the wrong time to push more people into adjustable-rate loans because interest rates are likely to rise over the coming decade.
Wouldn't banks still offer the 30-year fixed mortgage without a government guarantee if it's so popular? Maybe, but they would likely require bigger down payments and higher rates.
It's a math issue. There is nearly $10 trillion in mortgage debt outstanding today with around $4.5 trillion backed by Fannie and Freddie. Scrapping the government's role means finding trillions of dollars ready to absorb the credit and interest-rate risk for new mortgages, since the firms have backed around two-thirds of those made since 2009.
Our two cents: just like with HFT-infested broken capital markets, and the centrally-planned economy in general ("planned" by a Fed whose communication skills are put increasingly under the confidence microscope), don't expect any material (or even superficial) changes until the next big crash, which hopefully does not double down as the great systemic reset that increasingly more seem to believe is no longer avoidable but simply a matter of time.
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