Fannie Mae and Freddie Mac: How the Government has Warped the Housing Market for 80 years (Part 1)

The free market didn't build this.  It didn't even build itself (house logic)

The free market didn't build this.  It didn't even build itself (house logic)

An article in the NY Times this past week discussed the on-going court battle between the US Government and private shareholders over the profits of mortgage-finance companies Fannie Mae and Freddie Mac.  As part of one of the major bailouts of the 2008 crisis, the US Treasury took both companies into government receivership and secured rights to future profits of both institutions along the lines of a 10% dividend each quarter.  Surprisingly, in 2012, the US Treasury revised the deal and has since taken all of the profits from both companies (to the tune of $1.7 billion in Q4 2015 alone) which prompted the first lawsuit in 2013.

This post will be the 1st of 2 that will examine Fannie Mae and Freddie Mac and why they have had such a huge impact on housing policy in this country, whether you are a homeowner or a renter.  The first post will discuss their creation and the policy discussions that drove their evolution.  The second post will examine their role in the lead up to and aftermath of the financial crisis of 2008.

It all begins in the midst of the previous major financial crisis, the Great Depression. In 1933 just less than half of Americans owned homes, but about a quarter of those mortgages were in default and thousands of people had lost their homes.  This also meant that thousands of workers associated with the homebuilding industry didn't have jobs.  

FDR, in full New Deal swing, passed the National Housing Act of 1934 which established several government-sponsored enterprises (GSEs) to encourage the construction and financing of private homes: the Federal Housing Administration which offered insurance on mortgages that explicitly guaranteed them, the Federal Savings and Loan Insurance Corporation, which insured savings and loan associations which offered mortgages; and the United States Housing Authority, which made loans to local public agencies for low-income housing.

The underlying logic was that by supporting home ownership and home construction, the US government could kickstart the economy and stabilize the political environment which had many radical elements. Homeownership was seen as a social good as well as an economic good. There was notable opposition to these measure, but FDR's first administration had large enough majorities in Congress to pass such measures despite Republican and conservative Democratic opposition. 

FDR meant well (us news)

FDR meant well (us news)

An amendment to the National Housing Act in 1938 created forerunner of the Federal National Mortgage Association (FNMA) - conveniently shortened to Fannie Mae.  Fannie Mae was formed to encourage banks to offer more mortgages to Americans by creating a secondary mortgage market where banks could then package those mortgages and sell them to other financial institutions.  

So basically as a result of the National Housing Act, the government tilted the housing market heavily towards private ownership and away from renting by first guaranteeing mortgages through the FHA, which reduced the risk to banks, and then by creating a secondary mortgage market through Fannie Mae, which increased the amount of money banks could make from reselling mortgages.  This made offering affordable mortgage financing attractive to banks which dramatically lowered the cost of owning a home for average Americans.

This is an important and often overlooked moment in American history because it can be argued that this is where the idea of owning a home became such a large, bi-partisan part of the American Dream (a phrase coined around the same time in 1931).  Up until this point, homeownership rates were generally around 40-45% nationally with predictably huge swings between rural and urban dwellers (it is currently about 65%).

Certainly much of the foundational mythology of American homeownership can be traced back to the early European settlers carving out their own homes and to the early homesteaders settling the western frontiers, but there was always a smaller share of homeowners than commonly believed (and a larger share of slaves, indentured servants, and displaced indigenous that were obviously denied the ability to own a home). Indeed, as European immigration exploded in the 19th and early 20th centuries, people flooded into cities and few had any expectation of owning a home. Renting was cheap and allowed proximity to jobs, services, and cultural institutions that shaped many ethnic identities in America as well as the cities that housed them.

It was the perception that urban America was in irrevocable decay during the Depression that permanently changed American housing policy away from cities and urbanism. Hysteria over the conditions of the urban poor has long been an easily exploitable trope in American politics, often not so subtly tinged with racism and xenophobia.  Perhaps ironically, the New Deal created an unprecedented opportunity to address it on a national scale but unfortunately caused a lot of unintended damage, which further exacerbated those problems. Fannie Mae was just one policy tool that the US Government used, consciously or subconsciously, to start the suburban sprawl / white flight era that dominated the postwar American landscape.

Almost instantly, Fannie Mae went beyond its initial intended policy goals, which were to spark the private sector, and instead effectively established a 30-year monopoly over the secondary mortgage market because, as a government agency, it could borrow money at lower-rates than private institutions, which made it harder to compete against. 

Some members of Congress along with trade groups associated with homebuilding thought Fannie Mae exerted too much power over the private market (criticisms were a mixture of self-interest and philosophical beefs) and wanted it abolished or privatized - while other members of Congress wanted it to remain a government agency to ensure the social goods of affordable homeownership were preserved.  

The Eisenhower administration, which was stocked with people from the real estate industry, pushed through a compromise in the pivotal National Housing Act of 1954, which included the Charter Act that reorganized Fannie Mae into a semi-private company that allowed private investors to hold common stock. (The Act also established slum clearance as a national policy of urban renewal, which also had far reaching consequences.) This left Fannie Mae as a "mixed-ownership corporation" but undeniably set it up for future privatization.

In 1968, at the height of the Vietnam War, President Johnson re-chartered Fannie Mae as a private company to remove it's holdings from the federal budget through the Housing and Urban Development Act of 1968.  The cost of the war was skyrocketing and though Johnson could largely ignore citizen protests (to a point), Congress was starting to question the impact on the budget, so Fannie Mae - which many in Congress still wanted privatized - was an elegant solution to reduce the raw numbers. From this point forward, Fannie Mae would be a private corporation beholden to its shareholders. 

Johnson less so (housing perspectives)

Johnson less so (housing perspectives)

Fannie Mae officially went public in 1970 and also began purchasing conventional mortgages, expanding beyond the secondary market, but technically no longer had the explicit backing of the federal government. In order to create 'competition', Congress also created the Federal Home Loan Mortgage Corporation (Freddie Mac) which had an almost identical structure and mission but was a separate entity with its own board and leadership.

The modern Fannie and Freddie were born. Today they are two of the largest financial institutions in the world and control over $5 trillion in mortgage assets. I'll explore how this happened in the next post.

It might seem weird to have kinda-sorta private-but-public companies have so much power in the mortgage industry, because it was and is.  Let's not forget that this was a political choice that had broad bi-partisan support.  Politicians on the left and right both saw the virtues of homeownership and wanted government policy to encourage it. The key intention here was to 'encourage' it, but creating such a large force within the private sector that has a government guarantee ultimately did more than encourage the private market - it dominated the private market and warped it.

Without the government guaranteeing the market directly and indirectly, homeownership would simply never have been such an economic and cultural driver in the second half the 20th century.  

Just as importantly, the amount of federal money that went into homeownership (including through infrastructure spending and the tax code) created a vacuum that sucked money out of America's cities during this period. Though billions were spent on "urban renewal" the devastating impact on poorer urban residents (the majority of which were minorities by this time) has been chronicled for years.

It is fascinating to imagine how differently America would look physically and socially without such a large government intervention over decades in homeownership.  Would the private market still have driven up homeownership rates to their current levels? Would there have been such an explosion of car-centric suburban and exurban communities? Would there have been such a focus on highway construction over transit construction? Would there have been such conscious racial exclusionary policies? Such a concentration of extreme poverty in inner city neighborhoods? Such a political divide between urban and rural across state-lines

No question there are social goods for owning a home, and no question there are a lot of benefits from the type of society it has created, but the costs and trade-offs of the US government tilting the scales so heavily in the favor of homeownership are difficult to comprehend, even without looking at the hard numbers of the bailout.  At a time when the environmental and political impact of these policies have started to manifested themselves in troubling ways, we must look honestly at how we got here if we are to address these challenges responsibly. 

In post 2, I will give a quick overview of Fannie and Freddie from 1970 to today and why all this blew up in 2008. I'll also return to the current court case and where both companies stands today.