Little Orphan Fannie

The Mortgage Debacle and the
Death of the American Dream

There are few occasions in the political life of a nation when partisans of all stripes find it worthwhile to stake out the same position on an issue. We are currently witness to an example of this rare phenomenon: the fate of Fannie Mae and Freddie Mac, the two largest funding sources for mortgages in the United States, both of which have been kept afloat for the last two years only with gargantuan quantities of taxpayer dollars. One would be hard pressed to find anyone in the Obama Administration or any member of either house of Congress who would dare to muster a public defense of either of these two faltering behemoths. As John F. Kennedy said, "Victory finds a hundred fathers but defeat is an orphan."

As recently as a few years ago, however, the story could not have been more different. Administrations as divergent in their ideologies as those of Bill Clinton and both of the Bushes strongly advocated home ownership, and Congressional majorities of both parties were only too happy to second their motion. Fannie and Freddie are only quasi-private corporations in the sense that they were established by Federal statute and have always had the implicit, if not the actual, backing of the national treasury. But they were nonetheless free to act like other companies in the lavishing of campaign contributions upon any politician with an extended hand. In return, Fannie and Freddie were encouraged to go about their business with somewhat less regulatory oversight than was probably sensible, given the financial calamity of the last two and a half years. The rest, regrettably, is history.

So familiar are they in the world of mortgage financing that Fannie Mae and Freddie Mac no longer even use their actual names on their websites. (Officially they are, respectively, the Federal National Mortgage Association, established in 1938, and the Federal Home Loan Mortgage Corporation, hatched in 1968.) Their purpose is to maintain a healthy secondary mortgage market, wherein banks and other lenders have sufficient funding to provide home mortgages to all who qualify (and many who don't, as it turned out, but let us save that for later). Fully half the mortgages in America are backed up in this way, which means that unwinding these giant entities, as the government is poised to do over the next few years, could have enormous ramifications for the mortgage industry in particular, and the financial markets in general.

When Fannie was founded during the Great Depression, its mission could not have been more clear or more essential: providing mortgages for homeowners that banks just wouldn't lend to. Leaving banks alone to issue mortgage loans had proven too risky before the crash in 1929, and provided too little liquidity for new loans after it. Fannie went along more or less as intended until it was restructured in the late 1960s, when Freddie was established to further expand the mortgage market and to provide, in part, competition for Fannie. (You may pause here for laughter.) With the hindsight provided by the 2008 financial meltdown, the Fannie/Freddie approach may seem ill-conceived, but in fact it worked quite well for the better part of 70 years. Millions of responsible, eligible home buyers were able to get mortgages that would have remained out of reach in the "regular" mortgage market.

More to the point, the philosophical underpinnings of Fannie and Freddie seemed unassailable. Why wouldn't we want people to own, rather than rent, their homes? The logic behind the mortgage binge is neatly summarized in the popular axiom, often quoted by Thomas Friedman, that in the history of the world nobody ever washed a rented car. People who own their homes tend to take more pride and better care of them, and better care of their neighborhoods and communities, too. Or so conventional wisdom would have it. There should, in theory, also be less crime and social disorder in areas of high home ownership. Hence, the government's encouragement of home ownership was seen as a benign way of fostering good citizenship and social cohesion. And by making Fannie Mae and Freddie Mac nominally private corporations, this could be accomplished without a direct draw on the government purse, notwithstanding annual infusions of money from the Federal Housing Administration (FHA). The tax deduction on mortgage interest — another decades-old institution currently in the cross-hairs — was an additional pillar of this approach, using the tax code to favor owning over renting. None of this was without cost, though the extent of the downside risk went blissfully unnoticed for a very long time.

So what went wrong?

Volumes have already been written about the many failures of the lenders and of the regulators who were supposed to be watching them. Suffice it to say that the problem was less one of conception than of execution. Fannie and Freddie were caught in the whirlwind of financial deregulation that began in the 1980s and came to its natural conclusion in the disaster of 2008. It is fashionable at present, particularly among conservatives who are loath to hold corporations or the financial system responsible for anything that goes wrong in the economy, to blame the Great Recession mainly on Fannie and Freddie, which, as government-created entities, are easy targets for right-wing demagoguery. Liberals, on the other hand, tend to point the finger at the anything-goes attitude engendered on Wall Street in the Wild West-like atmosphere of deregulation. The Financial Crisis Inquiry Commission, established by Congress and headed by Phil Angelides, split exactly along these lines in the dueling reports they issued recently. Surely Fannie and Freddie behaved badly, but they were hardly alone; nor could they possibly have created the crisis of credit default swaps and other unrestricted derivatives all by themselves.

Exactly how the mortgage industry will look post-Fannie and Freddie is anyone's guess, but the losers are almost sure to be working- and middle-class home buyers. The consensus among economists and other observers is that the 30-year, fixed rate mortgage, which has been the mainstay of home financing for decades, will probably go the way of the corner savings bank. The FHA will probably continue to provide mortgages for lower income Americans. But without Fannie and Freddie, this could paradoxically give the government an even bigger role in home financing. In fact, the proportion of mortgages backed by the FHA since the onset of the recession and the retreat of conventional lending jumped from two percent to nearly one-third of all new mortgages. When the options facing home buyers are limited to commercial lenders, who will sell your mortgage to the highest bidder before the ink is dry on the closing papers, and the Federal government, which for the good of the country really ought to get out of the business of lending and borrowing altogether, there is little reason for optimism. If Republicans have their way, there won't be a government option at all, which will leave us entirely at the mercy of the banks for the first time since the 1920s.

There are those who will argue that the bias in favor of owning has always been misguided, and that until the middle of the last century there were innumerable stable communities in which the vast majority of residents were renters. Indeed, when apartment buildings in New York and other cities were converted to coops and condos on a large scale beginning in the 1980s, there was something suspicious about the entire enterprise. Thousands upon thousands of tenants, many of whom had lived contentedly as renters their entire lives, were forced either to buy their apartments or move out. Finding other rentals became increasingly difficult as more and more buildings fell into the hands of speculators. Some people were no doubt convinced of the advantages of home ownership, but for many others there didn't seem to be any point to buying at all. A lot of people would make money on the deal — investors, real estate agents, mortgage brokers, bankers, lawyers — while you, the tenant, were given the privilege of spending a lot more money to live within the same four walls. (Do the words "subprime mortgage" ring a bell?) Sure, you would have equity in your home, but instead of rent you would still have to pay taxes and carrying charges for the rest of your life. Each time you wanted to move, all the equity you earned would just be poured into another flat, and, to add insult to injury, you would have to pay thousands of dollars in closing costs.

These detractors would further say that the promotion of home ownership, in the end, did little more than create an endless series of financial bubbles that wreaked havoc on the whole economy whenever they burst. That view, of course, ignores the feeling of financial security that countless millions feel they have in fact gained from owning their own homes, as long as they weren't caught on the wrong end of the most recent collapse in prices. If you were lucky enough to buy low and cash out when the market was high, and retire to a state where living is cheaper, good for you. But that's just another version of playing the markets; in other words, gambling with your nest-egg, which is something the renter chooses to avoid altogether. The main difference between the real estate market and the stock market, of course, is that you can't live inside your stock portfolio. Worse, this scenario only gives credence to the conservative position that Fannie and Freddie are more to blame for the last financial crisis than Lehman Brothers or Goldman Sachs (in other words, it was the mortgages, stupid). But even if most of us did come to agree that home ownership was not the win-win social policy that we long thought it to be, and that its consequences were not worth its advantages, what are we proposing to take its place?

The dream of owning one's own home remains very much alive for many people, but the means of achieving it are being eroded. As we have already seen, the financial crises at the Federal and state level are leading to assaults on all manner of previously untouchable notions, from the pensions of public employees to the reliability of state-issued bonds. What is clear is that the real estate market in most of the country may never again be what it was prior to 2008, and that we may face a prolonged period of stable or even declining property values. Without a concerted, nationwide effort to make money available to borrowers of limited means, and a regulatory system that is up to the task of keeping such an effort honest, there will continue to be a lot of mortgage defaults in the years to come, and a lot more owners walking away from their properties — that is, behaving just like renters. So much for that particular slice of the American dream, John Boehner's tears notwithstanding.