Dimensions: 6'' x 8.75'' 187 pages AEI Press  (Washington) Publication Date: July 2001 Paperback ISBN: 0-8447-4166-3 Price: $ 20.00 Add to Cart   Examination Copies

July 2001
Serving Two Masters, Yet Out of Control: Fannie Mae and Freddie Mac
Edited by Peter J. Wallison

Because two disparate, almost diametrically opposite clients demand loyalty from Fannie Mae and Freddie Mac, both of those government-sponsored entities must fulfill two ultimately irreconcilable roles. As publicly-owned corporations, they must maximize profitability for shareholders. Yet, as quasi-government agencies, they should use their huge, implicit government subsidies in support of their public missions.

Those subsidies' conflicting objectives, the risks to taxpayers, and the agencies' resistance to any regulation create the internal tensions at Fannie Mae and Freddie Mac. Would privatization solve the dilemma of the dual public and private form? If not, what other options exist? In this volume, public figures, economists, and government officials probe the favored positions that have allowed the two agencies to grow to unprecedented size, realize extraordinary profitability, and achieve unparalleled influence over the political process.

Peter J. Wallison, the volume’s editor, is an AEI resident fellow. This summary is adapted from his introductory chapter. The other contributors are Jonathan Brown, Essential Information; Charles W. Calomiris, Columbia University and AEI; Richard Scott Carnell, Fordham University; Ron Feldman, Federal Reserve Bank of Minneapolis; Ralph Nader, consumer activist; Mark Overend, SLM Holding Corporation; Robert S. Seiler Jr., Office of Federal Housing Enterprise Oversight; Thomas H. Stanton, attorney; Robert Van Order, Freddie Mac; and John C. Weicher, formerly of the Hudson Institute.

In 1999 and 2000 AEI sponsored three conferences on the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), each exploring a different aspect of the public policy problem presented by these government-sponsored enterprises (GSEs). The series began with a conference entitled "Fannie Mae and Freddie Mac: Public Mission and Private Interests;" in a sense, this title encapsulates the contradiction that lies at the root of the controversy over these organizations.

Fannie Mae and Freddie Mac have two ultimately irreconcilable roles. In effect they serve two masters. As publicly owned corporations, they are required to maximize profitability for their shareholders; as government agencies, they have been assigned public missions for which they receive an implicit government subsidy. The size of that subsidy and how it is divided between the organizations' public and private objectives, the risks that those objectives create for taxpayers, and the organizations' resistance to efforts by any regulatory body--or even Congress--to gain control over their activities exemplify the internal tensions created by their conflicting objectives.

Unsurprisingly these issues should also be the focus of any serious inquiry into whether Fannie Mae and Freddie Mac should retain the favored positions that have allowed them to grow to unprecedented size, to realize extraordinary profitability, and to achieve unparalleled influence over the political process. Because they address the key issues most directly, the essays in this volume were selected from the many excellent contributions to the three AEI conferences.

The Subsidy

Contradictory goals lead to contradictory results. The Congressional Budget Office estimated in 1996 that Fannie Mae and Freddie Mac were simply dividing their subsidy between their shareholders and the mortgage markets they were created to serve; about two-thirds was being used to lower mortgage rates, while the remaining third was used to make both companies highly profitable. CBO found that about 42 percent of the agencies' profitability in 1995 resulted from government backing in that year. The Treasury Department prepared a study with similar results in the same year.

In 2001, CBO did a somewhat more sophisticated study. This time the subsidy was judged to be even larger, $10.6 billion, and the percentages that went to shareholders rose to almost 37. All the essays in this volume were prepared before this second CBO report was made public.

Two analyses delivered at the first conference were particularly noteworthy. Robin Seiler, then at CBO, reviewed and expanded on the CBO and Treasury findings. He noted that both studies understated the size of the implicit subsidy because they focused only on the subsidy’s effect in lowering the agencies’ borrowing costs. Additional subsidy may be implicit in the fact that they function with far lower capital ratios than other financial intermediaries.

The Comparison with National Banks

At the same conference Robert Van Order, chief economist at Freddie Mac, argued that the GSEs did not substantially differ from national banks. Van Order pictured the housing market as a case of "dueling charters" with two kinds of GSEs--national banks on one hand and Fannie Mae and Freddie Mac on the other--performing different roles. Van Order did not deny that the GSEs received some government backing but contended that they used their support more efficiently than national banks and thus--to the extent that they outcompeted national banks--increased overall welfare.

The Van Order thesis is by all accounts the best and most sophisticated justification for the continued existence of the GSEs, and it provoked two contrary analyses at the second conference. Richard Scott Carnell argued that the GSEs and national banks cannot really be considered similar or competitive entities because of many significant differences between the two. Charles Calomiris argued that Van Order's welfare analysis failed to consider that the GSEs would use their subsidy elsewhere with no welfare benefit to society if GSE competition displaced banks from the mortgage market. Calomiris also presented an economist's discussion of the other benefits frequently attributed to the GSEs and proposed a better way to allocate the agencies' subsidy.

The second conference also considered the question of whether and how Congress could effectively control Fannie Mae and Freddie Mac. Ralph Nader outlined the difficulties of doing so; he sees the GSEs as an egregious case of corporate welfare. His essay, however, goes beyond the critique of Fannie Mae and Freddie Mac as feeders at the trough to delineate the many ways in which they use their wealth and power to perpetuate their advantages.

Ideas for Change

The third conference focused on choices available to policymakers who are willing to consider modifying the status of Fannie Mae and Freddie Mac. Several possibilities presented themselves. The most popular idea has traditionally been full privatization, in which all the GSEs' ties to the federal government would be cut. As a precedent for this, the Student Loan Marketing Association, a government-sponsored enterprise known as Sallie Mae, voluntarily privatized by cutting its government connections in the mid-1990s. Mark Overend of Sallie Mae discussed why and how the company took this step.

Other proposals were discussed at the conference. Thomas Stanton proposed chartering additional GSEs as competitors for Fannie Mae and Freddie Mac. John Weicher, then of the Hudson Institute, discussed the feasibility of restraining Fannie Mae and Freddie Mac through restrictions in their charters or through laws or regulations and concluded that such a course would likely be unsuccessful. Ron Feldman of the Minneapolis Federal Reserve Bank reached a similar conclusion; he explored the possibility that mandatory credit ratings, imposition of a guarantee fee, or inclusion of the agencies in the federal budget might control Fannie Mae and Freddie Mac or reduce their risks.

Finally, Jonathan Brown of Essential Information considered whether requiring the GSEs to meet stricter affordable and low-income housing guidelines might recapture all or a portion of the agencies’ subsidy. Brown illustrated that the GSEs do considerably less for low-income homebuyers than do ordinary banks and savings-and-loan institutions despite congressional efforts to get the GSEs to share a greater proportion of their government benefits. That conclusion raises the interesting question of why so many key congressional supporters of the GSEs come from minority communities that receive the fewest benefits from Fannie Mae and Freddie Mac.

More generally, however, the failure of Fannie Mae and Freddie Mac to respond to prodding by Congress and the Department of Housing and Urban Development illustrates why shareholder-owned corporations should not be charged with public missions. Fannie Mae and Freddie Mac, as privately owned companies, must seek every avenue for profit and every opportunity to escape those government mandates that will reduce their profitability. This objective is reinforced by the compensation that their managements receive--through stock options and other benefits--from increases in their stock prices.

Moreover, as Nader makes clear, Fannie Mae has used its wealth and power in Washington to escape virtually all forms of control. And it has done this through means that could--if fully exposed to public view--be seen as verging on the corrupt.

Because of the agencies' dual public and private form, various efforts to force Fannie Mae and Freddie Mac to fulfill their public mission at the cost of their profitability have failed--and will likely continue to fail. The only viable solution would seem to be full privatization or the adoption of policies that would force the agencies to adopt this course themselves.