The Government Mortgage Business Is A HUGE Mistake

The knee-jerk reaction of politicians to the beginnings of the deflation of the housing bubble has been to yell for the limits on Fannie Mae and Freddie Mac to be raised so that they can buy more mortgages with less security. This would be a terrible mistake, and not just for Joe tax payer how implicitly foots the bill for the quasi-public entities. The downside is the only public part.

But I'd lay the entire housing bubble at the foot of Fannie and Freddie because these agencies were essentially responsible for making the mortgage origination business a business. Without the F twins, banks used to originate and hold mortgages. This gave them plenty of reason to exercise due diligence in determining whether or not to grant a mortgage, to evaluate the property realistically, and to require a down payment that would cover a sudden dip in the housing market and default. The norm for down payments used to be 20%.

But the government came along and intervened in the market with Fannie and Freddie, and the obvious business model became: originate as many loans as possible that meet the minimum requirements and pawn them off on the taxpayer backed companies. Some analysts point to the bubble in California where prices are well beyond what the agencies can take on as proof they aren't responsible, but they invented the business model!

The whole sub-prime mess isn't about the hedge funds and banks who pulled the wool over each others willing eyes, it's about the conception that mortgages can and should be resold by banks. Whether you call that a moral hazard or a conflict of interest, it's clear that the human beings involved can't hack the responsibility of getting paid up front and passing on the risk.