Fannie, Freddie, and the Mortgage Market

by Veronique de Rugy

The Obama administration last month issued a white paper with proposals for gradually phasing out the two housing giants, Freddie Mac and Fannie Mae. Critics of the plan have argued that handing mortgage financing over to the private sector will lead to further “market” failures — by which many people mean that it would become harder to secure a loan to buy a house because down payments would be higher and interest rates would go up.

And it’s true (though not a market failure) that without federal backing, a 30-year mortgage with a 5 percent interest rate is unlikely to be offered by any bank. In addition to charging higher interest rates, banks would probably also require larger down payments. However, it is wrong to assume this will necessarily mean a severe decline in home ownership. First, as the following chart shows, in the last 30 years, interest paid by homeowners has fluctuated quite dramatically while the rate of home ownership has remained steady.

In 1981, for example, interest rates were at an all-time high of 16.6 percent and the home ownership rate was 65.4 percent. In 2009, interest rates were near record lows at 5 percent but home ownership held steady at 67.4 percent. The last time we had that home ownership rate was in 2000, and at that point the interest rate was 8 percent.

Furthermore, low down payments are a relatively recent phenomenon. In the 1980s and most of the 1990s, down payments had to be roughly 20 percent of the value of your home.

Finally, higher interest rates and higher down payments are not necessarily bad for home buyers. Both will incentivize new owners to keep and maintain their new property. If we have learned anything in the last decade, it’s that redefining the American dream to mean home ownership for everyone is a very risky endeavor. Besides, the alternative to home ownership isn’t living on the streets; it’s renting.

I talked about several other Freddie and Fannie myths in my weekly “Reality Check” with Bloomberg’s Carol Massar and Matt Miller. Among other things, we talked about the role of Freddie and Fannie in the financial crisis. I explained how the GSEs weren’t the only factor leading to the financial crisis, but they played an important role in pushing up the demand for housing at the low end of the market, especially between 1998 and 2003. That in turn made subprime loans increasingly attractive to other financial institutions as housing prices rose steadily.

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