Where’s Lumpy?

Over steak and beer the other night, some friends and I were discussing how the perception that Fedzilla won’t let Fannie Mae or Freddie Mac fail encourages mortgage lenders to assume too much risk.  Of course, any action the state takes to fend off F & F insolvency is stark naked corporate welfare at its finest, and will cost taxpayers.  In the wake of the subprime mortgage crisis, we all agreed that the end of the story isn’t pretty, though none of us pretended to understand all the variables in play.

To eliminate the perception that the state won’t let Fedzilla fail, I suggested the state liquidate Fannie and Freddie completely, and allow the private sector to absorb F & F’s share of mortgages backed or owned in the US (roughly 50% of the market, according to this NYT article).  Perhaps a better solution would be to cut the few remaining regulatory ties and let them float as fully independent, tax-paying, SEC-filing private corporations.  They might not survive such a shock to the system, and their lobbyists will fight it tooth and nail, but such a move would go a long way to eliminating the perception that F & F are “too big to fail.”  Then again, it might not (Google “Bear Stearns bailout”).

One of my friends at the table, while not necessarily disagreeing, pointed out that without Fannie and Freddie, we would become a nation of renters like the UK.  I don’t remember what my response was, but it should have been this:

So what?

First, see the figures cited above:  F & F currently back or own half of all the mortgages in the US.  That means that the other half is not backed by F & F.  According to William Poole at the Cato Institute, there are good reasons for believing that the private sector would pick up F & F’s slack:

In fact, there has already been a test case for how the mortgage market would function without Fannie and Freddie. After an accounting scandal in 2005, regulators severely constrained their activities. The nation’s total residential mortgage debt outstanding rose by $1.176 trillion in that year, even though Fannie’s and Freddie’s stakes rose by only $169 billion, just 14.4 percent of the total. In essence, the market barely noticed that the two agencies’ private competitors were providing 85 percent of the increase in mortgage debt in 2005.

Second, assume the market doesn’t pick up the slack, or that it does but charges more for the increased amount of risk it must assume.  Sure, mortgages will become more expensive, and people will have to either settle for smaller homes or continue renting.  Why does this require the state’s intervention, if “only” in the form of an implicit backing of F & F with taxpayer funds?

We like to speak of the “American Dream” of home ownership, but where is this enshrined as some sort of inalienable right?  Nowhere but in our own misguided sense of entitlement.  I own a home, praise God, that is well within my means to afford, and so did everyone sitting around the dinner table that night.  If, when I bought my home on a fixed-rate basis, I could not afford the home I did buy, I would have waited until I could afford it.  That’s what financially responsible people do, and they should not be asked to foot the bill when others live beyond their means or can’t read the fine print.

What about the large segment of our population that’s quite content to continue renting?  If I were a single, urban hipster (heh) with no family and a burning desire to live downtown somewhere, I might be perfectly content to rent a small loft, and to spend and invest my money elsewhere.  Not exactly my ideal life, but to each his own.  Why should my alter-ego urban hipster be required to subsidize those who feel entitled to a house and grounds they really cannot afford?

My friend was only pointing out that F & F, with the implicit backing of the Fed, have enabled greater home ownership, and he might be right.  If this implies that we must keep F & F around at all costs, I have a problem.  F & F have also enabled the subprime crisis that is driving many homeowners back into rented accommodations.  If those homeowners could not afford the mortgages they bought, too bad.  I don’t mean to sound callous, but it’s equally callous to imply that the fiscally responsible and the “happily unpropertied” have some obligation to bail out F & F to perpetuate the “American Dream” as if it were some sort of inalienable right.

UPDATE:  A few hours after I posted this, I read this bit of breaking news.  The perception has become the reality:

Federal Reserve Chairman Ben Bernanke, Treasury Secretary Henry Paulson and James Lockhart, the companies’ chief regulator, met Friday afternoon with the top executives from the mortgage companies and informed them of the government’s plan to put the companies into a conservatorship as early as this weekend.

Buckle up, it’s going to be an expensive ride.