A Further Perspective

The Two-Headed Wooly Mammoth

Fannie and Freddie should have been treated by Dr. Kevorkian years ago.

By 5.26.10

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This time it's not an elephant in the room that no one sees, it's a large, two-headed wooly mammoth. It subsists on endless amounts of money. Each head has a name. One is named Fannie Mae and the other is named Freddie Mac.

If you were a wooly mammoth you, too, would want to have a name that is deceptively innocent sounding, almost cuddly. Like the wooly mammoths of prehistoric times, however, this one is anything but cuddly.

Fannie was created toward the end of the Depression, in 1938, to add to liquidity in the home mortgage market. It puttered along until 1968 when it was converted to a private, but government-sponsored, shareholder corporation. This had the handy effect of taking it off the federal budget. Although the government would no longer guarantee Fannie-issue mortgages, Fannie's government-sponsored status implied the “full faith and credit” of the government behind it, and business grew as a result.

In 1970. Freddie Mac became Fannie's younger brother for the purpose of stimulating competition. Then, in 1977, the Carter Administration and its Congress passed the Community Reinvestment Act. In exchange for banks receiving federal insurance of their depositors' money, the CRA required them to "help meet the credit needs of the communities in which they operate, including low- and moderate-income neighborhoods, consistent with safe and sound operations."

This was intended to end the practice of "redlining," in which a bank wouldn't lend in an entire neighborhood so marked. It was to be replaced by making mortgage decisions on a case-by-case basis. Things moved along until 1999 when officials of the Clinton Administration pressured Fannie to pressure banks to increase the number of their loans in urban areas that had been designated by the CRA as "distressed." Meanwhile, community groups (remember Barack Obama, "Community Organizer"?), using the disruption tactics of radical Saul Alinsky, began picketing and intimidating banks they thought were dragging their feet.

Fannie's demand that lenders increase their ratio of low-income loans led to pressure on it to lighten credit requirements it had maintained as to which mortgages it was willing to purchase.

Subprime lending grew like Topsy. Rep. Barney Frank was a cheerleader for this rapid expansion. Fannie's shareholders loved the steady profits. Its executives (several of them former Clinton Administration officials) loved their big bonuses.

All this led to more subprime lending and the tricky, new convoluted mortgage schemes in the market. The whole bubble began to come apart at the seams in late 2007. The New York Times showed prescience back in 1999 when it wrote, "Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times, but the government-subsidized corporation may run into trouble in an economic downtown, prompting a government rescue similar to that of the savings and loan industry in the 1980s." And that is what happened. 

By summer 2008, Fannie and Freddie, between them, were backing more than half of the nation's home mortgages and they were in the red. By August that year, their share prices had dropped by 90 percent. In September, the federal government took over both, putting them under conservatorship. The U.S. Treasury now owns 80 percent of both through preferred stock and common stock warrants.

Instead of planning to phase them out, the government vowed to keep them running. It has pumped $127 billion into the two since the takeover, with no end in sight. Indeed, the Obama Administration has lifted restrictions on borrowing by the two-headed mammoth with the big appetite.

Senator Chris Dodd's finance "reform" bill conspicuously leaves out any reference to either Fannie or Freddie. What should happen to both is euthanasia. Like Dr. Kevorkian's death machines, the plan to do so should be built carefully and, unlike Dr. Kevorkian's, which work in minutes, the euthanasia should be phased in over a reasonable period of time so they can fall into the long, long sleep of real wooly mammoths.

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About the Author
Peter Hannaford was closely associated with the late President Reagan for a number of years. He is a member of the board of the Committee on the Present Danger. His latest book is “Presidential Retreats.”