Yesterday, Freddie Mac announced that it would require an additional $31.8 billion from the government, after losing $50 billion last year. That comes on top of the $13.8 billion Freddie took late last year. It may even need more: the government has pledged a $200 billion credit line to support the company. It would likely raise that limit if Freddie ever approaches it.
It is now increasingly clear that Fannie Mae and Freddie Mac have been disasters from the start. While the losses are staggering, the strongest evidence against them actually comes from a comparison of the costs to taxpayers for the bailouts of these two troubled mortgage companies and the benefits homeowners collectively received over the years from the operation of these two government sponsored companies. The evidence is now in, and it weighs heavily in favour of the conclusion that Fannie and Freddie have been a terrible deal for the American people.
This may surprise many people. After all, how could it be that Fannie and Freddie completely failed in their mission to provide affordable housing to Americans? Weren’t there benefits in terms of lower mortgage rates that should balance out the bailout costs? Well, as it turns out, those benefits may have already been dwarfed by the amount of taxpayer money that has been used to rescue the companies. Even judging by the most optimistic estimates of the benefits from Fannie and Freddie, the companies will likely be net losers for the U.S. by year’s end.
The key to understanding this is to look at how much in total Fannie and Freddie may have saved homeowners in mortgage payments. The advantage of having Fannie and Freddie operate as government sponsored entities was that they could borrow at lower rates than purely private companies. Under the so-called “implied guarantee” lenders assumed the government would back up Fannie and Freddie, so they were willing to lend to the companies at lower rates. This, in turn, enabled them to make mortgage loans at lower rates.
According to economist Lawrence J. White of New York University’s Stern School of Business, the consensus among economists holds that the “implied guarantee” Fannie and Freddie enjoyed for most of their existence allowed the GSE’s to borrow at rates between 35 and 40 basis points lower than rates available to purely private sector companies. If a private mortgage lender paid 6.35 per cent to borrow, Fannie Mae pays only 6. Home buyers only got a part of that benefit–the rest went to management and shareholders. Buyers benefited from the ability to get mortgages with rates that were somewhere between 7 and 25 basis points lower than they would have been otherwise. (The numbers are disputed by economists.)
Let’s stick with the high number, just for the sake of argument. Over the years and spread across millions of home buyers, that 25 basis point savings adds up to a lot of money. With Fannie and Freddie holding or guaranteed mortgages on 31 million homes worth about $5.5 trillion at the end of 2008, borrowers would have saved over $10 billion in 2008. The numbers change from year to year. But last year Daniel Gross reported in an article for Slate that Professor White believes it could add up to more than $100 billion in current dollars over the years.
Comparing that $100 billion savings against the government’s pledge of $400 billion in financial support for Fannie and Freddie raises the question of what good these companies ever did. The drawings on that pledge are still less than $60 billion–around $45 billion for Freddie and $15 billion for Fannie–but are expected to exceed $100 billion by the end of 2009. If further drawings come to pass it will mean that even using the most optimistic estimates for the interest rate savings provided by Fannie and Freddie, the companies have been huge costs for taxpayers with no net tangible benefits.
Using more conservative estimates, they’ve already passed that mark.