Carnegie Mellon University

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September 12, 2019

The Administration’s Plan to Privatize Fannie and Freddie Could Cause More Harm Than Help

By Deeksha Gupta, Assistant Professor of Finance

On September 5, the White House introduced its plan to privatize Fannie Mae and Freddie Mac eleven years after the two mortgage finance companies collapsed during the 2008 financial crisis and were bailed out by taxpayers for $187 billion.

There are arguments for and against government involvement in the housing market, however, a structure in which there are enterprises that are neither completely public nor completely private, as is what is being proposed, has many potential flaws.

Under the new plan, Fannie and Freddie would have private shareholders but would continue to have a government backstop. This would be very similar to their structure at the time of the housing boom and bust, before they were taken into government conservatorship. Many economists have argued that such a private-public structure was a contributing factor in the housing crisis of 2008. Essentially, the government-sponsored enterprises (GSEs) are incentivized to maximize profits for their shareholders while simultaneously being backed by the government. In return for this backing, they are expected to fulfill certain housing goals and targets, typically aimed at providing credit to lower-income households and more broadly promoting homeownership.

This type of public-private mandate can create a number of issues that could encourage risk-taking in the mortgage sector and distort the provision of mortgage credit. A key problem with such a structure is that implicit and explicit government guarantees give the GSEs a lot of market power in the mortgage market and arguably a duopoly in certain segments of the housing market. This essentially makes the GSEs systemically important and too-big-to-fail. This can encourage the GSEs to take on risks to maximize profit for their shareholders on the back of their government guarantee. Shareholders can benefit from profits when the housing market is booming, with taxpayers bearing the downside risk in the event of a housing downturn. Such risky lending can make the housing market fragile and increase the risk of an economy-wide recession should housing prices drop.

Under this proposed structure, the GSEs are asked to increase mortgage provisions to low-income and other underserved communities, but are simultaneously being asked to maximize profits for their shareholders. These two goals may not—and typically will not—align. This can result in either the GSEs increasing the risk they are taking or simply ignoring goals that are targeted toward helping households access credit. This has been the case in the past, when the GSEs often missed their housing targets regarding improving credit access to lower-income households. Perhaps, stricter oversight can help resolve this problem partially, but fundamentally it is unclear how privatization helps to better achieve public housing goals. In fact, a large body of research has found little to no impact of the GSEs on promoting sustained increases in low-income homeownership.

Ultimately, if one believes that a private and competitive mortgage system is optimal, the proposed structure does not allow for this. Fannie Mae and Freddie Mac will continue to enjoy an exclusive competitive advantage due to their government guarantee. If, alternatively, one believes that the government needs to be involved in subsidizing the provision of mortgage credit so that a greater number of households can access mortgage credit, such a structure is not a direct way to achieve this goal and can create unintended incentives to take on mortgage risk.

Proposing a structure that is neither completely private nor public, may not only potentially create new problems, but may also recreate some of the problems that contributed to the housing bubble and its collapse.  

Deeksha Gupta, assistant professor of finance at Carnegie Mellon University's Tepper School of Business, is an expert in housing markets and financial fragility. Her research focuses on housing booms, crowding-out effects and lending in mortgage markets.