My Solution For Ending the Fannie/Freddie Fiasco

Lately, Fannie Mae and Freddie Mac's have come to the forefront and they have exposed flaws that those in the mortgage industry have known about for years. In my opinion, both suffer from a structural problem inherent in the manner in which they were created that has caused them to be Socialistic monopolies. That is, both dominate the universe of mortgage securitization. In fact, if you are looking to securitize a loan for a borrower with strong credit credentials, they are literally the only game in town. Because securitization allows both to control the entire process of approval, in fact, we are stuck with a system in which the whole market is reliant on both. As such, we would have no choice but to bail them out if it came to that.

Because they package and securitize loans, they also are ultimately the ones underwriting these loans. Because Fannie and Freddie backed loans account for a minimum of 60% of all loans at any given time (and sometimes as much as 90% given the time and place) the whole system collapses if they collapse. Clearly, we all have done something terribly wrong. Keep in mind that both were creations and still extensions of the federal government. In other words, this terribly flawed system is a creation of the government, and in many ways by design. Don't get me wrong, the government certainly didn't mean to create such a mess. They just simply were blind to the unintended consequences of everything they did.

Securitization adds liquidity to the market. Liquidity allows banks to do many more loans and thus allows more people to own property. Furthermore, securitization allows for the creation of more creative and aggressive loans which also ultimately allows more people to own. As such, any solution would have to maintain liquidity and securitization while formulating a system that doesn't create a socialistic monopoly.

The solution involves two steps. The first is finally, once and for all, privatizing these two and totally separating them from the government. While both are publicly traded companies, they are also Government Sponsored Entities. They have access to government credit lines and their own debt is thus implicitly guaranteed by the government. That's done because their vitality is crucial to the market. Therein lies the rub. Here again, the government has created a situation where companies can't fail. That simply must stop. The first step towards that is cutting the cord entirely and no longer making these two GSE's, but rather fully privatized companies like any other private company. Fannie Mae and Freddie Mac can no longer enjoy any privilege from the federal government that an entity like Microsoft enjoys.

The second solution is to break them up. In fact, the Sherman Anti Trust Act was created exactly to prevent the situation we now have in mortgage securitization. In other words, the government created exactly what it usually would break up using Sherman. If Fannie and Freddie were six to eight companies most of the current problems would be avoided. By increasing competition, we would also increase the underwriting choice. Now, if you are denied by Fannie you go to Freddie. If you are denied by both, you have no conforming loan to do. Furthermore, if there were six to eight of them we would no longer face a situation where each is so vital that they can't fail.

When Standard Oil became so powerful that they controlled more than 90% of the gasoline market, they were broken up. A similar thing happened when AT&T grew too large. The world of mortgage securitization is no different. Securitization controls every other aspect of mortgage lending. So, why should we allow that industry to be monopolized? We shouldn't and the answer to that problem is to break these two companies. No longer would these two companies stand on their proverbial mountain top answerable only to their bottom line. With multiple companies securitizing, banks would have a choice. No longer could either make random and nonsensical underwriting decisions with no explanation. (and believe me there are many and too long to list here) It would not only increase the choices of underwriting but frankly customer service and everything else that increases when competition increase.

Whether or not the two are in fact in real trouble, we all now face an opportunity to fix a serious structural problem with both. By fully privatizing and splitting them up we would fix what is structurally wrong with both and return the free market to mortgage securitization.