NCPA - National Center for Policy Analysis

Two Approaches to Reforming Freddie Mac and Fannie Mae

March 7, 2011

There are two alternatives to reforming Freddie Mac and Fannie Mae, the government-sponsored enterprises (GSEs), says Arnold Kling, a member of the Mercatus Center's Financial Markets Working Group.

The first approach returns Freddie Mac and Fannie Mae to the investing public as private corporations with government backing, subject to limits on loan amounts and subject to safety-and-soundness regulation.  This approach has a number of advantages:

  • It would ensure the survival of the 30-year fixed-rate mortgage.
  • It would take advantage of the substantial organizational capital that the GSEs have accumulated with respect to standardizing mortgage lending, managing credit and interest-rate risk, and using computer technology to handle complexity and achieve reliability.
  • In addition, there is a regulatory model for the GSEs, based on stress testing, that is very robust: it only failed because political leaders imposed other priorities on the GSEs that were in conflict with safety and soundness.

The second approach would be for the government to get out of the mortgage-guarantee business, and to let the mortgage market evolve in a decentralized way.  This has the advantages of:

  • Leading to a more decentralized mortgage-finance system, with a much smaller role for Wall Street, thus reviving an American tradition of smaller, independent financial institutions.
  • Creating a playing field that is not dominated by gigantic, government-advantaged firms.
  • Offering politicians less opportunity to impose priorities on the mortgage-lending process that produce instability and hazard.

Source: Arnold Kling, "Two Approaches to GSE Reform," Mercatus Center, March 2011.

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