Fannie and Freddie, the $5 Trillion Gorillas the U.S. Just Can’t Kill

Photographer: Andrew Harrer/Bloomberg

An anti-foreclosure demonstration outside Fannie Mae headquarters.

Update: Fannie Mae today reported a record 17.2 billion profit for 2012, underlining the dilemma Clea Benson explained in yesterday’s story.

If there’s such a thing as too big to fail, no one qualifies more clearly than Fannie Mae and Freddie Mac. Together the two agencies own or guarantee more than $5 trillion in mortgages. After they were taken over by the government, the consensus was that we’re certainly not going to let the government take the risk of losses on the entire mortgage market again.

Not so fast. Bloomberg’s Clea Benson today reports that the government is trying to figure out what to do with the substantial profits collected by Fannie and Freddie. The two have now given back $50 billion to the government out of $187.5 billion in bailout costs. The question is how the government plans to run a profitable business that it never wanted to be in.

From the beginning, discussions of what to do with Fannie and Freddie have focused on getting the government out of the business of unlimited guarantees. A Treasury report on reforming the housing market two years ago outlined the problems with the agencies succinctly, noting their “profit-maximizing structure undermined their public mission.” Telling the agencies to do anything they could to make a profit, while also asking them to avoid irresponsible risks, plainly didn’t work.

What would be better? As yet, there’s no really good answer. One option is just to split up Fannie and Freddie into smaller pieces. That won’t be enough. It’s often claimed that lenders act recklessly when they’re too big to fail and can count on the government to step in when they get in trouble. The evidence for that is slim: the mass of smaller companies in the subprime industry happily drove themselves into oblivion with no expectations of government help (Roger Lowenstein has made a similar point). The problem with smaller financial companies, whether you talk about subprime lenders or, to go back in history, savings-and-loans, is that most of them make similar mistakes at the same time. When they fail, they all fail at once.

The invisible hand of the market alone isn’t going to fix that. Benson writes that proposals now focus on developing a private mortgage market, with a final backstop of direct government guarantees. Like it or not, some version of that last part is always going to be in play.

What do you think about this article? Comment below!