On Sunday the U.S. government took control of Fannie Mae and Freddie Mac.
The two government-sponsored firms own or back about half the mortgage debt in the U.S., and have lost billions in the housing market collapse.
So, why is the federal government involved in the U.S. mortgage market?
It all started back in 1913, when the U.S. Income Tax rules were amended to make mortgage interest payments tax deductible. Of course back then the maximum tax rate was 6%, and everyone paid cash for their houses anyway, so it didn’t have any immediate impact.
But then, in 1938, Franklin Roosevelt’s “New Deal” created the Federal National Mortgage Association (Fannie Mae) to guarantee mortgages. This government guarantee made mortgages cheaper.
As income tax rates rose, mortgage interest deductibility became more valuable, so buying a house became a good tax savings strategy.
Then came 1968, when Fannie Mae became a public company, with directors, shareholders and a stock market listing. Since the government started the company, and since everyone assumed the government would never let Fannie Mae fail, there was an implied guarantee on all of Fannie Mae’s debt. This meant that big institutions could invest in Fannie Mae debt without fear of loss.
So Fannie Mae management, with access to cheap money, began using that leverage to write an increasing number of mortgages. The balloon kept getting bigger and bigger.
Unlike most bubbles that eventually burst, the housing bubble kept growing. Mortgage rates were cheap, and to save taxes and protect against inflation, buying a house made sense. And, when this millennium started, the Fed kept lowering rates, encouraging even more people to buy houses, blowing up the bubble even more.
Until now.
The sub prime crisis of 2007 meant that mortgages were harder to get. Fannie Mae’s books got so bad that the government finally had to step in. There are now over 1 million homes in the U.S. that are under foreclosure. Things look bleak.
So here’s the million dollar question: Would the bubble have gotten so big without the involvement of the federal government? If the feds had not encouraged excessive borrowing with the creation of Fannie Mae, and artificially low interest rates, the bubble would never have formed, and one million Americans would not have lost their homes to foreclosure.
Just one more example of why the government should stay out of our lives.