Monday, July 21, 2008

Christopher Westley has an economic history lesson for us:

How Fannie and Freddie Made Me a Grumpy Economist:
From the beginning, first Fannie and then Freddie (which was created in 1970) served the purpose of shielding the public from the adverse effects of expansive government — and bad fiscal policy in particular. This makes government relatively more tolerable to the rank and file.

The creation of both entities, I told the host, was a mistake, because it created greater investment in housing and home ownership than would have been justified by market forces. The result is an inefficient use of resources — a malinvestment. Furthermore, entities like Fannie and Freddie forced out private firms that otherwise would have satisfied the demand for housing, but couldn't, because they lacked the preferential treatment from which Fannie and Freddie benefited, especially in terms of taxes and regulations.

By the 1960s, Fannie was turned into a GSE — a government-sponsored enterprise. (Freddie was created as a GSE from the beginning.) This structured their operations so that they would become more like private firms, required to offer stock and compete in the marketplace, with the understanding that they would finance themselves out of their own profits. This is not an arrangement that has worked well for the post office or Amtrak, but with the first of the baby boomers getting their starter homes, and then later when the dollar's last remaining ties to gold were severed, it worked better for Fannie and Freddie, especially since they were allowed to maintain some of the privileges denied their competitors.

For most of their history, Fannie and Freddie were (in my opinion) relatively benign. They never should have been created, but they didn't do much harm. This would change in the 1990s, when they became big players in the economy. That is when the current problems began.

See the previous post.

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