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Sep 07 2013

The unfinished business of Fannie and Freddie

Henry Paulson, former Treasury Secretary, likes to call saving Fannie and Freddie with huge bailouts “…the single most important thing we did to prevent disaster—real disaster.” However, five years after “preventing disaster” he comments that,

it didn’t occur to me that we’d be here with nothing done.

What makes change more difficult in today’s climate is that Fannie and Freddie are once again showing a profit. This does not mean they are a good thing, just that they are a profitable thing. However, the dominance that they lord over the lending world can only lead to another eventual crash. The reason for this is that when you tamper with a system that should be left to free markets, you inevitably will start making decisions based on political expediency rather than good lending practices, commons sense or fiscal responsibility.

Remember, Fannie and Freddie do not originate loans. They buy them on the secondary market. However, they have rules for the loans that they are willing to buy. So, lenders like to keep their options open so most of them will only make loans that meet the requirements set forth by Fannie and Freddie. So without officially controlling the lending market, they control the lending market – most of it anyway. There are still lenders out there that see a need and fill it by funding loans that will not meet Fannie and Freddie criteria.

It also important to recall that it was this kind of interference from Fannie, Freddie and the government that resulted in the crash in the first place.  Eliminating Fannie and Freddie will not eliminate downturns in the market. Ups and downs are a natural part of any healthy market just as life and death are a natural and normal part of our lives. However, only the “well intentioned” meddling of government can cause the kind of earth shaking downturns that we have tended to see since the government made its first bad step toward controlling our finances with the creation of the Federal Reserve just over 100 years ago.

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