Nationalize Fannie Mae? It Worked Until It Was Privatized

By Robert Kuttner, Huffington Post. Posted September 9, 2008.

Amid all the hubbub, it's important to remember Fannie Mae's pedigree.
In the past several days, before the U.S. Treasury Department acted to
seize Fannie Mae and Freddie Mac, several people asked me if I thought
it was a good idea for the government to "nationalize" the two
mortgage giants. In virtually none of the coverage of the Bush
administration's latest emergency action did anyone bother to tell the
backstory. Fannie Mae, nee the Federal National Mortgage Association
(FNMA), began life as a government invention. It was born
"nationalized" -- and it worked beautifully until it was privatized.

FNMA was part of the New Deal's trinity of housing agencies -- the
other two being the Home Owners Loan Corporation and the FHA agencies
that Roosevelt formed in order to literally create the modern mortgage
system. Before the New Deal, there were no long-term, self-amortizing
mortgages. The loan was due and payable at the end of the term --
usually five years -- and if you couldn't persuade a bank or
savings-and-loan to roll it over, you lost the house. After
foreclosures exploded during the Depression, Roosevelt invented a
whole new system. FNMA's job was to buy approved mortgages from banks,
to replenish their working capital, so that they could make more
mortgages. As the biggest buyer, FNMA also maintained standards.

The system worked like a fine watch. Home-ownership rates soared. Loan
standards were generous but not stupid. Nobody in the home mortgage
business got filthy rich, and mortgage lenders hardly ever went broke.
The government's bank insurance funds regularly turned a profit. And
here's a quaint, archaic concept: It operated in the public interest.

Then in 1968, as part of a general budget reform, government
technocrats decided to get FNMA off the government's books. This was
intended as a purely technical revision. It was tacitly understood
that Fannie was to keep doing the same thing it always did -- buy
mortgages from banks, turn them into securities, keep some and sell
others, but maintain its standards and service to the public good.

It took about two decades for the wise guys to realize that there was
big money to be made. And I am sorry to report that this was a
bipartisan trough. In the Clinton era, many of the wise guys at FNMA
were Democrats.

Criticism was limited to the Right and Left. The Wall Street Journal
and libertarian think tanks regularly warned that Fannie was getting
too big and too speculative with an implicit government guarantee. A
few progressives like your faithful writer objected that FNMA's true
purposes were being perverted and the system was being put at risk so
that insiders could get very rich.

After 2000, Fannie also served to abet the subprime mess. For the most
part, Fannie refused to buy the very worst subprime loans, but it was
happy to buy so called "Alt-A" loans, which were a slightly milder
version of the same abuse -- very risky loans with exorbitant interest
costs (and profits) and almost nonexistent standards. Those loans are
now going into default at almost the same rate as subprime loans.

Under private management, Fannie did a 180. It was perverted from a
government-sponsored and well managed agency that served the public
interest into a privatized casino whose big bets enriched a few
insiders and then helped crash the entire system.

So now, the Bush administration is playing half-of-FDR. It is saving
capitalism from itself as Roosevelt did -- but without getting serious
about regulatory standards going forward. The taxpayers will bail out
Fannie, but the rules for regulation of the mortgage system have yet
to be written. That will await the next administration. And if the
next administration is led by John McCain, the top financial guy is
likely to be former Sen. Phil Gramm, the senate's biggest cheerleader
for reckless deregulation.

Here is the cycle: The government invents something virtuous; the
private market takes it over and loses hundreds of billions; the
government then bails it out. This is best understood as socialized
risk, privatized gain. Yes, the shareholders of Fannie Mae will
deservedly lose a bundle -- it's always the shareholders who take a
hit -- but the insiders who thought up subprime and the executives of
Fannie Mae during the roaring '90s already made their pile.

Surely there is an Obama teachable moment here. It isn't even that
complicated. To wit:

Ordinary homeowners got suckered so that a few fat cats could get very
rich.

The needless damage to the mortgage sector has wreaked much wider harm
on the economy -- causing other people to lose jobs, not get raises,
lose health coverage and suffer losses to their net worth because of
collapsing housing prices.

This was all the fruit of ultra-free-market ideology, as carried out
by an opportunistic Wall Street-Washington axis.

In competent hands, government can do some things more reliably than
Wall Street.

(That only took 84 words, less than a typical TV spot. This could also
be the subject of a major, high-profile Obama speech, laying out all
the gory details and drawing the lessons.)

What has Barack Obama said about the Fannie Mae rescue? Here's what
the Obama campaign put out Sunday afternoon, the same day that a new
USA Today poll was finding McCain ahead by 10 points among likely
voters:

Given the substantial role that Fannie Mae and Freddie Mac play in our
housing system, I believe that some form of intervention is necessary
to prevent a larger and deeper crisis throughout our entire economy. I
will be reviewing the details of the Treasury plan and monitoring its
impact to determine whether it achieves the key benchmarks I believe
are necessary to address this crisis.

First, this plan must not focus on the whims of lobbyists and special
interests worried about their bonuses and hourly fees, but instead on
strengthening our economy and helping struggling homeowners who are
also being hit by lost jobs, stagnant wages and spiraling costs of
everything from gas to groceries. Second, the plan must protect
taxpayers, not bail out the shareholders and management of Fannie Mae
and Freddie Mac. Third, once we ride out the current crisis, the plan
must move toward clarifying the true public and private status of our
housing policies. In our market system, investors must not be allowed
to believe that they can invest in a "heads they win, tails they don't
lose" situation.

That's it. The entire statement.

He'll be reviewing the details of the Treasury plan and monitoring its
impact to determine whether it achieves the key benchmarks ... ? Gawd,
did they hire John Kerry's second-string 2004 speechwriter? That would
put even a policy wonk to sleep.

I will be reviewing the Obama campaign and monitoring its impact -- to
see whether these people get off their fannies.

Robert Kuttner is the co-founder and co-editor of The American
Prospect magazine, and is a Distinguished Senior Fellow at the think
tank Demos. He is the author of Obama's Challenge: America's Economic
Crisis and the Power of a Transformative Presidency, just released by
Chelsea Green.