In 1996, the Congressional Budget Office found that these two companies [Fannie Mae and Freddie Mac] had received subsidies in 1995 of approximately $6.5 billion but that only about two-thirds of that subsidy was actually delivered to the mortgage markets. The remainder was retained for the benefit of the companies’ shareholders and management teams.
That is exactly what one would expect from this hybrid form. If Fannie and Freddie were fully performing their government mission, their entire subsidy would have gone to the mortgage markets. The fact that they retained a portion for themselves reflects their obligation to their shareholders and the incentives of their executives to increase their own compensation. This conflict of interest has direct practical consequences.
…But that is not the full extent of the problem. Because of their unique structure, Fannie and Freddie are able to determine the size of their own subsidies: There is no effective restriction on their issuance of debt… Because Fannie and Freddie are not on-budget agencies—which is to say, Congress does not appropriate funds for their activities—Congress and the executive branch have no effective control over their growth, and hence no control over the risks they create for the taxpayers.
Thus we have a vicious and dangerous cycle: Fannie and Freddie must grow in order to maintain their profitability and hence their high stock prices, but there is no countervailing check on their growth—no effective competition, no required government approvals, and no fear in the financial markets that there is any substantial risk associated with financing this growth. In other words, these agencies are literally out of control.
Today [December 2000], both companies are financially healthy and pose no immediate risks to the taxpayers. That is because our economy and our housing markets are strong. Even if those favorable conditions were to continue indefinitely, history tells us that no company is fully isolated from market forces. That is especially true of Fannie and Freddie, because they are growing so fast that they will soon run out of high-quality mortgages to buy.
…Aside from amounting to a nationalization of the mortgage markets without a vote of Congress, holding virtually all mortgages entails a great deal more risk than holding the high-quality mortgages that Fannie and Freddie have historically financed. Because of their implicit backing by the government, that increased risk will fall on the taxpayers. As was true of the savings and loan debacle, the story of Fannie and Freddie is a classic case of privatizing the profits but socializing the risk. Their executives and shareholders are benefiting now from government support, but if these companies ever stop growing or assume too much risk, or if interest rates spike, their losses will belong to the taxpayers.
But there is more. The ability of Fannie and Freddie to acquire all of the mortgages in the United States points to their threat to the private sector. It should be obvious that they are not going to let themselves run out of mortgages to buy. They are going to seek new assets to acquire, and hence new businesses to enter.
…From time to time, supporters of Fannie and Freddie have argued that these companies represent the perfect form of organization—a combination of private-sector efficiency and government financial power. The record shows, however, that the opposite is true. By combining the government’s exemption from market discipline with the aggressiveness of private-sector management, Congress has created a financial monster.
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