Final Fannie Freddie Cost: $311 Billion and Rising

Mark Calabria
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Posted: Nov 27, 2011 12:51 AM

At the beginning of the month, the Federal Housing Finance Agency (FHFA) released its updated projections of the cost of rescuing Fannie Mae and Freddie Mac.  These estimates update projections last made in October 2010.  The big headline has so far read that costs have been revised lower.  But will that really be the case?

If one digs into the revised numbers, a few striking facts emerge.  First, FHFA states losses since October 2010 have been lower than projected for a variety of reasons, including that “foreclosure delays [have] pushed some defaults into later years” and “net interest income is higher … due to lower interest rates.”  The first reason just sounds like a delay of the ultimate cost to me, rather than a reduction.  And given that homes often lose value during the foreclosure process (who bothers to maintain a home he is going to lose ?), these foreclosure delays are just as likely to increase the ultimate costs, even if they do delay those costs.

On the interest rate question, first, do we believe rates are going to remain low indefinitely?  Seems to me we could easily be in a situation in three to five years where the GSE funding costs are above their interest income.  This especially becomes the case if Obama has his way and Fannie/Freddie re-finance a large share of their book into lower rates.

All this aside, the revisions are still a brutal reminder that taxpayers have so far sunk $169 billion into Fannie and Freddie, more than the ultimate costs of the TARP and more than the cost of the savings-and-loan crisis.  The FHFA projects that, by the end of 2014, total taxpayer costs will be between $220 billion and $311 billion. 

Any way you slice it, Fannie and Freddie have been a massive drain on taxpayers.  The sooner we put an end to these entities, the sooner we can avoid having taxpayers pick up the dime for the next housing bubble.

If you really wanted to stick it to the rich, you'd get rid of Fannie and Freddie.

There’s an interesting new NBER working paper out this week on the impacts of Fannie Mae and Freddie Mac on the mortgage market and the overall economy.  I have to admit I’m still working through some of it (my matrix algebra is a little rusty).

To summarize the paper’s findings:

First, comparing stationary equilibria with and without the policy, a tax-financed interest rate subsidy of 40 basis points leads to a significant increase in mortgage origination, but has little effect on investment in housing assets or in the equilibrium construction of real estate. The mortgage subsidy does not significantly change the share of households with positive holdings of real estate, because on one hand the subsidy makes real estate ownership more attractive, but on the other hand the higher required taxes lower net of tax income and thus discourage homeownership for low-income and low-asset households. However, the subsidy does significantly affect the distribution of leverage in the economy by increasing both the fraction of households that have positive mortgage debt and the level of leverage. This suggests that the GSE’s may have led to over-investment in mortgages and excess household leverage, which may have exacerbated the response to the recent drop in house prices.

Using a steady state utilitarian social welfare functional we find that the aggregate welfare implications of the subsidy are negative, in the order of 0f 0.8% of consumption equivalent variation. However, since households are heterogeneous, there is disagreement over the desirability of the subsidy. Low-wealth households prefer to live in a world without the subsidy, whereas high wealth households prefer to live in a world with the subsidy. This can be explained by the fact that low-wealth households hold little or no housing, and thus do not benefit from the subsidy, as compared to high wealth households that have large homes and mortgages.

Of course you can always read the paper and decide for yourself.  I didn’t need to work out all the equations to prove that Fannie and Freddie have been a massive regressive theft from all of us to a narrow segment of higher-income homeowners (and bankers).