What will happen to Fannie Mae and Freddie Mac, and What Could it Mean?

Image Source: National Public Radio

Over the past several weeks, countless reports have emerged focusing on the fate of the government-created private loan securitization companies, the Federal National Home Mortgage Associate and the Federal Home Loan Mortgage Corporation, colloquially known as Fannie Mae and Freddie Mac.  The former is, famously, a product of the New Deal, finding its birth in a 1938 amendment to the Roosevelt Administration’s Housing Act, passed four years earlier.  At the time, the organization’s primary function was to inject capital into local, main street banks, which could in turn issue more mortgages, almost all of which were insured by the Federal Housing Administration, also established by the 1934 Act.  This resulted in an increase of home-ownership at a time when it was desperately needed, as well as the creation of a major market for secondary mortgages. Fannie stayed intact after the Depression ended, and the proportion of American home-owners rapidly increased, which perhaps paved the way f or the contemporary notion that owning a home constitutes some fundamental facet of what’s known as the “American Dream.”

Fannie only grew from here—the government opened the company to private investors in 1954, and in 1968, in order to accommodate the expanding market for secondary mortgages, the government split Fannie into two.  Freddie came about in 1970, in an effort to provide competition in the secondary mortgage market, which would ultimately lead to more accessible loans.  In time, Fannie and Freddie gained the ability to purchase and issue securities, leading to the development of the paradigmatic thirty-year fixed rate mortgage. They have been the focus of targeted policy efforts (i.e. the Clinton initiative to expand loans to low-income Americans), and they’ve shouldered considerable blame for purportedly encouraging the financial crisis.

This latter point has been vigorously debated along partisan lines, with folks on the right criticizing the organization for overseeing the expansion of easy credit, which, they argue, tipped the economy over the edge.  Those on the left level the blame on the financial industry, for their relentless practice of utilizing exotic new tools in order to securitize bundled mortgages.

No doubt, politics, one way or another, helped feed the Obama Administration’s desire to phase out these two giant entities.  While the Administration’s plans remain complex and difficult to follow, the New York Times, in a recent editorial, delivered a brief summary of each of three proposals released by the Administration:

The first option, for a system that is virtually all privatized, would result in the highest mortgage rates. It could imperil the availability of traditional, 30-year fixed-rate mortgages, which currently exist only because of federal backing. It would also curtail the government’s ability to mitigate a credit crisis — leaving taxpayers exposed to protracted downturns and possible bailouts.

The second, which involves a partial federal guarantee, raises similar cost and access problems. Theoretically, it would give the government a way to keep credit flowing in a crisis, but it would be difficult to shape a program that is small in good times and expands in bad.

Under the third and most promising option, losses on mortgages and related investments would be covered by capital set aside by banks and insurers or by other private institutions in the mortgage chain. On top of that, the government would provide reinsurance — essentially catastrophic coverage — but only for mortgages that met strict underwriting criteria and at a cost that would cover future claims.

As a someone who decisively is not an expert, my lay person’s reaction is that in it’s current setup, these governmental institutions serve to propel a financial industry (whose recklessness has been demonstrated) by continuing to back their activities in the form of government insurance.  As for option number one, which the Times implies to be the worst, numerous banks—the very same ones whose names became infamous for catalyzing the crisis—have already offered their own proposals to “Buy Pieces of the Fannie-Freddie Pie,” which by extension suggests their desire to not only continue but increase the industry’s practice of privatizing and trading complex securities backed by other people’s mortgages.  Even the “most promising” option proffers a way for the government to continue backing such “investments.”

I wish there was more talk about the fact that it doesn’t make sense to place calculated bets–“investments”–on pieces of other citizens’ mortgages, the way it wouldn’t make sense to purchase a fire insurance policy on your neighbor on your neighbor’s house.  But clearly, the Obama Administration, first and foremost, must grapple with realities of politics, as these proposals indicate.

Housing, White Privilege, and Wealth Inequality

As a social justice issue, housing seems simple and relatively bland: people need shelter, what else is there to talk about?

A lot, actually.

Housing issues are related to a complex web of social justice concerns. Two related concerns that are particularly relevant to housing are white privilege and wealth inequality. In fact,  understanding the history of discrimination in America—particularly housing discrimination—is indispensable to understanding contemporary economic inequality.  What’s the connection between housing,  white privilege, and wealth inequality? Here’s a statistic that might surprise you:

The Federal Housing Administration and the Veterans Administration financed more than $120 billion worth of new housing between 1934 and 1962, but less than 2% of this real estate was available to nonwhite families—and most of that small amount was located in segregated communities.[1]

In other words, for almost three decades the U.S. government backed $120 billion worth of home loans and 98% (!) of those loans went to whites.

How did this institutionalized racism become possible?

Spurred on by massive mortgage foreclosures during the Great Depression, the federal government […] began underwriting mortgages in an effort to enable citizens to become homeowners. But the mortgage program was selectively administered by the Federal Housing Administration (FHA), and urban neighborhoods considered poor risks were redlined—an action that excluded virtually all the black neighborhoods and many neighborhoods with a considerable number of European immigrants. [2]

More important than this shocking history, however, is the relationship between home ownership, wealth, and opportunity—a relationship that links past discrimination to economic inequality today. To begin with, a home is one of the most important assets that a family can own. As Dalton Conley—associate professor in the Department of Sociology at New York University—explains in the PBS documentary Racethe Power of an Illusion, “The majority of Americans hold most of their wealth in the form of home equity.”[3] Therefore, because of the significance of housing as an asset, discrimination in housing directly contributed to inequality in wealth accumulation.

Wealth, in turn, is an important determinate of the opportunities that a family can provide for their children. As Larry Adelman has written, “a family’s net worth is not simply the finish line, it’s also the starting line for the next generation.”[4] A family can take out a second mortgage on their home, for instance, to finance their child’s college education or job search. Actions such as these can significantly affect a child’s life trajectory.  Indeed, because of the way that wealth creates opportunity, “Economists have shown that about 50-80% of our lifetime wealth accumulation is really attributable, in one way or another, to past generations,” writes Conley. Wealth, in other words, provides a mechanism that transfers opportunity, or the absence of opportunity, from one generation to the next. It is this intergenerational link between wealth and opportunity that explains why the effects of long past institutionalized racism—such as FHA housing discrimination—are still felt today.  [*]

How are the effects of historic discrimination still felt? Take the “wealth gap,” for example. Thomas Shapiro, in The Hidden Cost of Being African American, writes that “The net worth of typical white families is $81,000 compared to $8,000 for black families.”[6] That’s a 10:1 difference! This present day racial inequality in wealth, however, must be understood in light of the history of institutionalized racism and privilege. And housing discrimination is a fundamental part of that history. As previously mentioned, a home is often a family’s most important asset or source of wealth. Housing discrimination, therefore, created inequality in the accumulation of wealth. Moreover, wealth has two distinct characteristics: 1) it creates opportunity and 2) is it inheritable. The combination of these characteristics produced a dynamic whereby inequality in wealth—initially bolstered by discriminatory practices—was often passed down and maintained from one generation to the next. So long past discrimination in housing affected the wealth and opportunities of later generations. In short, past housing discrimination is an important factor in explaining economic inequality today. Conley writes:

Today, the average Black family has only one-eighth the net worth or assets of the average white family. That difference has seemingly grown since the 1960s, since the Civil Rights triumphs, and is not explained by other factors like education, earnings rates or savings rates. It is really the legacy of racial inequality from generations past. No other measure captures the legacy – the cumulative disadvantage of race for minorities or cumulative advantage of race for whites – than net worth or wealth.[7]

Thus, the reverberations of long past institutionalized racism are still felt today. As a primary example, housing discrimination creates inequality in wealth and opportunity that is often inherited by succeeding generations. Tracing back the linkages between present day inequalities in wealth and past housing discrimination demonstrates that—as a social justice issue—housing isn’t simple. Yet these linkages also show that, in spite of their complexity, contemporary housing issues remain as important as ever.

[1] George Lipsitz. 1998. The Possessive Investment in Whiteness. Philadelphia:Temple University Press.

[2] William Julius Wilson. (2005 [1996]) “When Work Disappears: The World of the New Urban Poor,” in Mapping the Social Landscape: Readings in Sociology. ed. by Susan Ferguson. New York: McGraw Hill.

[3] Dalton Conley. 2003. Interviewed in Race the Power of an Illusion. PBS Transcript available at http://www.pbs.org/race/000_About/002_04-background-03-03.htm.

[4] Larry Adelman. 2003. A Long History of Racial Preferences – For Whites . http://www.pbs.org/race/000_About/002_04-background-03-02.htm.

[*] Note that wealth, not income, has been the touchstone for economic status throughout this discussion. This is no accident. For wealth, not income, is a much better indicator of opportunity: “Even when families of the same income are compared,” explains Adelman, “white families have more than twice the wealth of Black families. Much of that wealth difference can be attributed to the value of one’s home, and how much one inherited from parents.”

[6] Thomas M. Shapiro. 2004. The Hidden Cost of Being African American: How Wealth Perpetuates Inequality. New York: Oxford University Press.

[7] Dalton Conley. 2003. Interviewed in Race the Power of an Illusion. PBS Transcript available at http://www.pbs.org/race/000_About/002_04-background-03-03.htm.

How Housing Was Deregulated

For years, ordinary working people in Baltimore bought homes through FHA. FHA controlled 40 percent of the real estate market. Besides having low down payments, FHA loans had protections for buyers. All loans had to be reviewed and approved by the FHA. The FHA inspectors were tough, and they insisted on sellers making all the repairs before they approved the sale. The FHA also had a barrel of appraisers that were approved.


Then two things happened. In the late 1980s, the banking community got permission from Congress to underwrite FHA loans. In other words, FHA didn’t review them anymore. That led to a lot of new lenders making FHA loans. FHA kept one control, though – they still had the appraisers. But in the mid-‘90s, the banking community went to Congress and got permission to choose their own appraisers. Suddenly the number of FHA appraisers in Baltimore grew from 40 to 100, and a lot of the bad guys abused the FHA system.


That led to the flipping scandal, and to lots of foreclosures on FHA homes. It also forced a six-month moratorium on foreclosures. FHA tried to clean up its act by making its regulations stricter. But that only led more sellers and lenders to go outside of FHA. Six years ago, FHA’s share of the Baltimore market dropped from 40 percent to about 3 percent. And, it led directly to the crisis we’re in now.


Ironically, as a result of the current crisis, FHA sales are back up to 40 percent of the Baltimore market. For low-income and even middle-income families, the only way you can buy a house today is through FHA.


If there is a silver lining to the current mess, it is that we have regulations again. Buyers have protections, and lenders are more conservative in determining who can buy a house.

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