Fannie and Freddie have bought or guaranteed nearly half of the home loans outstanding in the United States. Those purchases and guarantees enable banks to sell the mortgages on their books to investors, freeing up the capital needed to make more loans. In ordinary times, their actions helped reduce the interest rate on home loans. And in downturns, their support helped keep mortgages available for new borrowers. A case in point: Since the financial market collapse in 2007, almost 90% of the country's mortgages have been bought or guaranteed by the two companies.
Some critics blame Fannie and Freddie's troubles on government mandates to finance more loans for lower-income Americans. But Wall Street firms started the rush into risky subprime and exotic loans; Fannie and Freddie just followed their competitors' lead. The real problem with Fannie and Freddie was that the public assumed — correctly, as it turns out — that the government wouldn't allow them to fail, making them more attractive to lenders and investors. They grew too big and took on far too much risk, precipitating a $187-billion bailout.
Fannie and Freddie demonstrate that Washington can't use government-sponsored private companies to carry out its housing policies. The companies' ability to privatize profits while sticking taxpayers with their losses poses an enormous and unacceptable moral hazard. And phasing them out won't eliminate investors' appetite for the mortgage-backed securities that supply capital for home loans.