Fannie and Freddie's House of Horror

From the Wall Streeet Journal:

By: Peter Eavis
Wall Street Journal, 6/17/2010 -- Does Frankenstein's monster always have to be a monster?

Mortgage firms Fannie Mae and Freddie Mac grew into terrifying creatures because they are private companies with a government backstop. That has already cost taxpayers over $100 billion. Wednesday's announcement that their bombed-out shares are being delisted from the New York Stock Exchange is a reminder of how badly the public-private model worked. Unfortunately, most housing-finance overhaul plans floated assume this hybrid approach will continue.

Most reformers want entities that continue most of what Fannie and Freddie do-- buy mortgages from banks and package them into bonds to sell in the market. The key change reformers advocate is removing government backing for the entities. They want a government guarantee on the bonds issued by these entities.

Granted, that approach substantially limits the degree to which the Frannie-replacements benefit from the government intervention. But the danger is that the government, in its desire to support housing, underprices the guarantee, leaving taxpayers again exposed to potential losses.

People want government intervention in the belief the mortgage market needs support during economic slowdowns. But promising that support likely will hinder changes that could make the mortgage market more resilient. If the government withdrew, banks would design mortgages they would want to hold through an economic cycle. Right now, they would rather sell their new mortgages to Fannie and Freddie.

A more radical shake-up is needed to avoid another housing horror story.