There are many lessons to be learnt from the financial crisis. But the need for countries to establish institutions such as Fannie Mae is not one of them. The failure and abrupt nationalisation of the US’s Federal National Mortgage Association was at the heart of that crisis. Yet George Osborne, Britain’s chancellor, has announced plans to introduce similar state-backed mortgage guarantees, with proposals for a “Help to Buy” scheme to underwrite mortgage lending.
Fannie Mae was a product of the New Deal and may at one time have played a useful role in advancing American home ownership. In most developed countries today, 60-70 per cent of households own their own houses. The US reached that norm around 1960, ahead of most of the world. But this was some time ago: more recently, countries such as Britain and France have achieved comparable levels of owner-occupation. (Germany, where many well-off households rent, is an exception to the international norm). These bastions of European socialism have achieved high levels of home ownership through competitive mortgage markets without the support of government guarantees.
The continued existence of Fannie Mae is a reminder that government and public agencies are often able to hang around long after their initial purpose is served. In 1968, Fannie Mae was privatised. What privatisation meant was never entirely clear: in particular, while the government and Fannie Mae itself repeatedly denied that the US Treasury underwrote Fannie Mae’s obligations, markets believed that it did – correctly, we now know. The consequent borrowing advantage was a substantial – perhaps the principal – source of Fannie’s profitability. Nor did privatisation involve a lessening of the organisation’s ties to the US Congress. Its lobbying efforts were intense and the nature of its business gave it a presence in every state. What privatisation certainly did mean, however, was that the company’s senior executives enjoyed share options, bonuses and related benefits similar to those offered by other financial institutions. Executives not only took advantage of these opportunities, but misstated company accounts in order to increase their value.
A second lesson of Fannie Mae is that removing or reducing underwriting risk from the primary lender in the mortgage market reduces the quality of underwriting. In Britain, default risk has typically remained with the originator of the mortgage, even if mortgages were securitised. Several UK mortgage lenders did collapse in the 2008 crisis – but the cause was not losses on the mortgage book that the lender had originated. This is in sharp contrast to the US, where there were failures not only among the originators of mortgages but among the institutions that had insured the loans or bought mortgage-backed securities based on them.
Britain had its own salutary experience of mortgage insurance, two decades earlier. When building societies were limited by regulation on high loan-to-value lending, they circumvented these restrictions with mortgage indemnity guarantee policies from insurance companies. Underwriting of these policies was casual to the point of negligence. When house prices fell in the early 1990s, insurers incurred massive losses. They repriced the policies to prohibitive levels and that was the end of mortgage guarantees in Britain – until Mr Osborne’s Treasury revived the idea.
But that is not the last of the cautionary lessons of Fannie Mae. Ambiguity is often attractive to politicians and costly to taxpayers. The uncertainty about whether or not the company’s borrowings were guaranteed by the US government was resolved, in an all too predictable manner when the crunch came. Across the whole field of public finance today, there are obligations, such as those of Fannie Mae, which markets expect state agencies to fulfil even though government has made no explicit promise to that effect. The danger is that – as at Fannie Mae – the public has to pay twice: first in the higher interest rate, then in repaying the principal.
Mr Osborne is right to worry both about the depressed state of the construction sector and the difficulty that buyers experience in affording their first house. But the appropriate response is not to try to stimulate demand for housing, but to stimulate its supply.