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What Would Happen If Fannie Mae And Freddie Mac Disappeared?

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A recent research report from Richard X. Bove of Rafferty Capital Markets paints a dire picture of the state of the home mortgage market if the federal mortgage-backing entities Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) are wound down as planned in the next few years. He persuasively argues that the 30-year mortgage would instantly disappear, as no financial institution would accept the risks.

This sea change in the mortgage markets would result in a number of negative ramifications, such as likely knocking the already battered residential real estate market into a tailspin, for starters. Bove concludes his report with a call to stretch the wind-down of Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) from the currently scheduled three years to 30 years.

The case for shutting down Fannie Mae and Freddie Mac

The Federal National Mortgage Association (OTCBB:FNMA) or Fannie Mae was created as part of the Federal Housing Authority in the mid-1930s in response to the Great Depression. This was an explicit government intervention into a moribund real estate market in an attempt to revive it. Government officials had come up with the idea of a 20-year self-amortizing mortgage to make buying residential real estate more affordable. Fast forward a few years, and the concept of a 20-year or longer mortgage became hugely popular during the post-WWII housing boom, and eventually came to be enshrined as a fundamental mechanism for enabling the American dream of owning a home.

However, political interventions, such as the 1960s when mortgage terms were stretched to 30 years to enable more low-income Americans to become homeowners, began to distort lending standards and eventually the entire real estate market. Markets became even further distorted as the global economy became more seamless and hot money flowed in from other countries to create a series of real estate bubbles. The biggest bubble burst in 2007-2008, bringing the global financial system to its knees and exposing its systemic flaws.

Bove’s point of view

Bove actually agrees with the Treasury Department and most Republicans that Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) should be wound down and the long-running, dangerous experiment in intervention shut down. However, he argues the wind-down should be done very gradually in order to protect the fragile real estate market, not in a short three-year horizon as is currently envisaged by the Treasury Department.

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