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November 30, 2011

The Failure of the GSE Purchase Program

In 2008, the housing market crashed, causing a broader financial crisis worldwide wrapped around mortgage backed securities and credit default swaps. Some of the biggest offenders in the mortgage backed securities markets were Fannie Mae and Freddie Mac, known as GSEs (or government secured enterprises). As Fannie and Freddie (with multi-trillion dollar balance sheets) crashed, the federal government was forced to step in and nationalize both institutions.

In doing so, they began to take on ownership of mortgage securities. Instead of winding down Fannie and Freddie to ensure that the taxpayers aren't put on the hook again, the government bloated their balance sheets and purchased over $4 trillion in mortgage securities. We previously reported the bloating of the Fannie/Freddie balance sheets last September.

The federal government expensed close to $100 billion in FY2009 'restoring' Fannie and Freddie's balance sheet. The assumption (as seen in the chart below) at the time was that the government would need to make reduced investments in the GSE's over the next two years. Then, they would begin reaping the benefits of interest payments (hence the negative balance on the chart).

I was amazed at the fact that the government assumed it would get the exact same return on the assets (percentage wise) from FY2012 to FY2019 (in the '09 budget). The shows two things 1) the government does not expect (then or now) to sell any of these assets over the next decade and 2) how irresponsible the government is in budgeting events dependent on an interest rate. It is completely impossible for the market to yield the exact same return for eight consecutive years. This highlights the incompetence of the government towards GSE purchases in the budgeting process.
In FY2011, the government reduced its outlook for purchasing GSE's and maintained its return. However, by this year (FY2012), the government swelled its expenses from FY2011 by $30 billion and now believes that because of its additional 'investment,' it's going to yield a better return in future years.

The bottom line is that nationalizing the mortgage industry has failed us. It will continue to cost us money as long as we have two government run organizations bloated with mortgage backed securities controlling the market. Additionally, for every 1% the housing market declines, these companies will need to write off $50 billion in assets!

Furthermore, the accountability of Fannie and Freddie (which wasn't all that great before the crisis, see today's video), has gotten worse since the companies' nationalization. I went to two websites and found that information required by law regarding GSE mortgage purchases, has not been updated since 2007.

How many tens of billions of dollars more do we need to throw away before we must recognize that centralized government intervention of the mortgage industry is not the solution to market stability?

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