Government as the Big Lender

The desperate worry over the health of huge financial institutions with country cousin names — Fannie Mae and Freddie Mac — reflects a reality that has reshaped major spheres of American life: the government has in recent months taken on an increasingly dominant role in assuring that Americans can buy a home or attend college.

Much of the private money that once surged into the mortgage industry has fled in a panicked horde, leaving most of the responsibility for financing American homes to the government-sponsored Fannie and Freddie.

Two years ago, when commercial banks were still jostling for fatter slices of the housing market, the share of outstanding mortgages Fannie and Freddie owned and guaranteed dipped below 40 percent, according to an analysis of Federal Reserve data by Moody’s Economy.com. By the first three months of this year, Fannie and Freddie were buying more than two-thirds of all new residential mortgages.

CNBC.com

A similar trend is playing out in the realm of student loans. As commercial banks concluded that the business of lending to college students was no longer quite so profitable, the Bush administration promised in May to buy their federally guaranteed student loans, giving the banks capital to continue lending.

In short, in a nation that holds itself up as a citadel of free enterprise, the government has transformed from a reliable guarantor into effectively the only lender for millions of Americans engaged in the largest transactions of their lives.

Before, its more modest mission was to make more loans available at lower rates. Now it is to make sure loans are made at all. The government is setting the terms and the standards of Americans’ biggest loans.

On Sunday, that federal oversight and protection was made more explicit, as the Bush administration sought to mount a rescue of Fannie and Freddie, asking Congress to devote public money to buying the two companies’ flagging stocks.

The new reality is scorned by libertarians and conservatives, who fear state intrusions on the market, and by populists and progressives, who dislike the idea of education and housing increasingly resting upon the government’s willingness to finance it.

“If you’re a socialist, you should be happy,” said Michael Lind, a fellow at the New America Foundation, a research institute in Washington. “But you should really wonder whether you want people’s ability to pay for housing and college dependent on the motives of people in Washington.”

The government is trying to support plummeting housing prices and spare strapped homeowners from the wrath of the market: last week, the Senate adopted a bill authorizing the Federal Housing Administration to insure up to $300 billion in refinanced mortgages, enabling borrowers saddled with unaffordable loans to get better terms.

How the government came to dominate these two crucial areas of American lending is — depending on one’s ideological bent — a narrative of regulatory and market failure, or a cautionary tale about bureaucratic meddling in commerce. Perhaps it is both.

To those prone to blame lax regulation, the mortgage fiasco was the inevitable result of a quarter-century in which American policy makers prayed at the altar of market fundamentalism, letting entrepreneurs succeed or fail on their own.

This was the spirit in which Alan Greenspan, the longtime chairman of the Federal Reserve, allowed banks to engineer unfathomably complicated webs of mortgage-based investments that, through the first half of this decade, sent real estate prices soaring and expanded homeownership.

The banks relied on these investments to raise money for the next wave of loans. The system worked so long as lenders could keep selling their mortgages, and so long as someone would guarantee most of the debts. Fannie and Freddie took care of both tasks. Together, they now guarantee or own roughly half of the nation’s $12 trillion mortgage market.

Belief in Fannie and Freddie gave banks a sense of certainty as they plowed more of their capital into residential mortgages. That easy financing, in turn, brought more and more people into the market for homes, generating a belief that American real estate prices could keep rising forever.

And that contributed to the banks’ ultimately making extraordinarily risky loans, which defaulted first when home prices started falling. As lending became conservative, the whole speculative bubble burst.

As some called for intervention by the Fed to cool a speculative binge, Mr. Greenspan resisted. He believed the risks of real estate were effectively limited because debt was widely dispersed. The market would sort it all out.

CONTINUED : Too Big to Fail?

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