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The Path to Responsibility, Part II


Why is there no private sector version of Fannie Mae? Why did Fannie Mae, a government-sponsored entity, become the big dog in home mortgages?

From Wikipedia and Mises:

Fannie Mae was founded as a government agency in 1938 as part of Franklin Delano Roosevelt's New Deal to provide liquidity to the mortgage market. For the next 30 years, Fannie Mae held a virtual monopoly on the secondary mortgage market in the United States.

In 1968, as a part of Lyndon Johnson's societal engineering agenda, Fannie was converted into a private corporation and the ability to guarantee government-issued mortgages was switched from Fannie to the federal government's newest creation, Ginnie Mae (Government National Mortgage Association). This meant that Fannie would begin to operate with private capital on a self-sustaining basis. Fannie was growing up, and she was going on to bigger and better things.

In 1970, Richard Nixon authorized Fannie Mae to purchase conventional mortgages, launching a national secondary market for home mortgages. As Fannie's foray into the conventional mortgage market began to surge upward, in the 1980s it began to purchase second mortgages and adjustable-rate mortgages, and it also commenced its mortgage-backed securities scheme.

It started out as a government-sponsored entity in the Depression, blossomed into a government-esque entity that could accept private funding while getting subsidies from the federal government. The implicit guarantee here is that the government will stand behind Fannie Mae.

I recently became a bank, myself. I loaned my money out, at $50 each to four borrowers, at an average of 18% interest for three-year terms. That sounds like an amazing rate, doesn't it? I think most people, when they hear of an 18% interest rate, think that's better than a stock return - especially since it's a locked rate for as long as the borrower pays me back.

But it's actually quite the opposite of an investment. And that 18%? It's not what it seems. Follow the math...

If I put money into an account that returns 18% anually, then my principle becomes larger with time. My $50 becomes $59 at the end of the first year, almost $70 by the end of the second year, and over $80 by the end of the third year. That's a whopping 64% return!

But if I loan it out, interest only accrues on the principle that remains, which is paid down over time. At the end of three years, my $50 only grows to become $65 when I loan it out at 18%. In three years' time, it's a 30% return. Still quite good, but only half that of an investment. That's a very distinct difference.

Nobody borrows money for a house at 18%. The going rate? For the sake of this discussion, let's say it's 6.5%. If I loaned my money out at that conventional rate, then I barely make a 10% return in three years. If inflation is a modest 3% annually, it's a wash. My money didn't grow relative to the market.

So I'll ask the question I started with: why is there no private sector version of Fannie Mae? Because at these rates, there is no real profit. No one is business would do this. It's a recipe for bankrupcy, which is why subsidies are the only way this could work for decades. It's all been a big taxpayer-subsidized smokescreen, and we're about to pay for it.

There was a way to make money on this, but the numbers still didn't add up, and I'll go into that in Part III.


by Brett Rogers, 9/22/2008 11:42:20 AM



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