Finance News

FE Editorial No Fannie & Freddie

The US housing market has been in a slump for a while now. It was the onset of the recession in housing that set the trigger for the subprime crisis, which has taken a heavy toll on US banking and financial institutions in the past few months. It should, then, be unsurprising that Fannie Mae and Freddie Mac, the two giant mortgage finance twins of the US, are in deep financial trouble. The trouble is greatly magnified because of the unique status the two firms enjoy. They constitute the unique category of government sponsored enterprises which are privately owned and managed but are supported by the government, through tax concessions, exemption from Securities & Exchange Commission oversight and emergency access to US treasury funds. So, any trouble for them is also likely trouble for the taxpayer. Also, the two firms operate in the secondary mortgage market dealing only indirectly with individual consumers. Banks and other financial institutions act as intermediaries—in this capacity they guarantee or own half of the US home mortgage market worth $12 trillion. This makes any collapse of these firms potentially disastrous for the rest of the housing market and even the economy. The US government has even mentioned the dreaded n-word - nationalisation - in the context of helping Freddie Mac and Fannie Mae stay afloat. Yet, it is impossible to see the two firms survive in the longer term—-they need to be broken down, made more competitive and less dependent on government support if they are to play a productive role.

What may be the lessons for India, which still has a relatively small market for housing loans? For one, the government must not create moral hazard by guaranteeing any home loans. That would compromise both the credit culture of the borrower and the efficient functioning of banks and financial institutions which lend to potential homeowners. India, of course, does not have any giant mortgage finance companies, which may not be a bad thing. In India, lenders have tended to be cautious in any case—-EMI does not normally exceed 40% of the debtor's monthly income. Banks and financial institutions have already taken a cue from the subprime crisis in the US and tightened up lines of credit, and the maximum amount given as credit, for home loans. Still, anecdotal evidence suggests that defaults are rising as interest rates have gone up to tame high inflation. But the government should desist from of playing any direct role in the home loan market.