Beyond Fannie and Freddie

Homeownership may be the American dream, but lately it has been an expensive one for taxpayers. The deduction for mortgage interest cost about $80 billion in lost revenue in 2009, and a tax credit for home buyers in this year's stimulus bill will add $15 billion to the tab. Taxpayers have provided Fannie Mae and Freddie Mac, two giant, troubled mortgage finance companies, nearly $100 billion that they have little chance of recouping. Mounting defaults also threaten the Federal Housing Administration, the agency that guarantees many home mortgages, raising the odds for yet another multibillion-dollar federal bailout. Meanwhile, the Federal Reserve has effectively been printing money to reduce mortgage interest rates, using the new dollars to buy more than $860 billion in mortgage-backed securities.

Nevertheless, some in Washington want to offer even more help to home buyers, arguing that a rebound in sales is crucial to the recovering economy. With the home buyers' tax credit due to end in November, Sen. Johnny Isakson (R-Ga.), a former Realtor, introduced a bill to continue the subsidy for one year, raise it from $8,000 to $15,000 and make even wealthy buyers eligible. The estimated revenue loss: up to $100 billion.

There are economic and social reasons to support Isakson's proposal -- home purchases spur other spending, and converting renters to owners leads to more stable neighborhoods. Those benefits evaporate, however, if people take on mortgages they can't afford. The gains in homeownership may prove to be evanescent too. Federal subsidies helped push the rate from less than 44% in 1940 to more than 67% in 2000, and nearly 70% in 2004. The rate has fallen since then to where it was before the housing boom. Rather than increasing subsidies for buyers who may not be able to afford a home, Washington should be planning for a slow but steady diminution of its role in the market, especially when it comes to mortgage finance.

Fannie Mae and Freddie Mac are government-sponsored but privately owned companies that buy mortgages and related securities from lenders and Wall Street. They also package the loans they buy into mortgage-backed securities. This secondary market has provided a steady supply of money that banks can lend to home buyers. The financing provided by the companies lowers mortgage rates while shielding banks from much of the risk of the mortgages they issue, as long as the terms comply with Fannie's and Freddie's standards.