On the Record

The Government Takeover of Fannie Mae and Freddie Mac

It’s been one year since Fannie Mae and Freddie Mac had to be taken over by the government to prevent their collapse. Economic Studies Co-Director Ted Gayer talks about what went wrong and why these government-sponsored enterprises were treated as “too big to fail.” Despite the fact that they keep recording billions of dollars in losses, they continue to play critical roles in the housing market during the recession.


“Part of the lesson that we learned here is the problem of “too big to fail.” Essentially that is what Fannie and Freddie became and everyone had said that all along. And sure enough they were too big to fail and the implications of that were harmful. The Administration is now heading towards financial reform, which I think is a wise move, and there’s a concern with too big to fail and systemic risk. The only thing I would caution is these kinds of things should apply broadly to financial institutions. We don’t want to have a situation where we have an implied government backstop for any sort of financial firm, thus rewarding them for getting too big and then having credit markets even sit on that by giving them reduced rates, (unbarring rates). So I think there’s a broad lesson to be learned there, both with housing markets and for financial reform in general.”

“I think the split between the private profit making role and the government social policy role is just a bad model. When it was reduced to failure or it was going to cause trouble at some point. When that happens I think nobody knew. A few years ago the world was operating in a state of mind that prices were always going up, and certainly that was a flawed model, but I would say that it was bred into it from the start. It’s just a bad model that led to really extreme risk-taking. There’s a reason why they had $5 trillion worth of obligations out there. Hence, to use a phrase commonly used, they were “too big to fail.” The markets read it as such.”

“There’s certainly a humorous story about how, originally, they were just going to need a little bit just to shore them up and send a signal. In fact it was thought that if we would just send a signal that we would back them up. That would be enough. I think Hank Paulson was saying that early on in the summer of 2008 and then, of course, that wasn’t enough and then they went to $100 billion for each and then it went to $200 billion for each. And then, on top of that you have what the Federal Reserve has done in buying their debt and their securities. You know is it a black hole? No. Is it a big hole? Certainly, yes. I think the CBO and OMB estimates – I have no reason to question those. When we’re looking at about $180 billion in direct debt purchases for Fannie and Freddie that seems about right.”