Freddie Mac and Fannie Mae own or guarantee a combined $5 trillion worth of mortgages. To put the size of that liability into perspective, remember that total U.S. federal debt is $9.5 trillion and total U.S. gross domestic product is $14 trillion. They are simply too big to fail.

The trouble that Freddie and Fannie are in, however, is not a failure of capitalism. Fannie and Freddie are both artificial government creations that use their big government advantages to distort the free market. They are both remnants of the Great Society and, like so many other Great Society disasters, the time has come to assign them to the dustbin of history. Congress should move to adopt much of what the White House outlined this Sunday to cool the current crisis. However, the White House plan does nothing to resolve the fundamental cause of the problem.

In the short term, Heritage senior research fellow David John recommends that Congress increase Fannie and Freddie’s credit line with the U.S. Treasury and enable Treasury to purchase stock in both. Language strengthening the Office of Federal Housing Enterprise Oversight’s power over Fannie and Freddie has already passed both House and Senate, so new Federal Reserve powers over them is unnecessary. Finally, the current housing bailout bills in both House and Senate contain measures that take money away from Fannie and Freddie in order to establish a housing slush fund. Given the financial difficulties of both Fannie Mae and Freddie Mac, this provision should be eliminated.

In the long term, Congress should seize this opportunity to remove the systemic risk Fannie and Freddie inject into the housing market. John recommends:

  • Break up Fannie Mae and Freddie Mac: Congress needs to break up both Fannie Mae and Freddie Mac and allow them to be replaced with a much larger number of genuine private-sector companies that they will not have the ability to dominate the market.
  • Eliminate government subsidies and preferences: After Fannie Mae and Freddie Mac have been replaced, Congress should eliminate any real or implied benefits including the line of credit with the Treasury, the ability of the government to own stock, and make it explicitly clear that there is no federal government backing for their securities.
  • Set strict standards for mortgage-backed securities: A major cause for today’s financial losses is the inclusion of poor quality mortgages that are likely to default in mortgage-backed securities. Both government and industry need to take strict steps to ensure that quality controls can weed out low-quality mortgages and properly grade these securities so that future investors can have confidence in what they are buying.

Liberals continue to insist that Fannie and Freddie can still be forces for good if only the proper rules are put in place to control their behavior. What the liberals ignore — when they are not being completely ignorant about the true role Fannie and Freddie played in the current crisis — is that Fannie and Freddie have spent hundreds of millions of dollars lobbying to be as free from regulatory oversight as possible. The time to bring the free market back to the U.S. housing financial system has come: Fannie and Freddie must go.

Quick Hits: