Congress created Fannie Mae, the Federal National Mortgage Association, during the Depression to make home mortgages more available. While home ownership is still part of the American dream, most people never think about the considerable risks that Fannie Mae poses to taxpayers.

Fannie Mae and Freddie Mac, the Federal Home Loan Mortgage Corporation, are government–sponsored enterprises (GSEs) that expand mortgage availability by establishing a secondary mortgage market. Fannie Mae and Freddie Mac buy mortgages from lenders and convert them into securities that they then sell to investors.

This process makes them relatively safe by lowering risk and frees lenders to loan more. But the advantages Fannie Mae and Freddie Mac enjoy over other firms operating in the private-sector market have sparked complaints. The list of privileges centers on the special “government securities” status issued by the two lenders.

Such securities are exempt from Securities and Exchange Commission (SEC) requirements, as well as state and local taxes, saving them hundreds of billions of dollars annually. Moreover, the lenders’ government ties translate into lower capital costs, enabling them to borrow at lower interest rates than conventional banks. In addition, the firms enjoy a $2.25 billion line of credit from the Treasury Department, an advantage not enjoyed by their competitors.

Fannie Mae and Freddie Mac received $10 billion in hidden taxpayer subsidies in 1999. However, these benefits are not passed on to homebuyers. The GSEs absorb almost $1 for each $2 dividend. Furthermore, Fannie Mae and Freddie Mac are allowed to keep their profits while their losses are borne by taxpayers.

Thomas Stanton, Fellow at the Center for the Study of American Government at Johns Hopkins, warns that the implied full government backing potentially leads Fannie Mae and Freddie Mac to moral hazard. Fannie Mae and Freddie Mac maximize lending because the GSEs bear only a portion of the cost of their risk-taking, with the remainder transferred to taxpayers. This arrangement enables the firms to take greater risks than they otherwise might, exposing the taxpayers to the potential loss of billions of dollars.

In June 2000, Federal Reserve Chairman Alan Greenspan warned taxpayers of the large, hidden costs the GSEs impose. Taxes ultimately finance the billions of annual subsidies at the expense of other initiatives, such as financing small businesses, or farms. The diverted resources disadvantage other groups by raising the price of capital for all other (potentially more productive) uses. The GSEs $1.4 trillion outstanding debt may approach $2 trillion by 2003 and is projected to exceed the national debt within the next few years. If over-extended homeowners default, taxpayers are at risk.

Fannie Mae and Freddie Mac advocates claim taxpayer risk is justified since the GSEs lower the cost of borrowing for homebuyers. However, a Federal Reserve study, authored by economist Wayne Passmore, concludes, “mortgage securitization does not necessarily lower” mortgage rates. The GSEs also largely benefit the middle-and upper-income households, rather than the poor.

Despite protests from the financial services lobby, Fannie Mae and Freddie Mac are expanding into mortgage insurance, subprime mortgages, and non-mortgage investments. These moves expose taxpayers to new risks and have prompted attention from policymakers.

Last year lawmakers and rival lenders mounted a campaign to reform the two agencies. The movement called for tightening financial oversight and ending some of the privileges now enjoyed by the quasi-government lenders. In a compromise, Fannie Mae and Freddie Mac volunteered to regulate themselves and increase the frequency of public disclosures, but their special status remains intact.

It is precisely this quasi-government status and privilege that is the problem. As a duopoly, the firms dominate the industry as the only two competitors. While Depression conditions may have prompted their creation, current conditions demand reform.

Fannie Mae and Freddie Mac have fulfilled their primary purpose of establishing a secondary mortgage market. But legislators should eliminate their quasi-government status and $2.25 billion of government credit.

Privatization of Fannie Mae and Freddie Mac would subject them to more stringent market regulation, create competition, and heighten consumer choice. This long overdue move will help increase accountability, protect taxpayers, and put the American dream of home ownership on a more solid financial footing.