The Role of Federal Housing Policy in Precipitating the 2008 Financial Crisis
Alex Zhihao Wang
Abstact: This paper examines the role of federal housing policy in precipitating the 2008 Financial Crisis and provides an analysis of the ethical implications of these policies. First, it examines the history of organizations such as the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), as well as the evolution of the federal government’s goal of promoting homeownership since the Great Depression. These homeownership goals ultimately spread subprime mortgages throughout the overall economy, thus creating the environment that allowed a larger financial crisis in 2008. The nature of these subprime mortgages, as well as their potential risks are investigated. An ethical analysis of these housing policies is combined with an analysis of the financial implications of the federal government’s housing policies. This analysis is conducted from a utilitarian point of view, examining the positive and negative externalities of homeownership. The paper closes with an update on changes in federal housing policy, the state of the housing market today, and changes in mortgage lending practices since the financial crisis.
The widely accepted trigger of the 2008 Great Financial Crisis (GFC) is the proliferation of subprime mortgages, many of which subsequently went into foreclosure. Although Wall Street is often blamed for their proliferation, it should be noted the federal government also played a role in spreading subprime mortgages. Since the Great Depression, the federal government has largely pursued a policy of promoting homeownership, especially among lower- and middle- income individuals. Although well-intentioned, the attempt to promote homeownership among these disadvantaged populations was ultimately unethical because it spread subprime mortgages throughout the financial markets.
Fannie Mae and Freddie Mac: A History
In the US, federal housing policy is largely conducted by three agencies: the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac), and the Federal Housing Administration (FHA)[1] (Kohn 382). Fannie Mae was originally founded during the Great Depression, which had decimated mortgage credit throughout the United States. To revive homeownership rates, Fannie Mae was set up as a federally owned corporation that bought and securitized residential mortgages (Kohn 382). The FHA, meanwhile, was authorized to insure these mortgages with a standard mortgage contract that applied to all mortgages below a given value (Kohn 382). The collective efforts of these two organizations significantly increased the securitization of mortgages, thus creating a vibrant secondary market for these assets.
During its initial history, Fannie Mae was a government agency. However, Fannie’s method of securitizing mortgages – that is, by borrowing money to purchase mortgages – was problematic for the government’s balance sheet. The federal government privatized Fannie in 1968 to remove Fannie’s debt from the government’s balance sheet (Alford). Freddie Mac, which performs many of the same functions as Fannie Mae, was created two years later. Fannie Mae and Freddie Mac are both government-sponsored enterprises (GSE), or privately owned enterprises serving public goals. These two agencies dominate the mortgage industry.
[1] Federal housing policy is also determined by organizations like the Federal Home Loan Banks and the Government National Mortgage Association (Ginnie Mae), among others.
