Not the Free Market #1: Fannie and Freddie

A lot of people, including the Obama administration, are laying 100% of the blame for this current crisis on the "free market policies" of the previous administration. They claim a lack of regulation is what's responsible, because the unbridled free market just can't work. They then point to the Bush years as proof of this. The problem with this argument is that there were many government interventions in this period, and it's not at all clear those interventions are blameless. Here's intervention #1: Fannie Mae and Freddie Mac.

Fannie Mae and Freddie Mac were created by the government in order to provide more credit for people buying homes. They are both pseudo-governmental organizations. They were created by the government and enjoy special government privileges, but are publicly owned and traded on the stock market. Fannie Mae and Freddie Mac are in the secondary mortgage market. They don't lend any money themselves, but instead buy mortgages from other lenders. When they purchase a mortgage from another lender, that lender then has more money to lend to someone else, and so the overall effect is to increase the amount of credit available to home buyers.

Fannie Mae and Freddie Mac partially through special government privilege and partially because of the (accurate) assumption that they would be bailed out if they went bankrupt were able to buy a lot more mortgages than if they were normal companies. The government's intent was to expand lending to people who normally would not have qualified. This effort was successful. It destroyed the normal balance between risk and reward. It made lenders willing to take on much more risk for a lower reward (interest rate), because they would be able to turn around and sell the loan to Fannie or Freddie for an immediate profit.

Overall, much more risk ended up in mortgages than would have normally been there. It only took a few minor shocks to send large numbers of these sub-marginal borrowers into default. Does that mean the lenders didn't have any responsibility in the mess? No, they certainly share in the blame, but Fannie and Freddie were massive players in the industry, greatly manipulated the market, and would not have existed without government intervention.