Making the Economy Worse Through Mortgage Subsidies

Henry Blodget has an excellent bit of commentary on the real consequences of Fannie Mae and Freddie Mac. Noting that they ostensibly were created to make houses more affordable to buy, the actual consequences of their intervention in the housing finance market is to keep houses more expensive. He begins:

As we noted yesterday, the raison d'etre of housing subsidizers Fannie Mae and Freddie Mac has changed radically in the past three years.

Specifically, the purpose of these two agencies has gone from "making housing affordable" to "keeping houses expensive."

How so?

The government is panicked about what will happen to the economy (and voters) if house prices decline further. By subsidizing mortgages through Fannie and Freddie, therefore, the government is now doing everything it can keep house prices as high as it can.

When government sponsored enterprises subsidize home mortgages, it does make it easier for banks to create mortgages and loan money to would-be home owners at lower interest rates. What appears to make buying a house more affordable, however, has consequences that do just the opposite. Because it is easier to borrow money, more people demand more houses resulting in higher prices. In the name of house affordability, Fannie and Freddie actually raise house prices. It is particularly sad, however, that instead of this being an unfortunate unintended consequence of government benevolence, higher house prices is exactly what the government wants, because of so many Wall Street balance sheets heavy in mortgage bonds. 

Higher house prices is exactly what we do not need right now. What I find most impressive in Blodget's piece is an almost Misesian view of what needs to happen to get us out of the Great Recession. 

[A]s long as Fannie and Freddie delay the inevitable return of house prices to fair value, they will also delay the clearing and healing process that this country must go through if it is to get back on solid economic footing again.

Blodget seems to understand that such intervention in housing finance serves only to hamper the necessary capital reallocation process required for real recovery.