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Figure 1 1 growth of the gses from 1980 until 2009

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Figure 1-1: Growth of the GSEs from 1980 until 2009 Source: FHFA and Federal Reserve
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19 How did the Commission get its prediction so wrong? When mortgage markets were deregulated, Fannie and Freddie were not meant to be the winners. The Reagan Administration at the time thought the opposite. They argued that deregulation – the act of lessening government’s control in favor of a free market – would lead to a race to the top as private-sector firms would enter the sector and compete openly. Free markets generally work well, with capital flowing to its most efficient use, ending up with better-run firms. So the theory goes. But there was nothing free about these markets. As we have already highlighted, Fannie and Freddie had a special status, which meant that the financial markets believed that there were implicit government guarantees on any debt that they issued and on the mortgage guarantees that they provided. No firm could compete with Fannie and Freddie under these circumstances: They paid no taxes, could borrow at cheaper rates, and were lightly regulated in that they faced low capital requirements for holding similar risks compared to private-sector counterparts. Opening up mortgage markets without restraining Fannie and Freddie was like bringing a gun to a knife fight. It is, of course, intriguing how Fannie and Freddie managed to get away with it for decade after decade. In 1999 and 2000, the conservative think tank, the American Enterprise Institute, ran a series of conferences on these firms, the end product being a book titled Serving Two Masters, Yet Out of Control: Fannie Mae and Freddie Mac . The book refers to the two masters – their shareholders and their public mission of encouraging greater home ownership – and the collision 0f the two as the government subsidy that is provided for one (i.e., the public mission) gets exploited by the other (i.e., the shareholders). The conference brought together individuals of quite different ideologies who reached similar conclusions. One fascinating piece was written by Ralph Nader, the consumer advocate, political activist, and left-wing ideologue, who outlines in detail the interconnections between successive presidential administrations and the payroll of Fannie and Freddie, documenting the heavy (and aggressive) lobbying by these firms: “Fannie Mae and Freddie Mac are fast learners. Born of the federal bureaucracy, these enterprises have swiftly and skillfully managed to pick up the roughshod tactics of the private corporate world and at the same time cling tightly to one of the federal government’s deepest and most lucrative welfare troughs…The combination has produced two GSEs that are not only too big to be allowed to fail but perhaps too influential and too politically connected to be regulated or shaped effectively in the public interest. Any suggestion that their power be limited or that subsidies be reduced triggers an immediate no-holds-barred counterattack from Fannie and Freddie. As John
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