Many complain that the primary failure of fannie and

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Many complain that the primary failure of Fannie and Freddie lay in its ownership structure: heads I win, tails you lose; or in other words, the privatization of profits (for the shareholders and executives) in good times but the socialization of downside risk (for the taxpayer). Having been delisted from New York Stock Exchange and being in conservatorship, Fannie and Freddie are effectively nationalized at the current point in time. However, simply nationalizing them for the indefinite future will not fix the state of mortgage finance in the United States. This is because the collapse of Fannie and Freddie during the financial crisis of 2008 is in fact emblematic of a much broader and worldwide problem with government-owned enterprises. The German Landesbanken , guaranteed by the state and explicitly public entities (unlike Fannie and Freddie), also went all-in funding the real
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7 estate boom in the United States and the United Kingdom, only to be the first banks to fail and be bailed out in the crisis. The Spanish Cajas , similar to the savings and loan associations in the United States, funded the biggest construction boom in Spain and are now deemed an important contributor to its economic malaise. Fannie and Freddie are the poster children of government- related institutions, often set up with an initially limited and worthwhile mandate, but grown far beyond their initial purpose into uncontrollable and systemically risky behemoths. Hence, nothing short of bringing the shutter down on Fannie and Freddie in the long run will suffice. As we were completing this book in August of 2010, the Obama administration has promised to lay out its proposals to reform these institutions by early 2011. This book presents and analyzes several proposals, including our own. First and foremost, government entities of the scale of Fannie and Freddie should simply not exist. That is, their job should be performed by private markets or not at all. However, if these entities must exist, then they should be run in smaller sizes as “boring public utilities” with three features: First, they should face highly ring-fenced usage of government guarantees; or, in other words, they can’t run a casino with taxpayer money. Second, the guarantees should be explicitly recognized on the federal balance-sheet so that there is no Ponzi scheme of each presidential administration’s passing the risk down to the next one. This would ensure that the scale of government entities is a function of pre-allocated fiscal budgets. Third, the sole purpose of these entities should be to remedy a clearly identified market failure, or, in other words, fill in where markets do not exist or are unlikely to achieve socially efficient outcomes. This purpose should be achieved through public-private partnerships, allowing private markets to grow side by side. Thereby, the government entities would pave the way for their own graceful exit in a pre-specified period from the time of their birth.
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