Fannie Mae and Freddie Mac were born out of the belief that social policy should focus on providing help at the margin—mortgage a monetary “nudge” that would push low- and moderate-income households that are on the cusp of a decision as to whether to stay as renters or to become homeowners to take the latter course of action.

This nudge could take the form of assistance with a down payment or with monthly mortgage payments, or both. In essence, social policy should operate in a focused manner in the area that matters.

However, Fannie Mae and Freddie Mac operate instead on a broader swath, encouraging households who would likely buy anyway to buy a larger, better-appointed house on a larger lot (or to buy a second home). Such programs wind up being extremely wasteful in terms of actually achieving the stated goal of encouraging more widespread homeownership.

Indeed, research over the past few decades has indicated that too much of the capital stock of the U.S. has been devoted to housing, at the expense of investments in physical industrial capital and human capital, with aggregate U.S. income suffering as a consequence.

And since the tax-based incentives operate through deductions and exemptions (rather than tax credits), which are worth more to upper-income households with higher marginal tax rates, it is clearly not the low- and moderate-income households who are the major beneficiaries of these programs.

In 2004, the conforming loan limit for Fannie Mae and Freddie Mac was $333,700, which would support the purchase of a $417,000 house. In that year the median price of a new home that was sold in the U.S. was only $221,000; the median price of an existing home that was sold was $184,000.

Thus, the housing that can be bought through a Fannie Mae or Freddie Mac mortgage far exceeds what is likely to be bought by a first-time low- or moderate-income household homebuyer.

Of course, the two companies do also cater to low- and moderate-income households. The Department of Housing and Urban Development has set targets for their efforts with respect to “affordable housing,” and the two companies have met those targets.

But the bulk of their mortgage purchases are not focused on the group that ought to be the target of ownership-encouraging activities. Indeed, when HUD in 2004 decided to ratchet up these targets, a major support for this ratcheting was HUD’s findings that the two companies’ mortgage purchases of loans for low- and moderate-income households and for first-time buyers were below (on a percentage basis) those of all lenders for comparable residential mortgages. Consistent with this, it appears that the activities of the two companies have had little or no effect on the rate of homeownership in the U.S.

In sum, the aggregate of housing policies in the U.S. has encouraged this country to over-invest in housing at the expense of other goods and services. The programs involving Fannie Mae and Freddie Mac have contributed to this overinvestment in housing, while also not doing an especially good job of focusing on the low- and moderate-income first-time home-buyer where the social argument for encouraging homeownership is the strongest.

The financial markets have been strong in their belief that, in the event that either company experienced financial difficulties, the federal government would very likely bail out the company’s creditors.

This has had the effect of encouraging too much housing. The two companies have enjoyed substantial gains. But it translates into a policy of privatizing the gains and socializing the losses. Taxpayers have been exposed to the risks of a sizable contingent liability.

There are far better ways to pursue the goal of encouraging homeownership in America. Truly privatizing the two companies, as well as pursuing a range of sensible reforms, would better encourage homeownership in ways that would improve the efficiency of the U.S. economy and increase social welfare and equity.