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Jerome Lyle Rappaport

Jerome Lyle Rappaport
Founder and Board Member
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Edward Glaeser

Edward Glaeser
Professor of Economics at Harvard University
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Stephen P. Johnson

Stephen P. Johnson
Executive Director of Phyllis and Jerome Lyle Rappaport Foundation
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Greg Massing

Greg Massing
Executive Director for the Rappaport Center for Law and Public Service
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Alasdair Roberts

Alasdair Roberts
Professor of Law and Public Policy at Suffolk University Law School
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Joseph Curtatone

Joseph Curtatone
Mayor, City of Somerville
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Tim H. Davis

Tim H. Davis
Independent Research Consultant
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Scott Harshbarger

Scott Harshbarger
Senior Counsel, Proskauer Rose LLP
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Vivien Li

Vivien Li
Executive Director of The Boston Harbor Association
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Guest contributors

Monika Bandyopadhyay
Suffolk University Law Student

David Barron
Harvard Law School and former Deputy Counsel for the Office of Legal Counsel in the US Department of Justice

Linda Bilmes
Senior lecturer in public policy at the Harvard Kennedy School. Assistant Secretary of Commerce during the Clinton Administration.

Brandy H.M. Brooks
Director, Rudy Bruner Award for Urban Excellence, Bruner Foundation

Felicia Cote
Rappaport Fellow, Harvard Law School/Harvard Kennedy School.

Amanda Eden
Suffolk University Law School student

Sara Farnum
Student, Suffolk Univ. Law School

Kristin Faucette
Student at Suffolk University Law School

Benjamin Forman
Research Director, MassINC

Arthur Hardy-Doubleday
JD/MBA student at Suffolk University Law School and the Sawyer School of Business

Theodore Kalivas
Boston Green Blog, Dukakis Center for Urban & Regional Policy

David Linhart
Student, Boston University School of Law

Antoniya Owens
Research Analyst, Mathematica Policy Research, Inc.

Susan Prosnitz
Senior Advisor, TSA, Washington, DC

Ben Thomas
Boston Green Blog, Dukakis Center for Urban & Regional Policy

Matthew Todaro
Student at Boston College Law School

Alexander von Hoffman
Senior Researcher, Joint Center for Housing Studies

Brett Walker
Student, Boston College Law School

Margarita Warren
Student at Suffolk University Law School

When Privatization Increases Public Spending

Tuesday, November 9th, 2010
By Edward Glaeser

What should the G.O.P. do after last week’s recapture of the House of Representatives? “Real spending reductions, an extension of the Bush tax cuts, ending earmarks, using the returns from the bailouts to reduce the debt and turning Fannie and Freddie into private companies should all be at the top of the G.O.P.’s agenda,” Karl Rove wrote in a commentary published in The Wall Street Journal on Thursday.

The Republicans were certainly elected to shrink the size of government. But while that goal naturally leads to less spending and lower taxes, it should not lead to privatizing the Federal National Mortgage Association, known as Fannie Mae, and Federal Home Loan Mortgage Corporation, Freddie Mac.

These companies, seized by the government in 2008 to ensure the availability of mortgage loans, provide money to lenders by buying new loans, then bundle those loans into securities for resale to investors.

We’ve seen too many decades of Fannie and Freddie to think that reprivatizing them will save taxpayers any money. (On Friday, Fannie requested an additional $2.5 billion from the Treasury, most of which will be used to pay a $2.1 billion dividend to the government on its nearly 80 percent stake.)

Most of the time, privatization does indeed reduce government expenditures. Those who opposed the public health care option were appropriately worried it would end up draining the Treasury. Privatizing municipal services, such as trash collection, has often been seen a tool to reduce the costs of public services.

But Fannie and Freddie are the rare exceptions where the taxpayer is safer with them in government hands rather than private hands.

Fannie Mae has been a private entity since 1968. Since then, the federal government has proven itself unable to allow let it or Freddie Mac default. When Fannie and Freddie get in trouble, the government is always there to back them up, most recently at a cost of many, many billions.

Given the trillions in mortgage-backed securities that are securitized by these enterprises, once a crisis occurs, the government faces the option of a bailout or risking financial Armageddon. Unsurprisingly, it chooses bailouts.

I sympathize with those who would like to end any prospect of a federal backstop for these enterprises, but we don’t have that option. The Bush administration clearly saw the problem five years ago and wanted to make sure that Freddie and Fannie’s risk-taking didn’t end up costing taxpayers billions. They couldn’t do it then, and the House of Representatives won’t be able to accomplish that feat now.

And trying to would effectively tie the hands of future Treasury secretaries and chairmen of Federal Reserve. If the federal government is going to bail out Fannie and Freddie anyway, the fiscally responsible thing to do is to keep them in government hands.

Then the government can write strict rules that limit their behavior. They can be forced to charge high fees for guaranteeing mortgages. They can be tightly restricted in the types of mortgages they insure.

If they remain government entities, the leaders of the House can play a large role in designing a structure that won’t cost future taxpayers billions.

All of that control disappears when the entities become private. They will be able to experiment with new products and cut their fees to expand market share. They will be able to hold billions, or trillions, of dollars in their retained mortgage portfolios. They will be able to go back to exerting enormous political influence.

If an entity is going to be able to gamble with taxpayer dollars, then we are far safer if that entity is a slow-moving government bureaucracy than rather than a nimble, profit-seeking company.

A quick comparison of Freddie and Fannie with the government’s Federal Housing Administration illustrates the dangers of reprivatizing those entities. For decades, the housing administration managed to provide mortgage insurance for poorer Americans without draining the budget.

It charged higher fees and was crowded out of the market by nimbler competitors during the great housing boom. It may, indeed, end up requiring a bit of taxpayer aid, but that support will be tiny relative to the fiscal tsunami of Fannie and Freddie.

I also respect those who argue that Freddie and Fannie should just disappear. Other mortgage markets work perfectly well without such government entities. But it seems dangerous to go cold turkey on government mortgage insurance in our weak economy.

The safer path is to let them exist, as tightly controlled government entities that charge high fees for their services. In an ideal world, they would be beaten out of the market by private competitors able to provide such insurance at a lower cost.

The government-controlled version of Freddie and Fannie seem likely to disappear over time — if lawmakers make sure they charges fees high enough to cover their costs. The great advantage of a slow transition to privatization through private competition is that the government will find it far easier not to bail out any new, purely private entrants in the market.

The G.O.P. returned to power buoyed by a desire or fiscal responsibility. Letting Freddie and Fannie loose again is a recipe for more multibillion-dollar bailouts. Keeping them in government hands is a way of keeping control and making sure that American taxpayers don’t end up footing another vast bill for private gambling with a government guarantee.


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