www.Heritage.org

For the past several years, it's not been an uncommon sight in Anytown, USA, to drive down the street and see home after home for sale after going through foreclosure. They are the still-lingering hangover from the housing crash that began in 2007. Though the true cause of what burst America's housing bubble is still debated, two of the culprits -- housing finance giants Fannie Mae and Freddie Mac -- are still going strong even though both essentially failed in 2008 and are under government control. Economists and politicians alike are now pondering whether we need Fannie Mae and Freddie Mac at all and what would happen if they were eliminated altogether.

For several years prior to 2007, home prices went through the roof, but then they crashed through the basement. Since then, more than 2.3 million homeowners have faced foreclosure -- an 81 percent increase over 2007. This all, of course, contributed to the Great Recession we're still rebuilding from today. "Easy credit" is pointed to as the corrosive acid that ate away at the housing market's foundation, and federal government-sponsored mortgage finance giants -- the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) -- were there to supply it and help other lenders to do so.

Consistent with policies dating back to the Carter and Clinton Administrations, Fannie Mae and Freddie Mac made it easier for low and moderate income Americans to obtain mortgages and purchase homes. In a new paper from The Heritage Foundation, A Housing Market Without Fannie Mae and Freddie Mac: Effect on Home Prices, Nahid Anaraki reports that this "fueled an excessive expansion of credit in the housing sector, shifted the demand for real estate to the right, and caused home prices to overshoot their underlying market equilibriums." In other words, Fannie Mae and Freddie Mac's intervention in the housing market helped to fuel the boom-to-bust housing bubble by subsidizing interest rates and enabling reduced down payment requirements on single-family homes, thus unnaturally boosting demand and causing prices to go up.

The trouble with all this, Heritage reports, is that though Fannie Mae and Freddie Mac have made it easier for a family to buy a home, in the long run their actions have a detrimental effect on the economy, as America has witnessed.

So what would happen if Fannie Mae and Freddie Mac were phased out? Would the absence of their ability to offer lower interest loans and smaller down payments impact the cost of homes in America? Anaraki's analysis shows that it would not. In fact, interest rates and changes in down payment requirements have little influence on housing prices. Instead, fundamentals--such as household assets, personal income, the S&P Index, and the effective tax rate--play substantial roles in shaping home prices. As such, she advises, it's time for Washington to get out of the business altogether:

The federal government should avoid offering any subsidy in the form of lower interest rates or lower down payments because it adversely affects both the housing market and the economy over the long term. Although such a policy may boost the demand side in the short term, it risks inflating another housing bubble in the medium or long term.

Eliminating Fannie Mae and Freddie Mac, in fact, will help more Americans afford homeownership. Since these institutions increase demand -- thereby increasing home prices -- it becomes increasingly difficult for lower-income Americans to afford to purchase homes without subsidized interest rates. If Fannie Mae and Freddie Mac are eliminated, interest rates may slightly go up initially, but Anaraki finds that "higher interest rates will lead to lower median home prices, which in turn will increase the ability of low-income groups to purchase a house." What's more, competition among housing lenders would increase, leading to lower interest rates in the medium to long term.

Owning your own home is the American Dream, but suffering a foreclosure and winding up on the streets is the American Nightmare. In pursuit of encouraging the former, the federal government helped produce the latter. Government intervention by way of Fannie Mae and Freddie Mac may have given more Americans the keys to their own homes, but they bought homes they could not afford and in a marketplace that could not be sustained. As Heritage showed in an earlier paper, Fannie Mae and Freddie Mac can be phased out without disrupting the housing recovery. A better way forward is to phase out Fannie Mae and Freddie Mac and let the home market find a healthy and sustainable equilibrium.

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