I couldn’t find the paper I want to reference but I remember reading a convincing analysis a while back that the advantage to consumers from Fannie and Freddie loans was on the order of 7 basis points.

The story was more or less that the difference between loans just over the Fannie/Freddie cap and those just under was only about 20 bps. Of that the estimated that less than half was due to the fact that the implicit federal guarantee was driving down Fannie/Freddie loan rates but that over least half was due to the fact that Fannie and Freddie’s guarantee was driving up rates on other loans.

Basically, investors had a choice: they could either by the Fannie Freddie loans with the implicit guarantee or they could buy private label mortgages with no guarantee. Obviously investors prefer to be guaranteed and so money moved from private label to Fannie/Freddie. This dropped Fannie/Freddie rates somewhat but it caused private label to rise by even more.

The moral of the story is that unless you think 7 basis points, which is .07% makes housing much more affordable, then Fannie and Freddie are not really that effective at providing affordable housing.

My question, however, is: what are the macro-economic implications of having no mortgage buyer with a guarantee.

As you can see during the crisis the spread exploded

Indeed, that was a big signal that things were going horribly wrong.

The rise in the spread during 2009 can be somewhat attributed the Fed’s buying of Fannie and Freddie bonds directly. However there was a clear jump in 07 that was related to the beginning of the housing crash.

Also its no well kept secret that Fannie and Freddie became the lender of only resort during much of the crisis. Rising to 100% by mid 2010

The question is: what would have happened to the US economy had Fannie and Freddie not been in a position to offset the collapse in the private mortgage market.

One possibility is that the price of housing would have collapsed. I know that people are still shell shocked by the decline in housing prices, but while there was a dramatic fall it was hardly a full scale collapse.

Here is the Case-Shiller 10-city index

Graph: S&P Case-Shiller 10-City Home Price Index

We are still 60% above the year 2000 level, roughly where we were in 2003. Imagine a collapse all the way back to 1992 levels? This is certainly possible, it happened in Detroit.

Graph: Home Price Index for Detroit, Michigan

Even bigger collapses are theoretically possible. If credit completely tightens then the market will turn to cash buyers and price will fall to the point where cash buyers can meet forced sellers.

The question is how bad would that have been macroeconomically?

On school of thought would be that reaching equilibrium faster would reduce uncertainty. It would cause a much larger wave of strategic defaults, but that on the other hand would have meant a huge decline in the debt overhand for consumers.

A key issue is whether or not the private banking sector could have been as easily saved without Fannie or Freddie. This I do not know. I would tend to think that the insolvency would have been much deeper and the success of TARP less certain.

In short, while I have little concern that the demise in Fannie or Freddie mean much for affordability I am more concerned about macroeconomic stability. Without a mortgage lender of last resort, much larger crashes in housing prices are possible and with that the possible unrescueable collapse of retail banking.