Reforming Fannie and Freddie

The graphic above is from a Wall Street Journal analysis of the housing market (here). What the graph shows is that the market share of Fannie and Freddie declined rapidly during the housing boom as privately issued (questionable?) mortgages came to dominate the market. The market share reversal is also mentioned in the Treasury report on reforming Fannie and Freddie (here).

In both the WSJ and the Treasury analysis, the recovery in market share from 2006-2008 is seen as the problem and it is asserted that "...Fannie Mae and Freddie Mac pursued riskier business to raise their market share and increase profits". Does this graph point the finger at Fannie and Freddie?

Purely from the standpoint of causal analysis, the finger has to be pointed at the private sector that was taking market share away from Fannie and Freddie. Consider this causal counterfactual: Why couldn't the market have stabilized at 40% Fannie/Freddie and 55% Privately Insured? It couldn't stabilize because the privately insured mortgages being written were garbage.

Fannie and Freddie's private-side drive for profit allowed them to be played by the private sector who dumped all their toxic assets back on Fannie and Freddie after 2006. At the end of all this, Fannie and Freddie are back to their 1992 levels of market share (70%), the private sector is down to almost nothing and government-guaranteed mortgages are up to 30%. In other words, the government and the public-private GSEs ended up holding the bag for actions taken in the private sector.

And, now the Treasury is trying to roll things back to 2006 (here) and replay history with good oversight. But I'm confused. Until 2003, Fannie and Freddie evidently were not a problem. How does reducing Fannie and Freddie's market share solve a problem that was created in the private sector after 2006? At least the Treasury recognizes that "Fannie Mae and Freddie Mac's profit-maximizing structure undermined their public mission." A big question in my mind is whether the private sector (who created the problem in the first place) is going to be a trustworthy player.

One point in favor of eventually winding down Fannie and Freddie is that any large pot of money or assets sitting somewhere close to the government is going to create problems. How to make sure originators can write sound mortgages without having to keep the entire mortgage (some percentage of each mortgage might be a good idea to keep their skin in the game) is going to be the challenge.