The desperate worry over the health of huge financial institutions with country cousin names — Fannie Mae and Freddie Mac — reflects a reality that has reshaped major spheres of American life: the government has in recent months taken on an increasingly dominant role in assuring that Americans can buy a home or attend college.
Much of the private money that once surged into the mortgage industry has fled in a panicked horde, leaving most of the responsibility for financing American homes to the government-sponsored Fannie and Freddie.
Two years ago, when commercial banks were still jostling for fatter slices of the housing market, the share of outstanding mortgages Fannie and Freddie owned and guaranteed dipped below 40 percent, according to an analysis of Federal Reserve data by Moody’s Economy.com. By the first three months of this year, Fannie and Freddie were buying more than two-thirds of all new residential mortgages.
A similar trend is playing out in the realm of student loans. As commercial banks concluded that the business of lending to college students was no longer quite so profitable, the Bush administration promised in May to buy their federally guaranteed student loans, giving the banks capital to continue lending.
In short, in a nation that holds itself up as a citadel of free enterprise, the government has transformed from a reliable guarantor into effectively the only lender for millions of Americans engaged in the largest transactions of their lives.
Before, its more modest mission was to make more loans available at lower rates. Now it is to make sure loans are made at all. The government is setting the terms and the standards of Americans’ biggest loans.
On Sunday, that federal oversight and protection was made more explicit, as the Bush administration sought to mount a rescue of Fannie and Freddie, asking Congress to devote public money to buying the two companies’ flagging stocks.
The new reality is scorned by libertarians and conservatives, who fear state intrusions on the market, and by populists and progressives, who dislike the idea of education and housing increasingly resting upon the government’s willingness to finance it.
“If you’re a socialist, you should be happy,” said Michael Lind, a fellow at the New America Foundation, a research institute in Washington. “But you should really wonder whether you want people’s ability to pay for housing and college dependent on the motives of people in Washington.”
The government is trying to support plummeting housing prices and spare strapped homeowners from the wrath of the market: last week, the Senate adopted a bill authorizing the Federal Housing Administration to insure up to $300 billion in refinanced mortgages, enabling borrowers saddled with unaffordable loans to get better terms.
How the government came to dominate these two crucial areas of American lending is — depending on one’s ideological bent — a narrative of regulatory and market failure, or a cautionary tale about bureaucratic meddling in commerce. Perhaps it is both.
To those prone to blame lax regulation, the mortgage fiasco was the inevitable result of a quarter-century in which American policy makers prayed at the altar of market fundamentalism, letting entrepreneurs succeed or fail on their own.
This was the spirit in which Alan Greenspan, the longtime chairman of the Federal Reserve, allowed banks to engineer unfathomably complicated webs of mortgage-based investments that, through the first half of this decade, sent real estate prices soaring and expanded homeownership.
The banks relied on these investments to raise money for the next wave of loans. The system worked so long as lenders could keep selling their mortgages, and so long as someone would guarantee most of the debts. Fannie and Freddie took care of both tasks. Together, they now guarantee or own roughly half of the nation’s $12 trillion mortgage market.
Belief in Fannie and Freddie gave banks a sense of certainty as they plowed more of their capital into residential mortgages. That easy financing, in turn, brought more and more people into the market for homes, generating a belief that American real estate prices could keep rising forever.
And that contributed to the banks’ ultimately making extraordinarily risky loans, which defaulted first when home prices started falling. As lending became conservative, the whole speculative bubble burst.
As some called for intervention by the Fed to cool a speculative binge, Mr. Greenspan resisted. He believed the risks of real estate were effectively limited because debt was widely dispersed. The market would sort it all out.
“Alan Greenspan had this view that the light hand of regulation was best,” said Vincent R. Reinhart, a former Federal Reserve economist and now a scholar at the American Enterprise Institute.
When housing prices commenced plummeting, the ugly truth emerged that many banks did not understand the details of the mortgage-backed investments they owned. Ignorance proved expensive.
As one bank after another announced losses that now exceed $400 billion and that some estimate will ultimately cross the trillion-dollar mark, money ran screaming from the field, leaving Fannie and Freddie pretty much the only players.
A general fear of debt took hold. Banks that had offered loans to students under a federally guaranteed program suddenly could not sell investments linked to those outstanding debts, meaning they could not raise cash for the next crop of loans. Dozens of banks pulled out of the program.
“What’s happened kind of speaks for itself,” said Dean Baker, co-director of the Center for Economic and Policy Research in Washington. “You had this effort to weaken the government’s role. There was this conscious effort to turn things over to the private sector, and it failed.”
But there is a parallel narrative, the story that critics and competitors of Fannie and Freddie have told for years: how the two companies exploited their pedigree as entities backed by the government to secure an unfair advantage over the private sector.
They swelled into highly leveraged behemoths, it was said, on the implicit guarantee that the government would step in and rescue them if they ever got into trouble. This allowed them to borrow money more cheaply than their competitors could, enabling them to make loans more cheaply.
That secured more business and rewarded their shareholders, along with their handsomely compensated executives. It emboldened them to trade in highly risky investments.
“They were using their privileged position as favored children of the government to dominate the market, and taxpayers were on the hook for substantial risk,” said Martin N. Baily, a chairman of the Council of Economic Advisers in the Clinton administration. “You couldn’t possibly say this was a pure unfettered market.”
The government was getting something for its protective largess. It was using Fannie and Freddie to pursue the social goal of broader homeownership, particularly among racial minorities.
“When you’re looking at the upside, here’s the government helping people get mortgages and student loans,” said David R. Henderson, a self-described libertarian economist at the Hoover Institution at Stanford University. “The downside is there might be a bailout and then you pay in taxes. These things don’t come cost-free when government gets involved.”
As the Bush administration readies funds to buy student loans from cash-short banks, and officials plot a potential bailout of Fannie and Freddie that could run into tens of billions of dollars, the government’s outsize role in these two huge areas will not shrink anytime soon.
It seems a strange coda to an era in which markets were sacred, and regulation heresy.
For a generation, American policy makers have lectured the world on the need to unleash the animal instincts of the market. China’s rickety banks should stop lending to protect state factory jobs, Americans said, and focus on the bottom line. Now the Bush administration is reluctantly concluding that Fannie and Freddie might need to be propped up to protect the American homeowner.
During much of Japan’s lost decade of the 1990s, Americans called for an end to its coddling of weak banks. Better to let them keel over, along with the paper tiger companies they sustained. No company was “too big to fail,” Washington said.
Yet here, in the aftermath of a financial crisis brought on by what were once called American virtues — financial engineering and risk management — Washington may bail out Fannie and Freddie for the simple reason that they are too big to fail. If they go down, so do whole neighborhoods. So, perhaps, does the global financial system.
“The thing we have to do now is to make sure that Fannie and Freddie remain solvent and continue to make loans,” Mr. Baily said. “We just don’t have any choice.”
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