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In other words, the Agencies (Fannie Mae/Freddie Mac) don't have huge stockpiles of money that it lends to consumers through the go-between of the nation's lenders.

That's correct.

They only have the formerly implicit and now explicit backing of the US Federal government. You know - the guys who can just print money if they want.

More seriously - here's my point.

All of the mortgage money comes from investors. Today, my claim is that something in excess of 80% of investors money goes through Fannie/Freddie. (aj kindly came up with a source claiming 95%, but including a couple of additional agencies. The difference is immaterial for my argument.) From there, the money goes to "lenders" and finally to borrowers to buy real estate.

The other path is from investors directly to "lenders" to the borrower.

Here's the rub. When Fannie/Freddie get involved, the investors look to those agencies if things go wrong. They don't look any further down the money trail. With the vast majority of loans going through this path, there's no incentive for lenders to care about the quality of the loan. They only care about meeting the paperwork requirements to get Fannie or Freddie to back the loan. If they can show they did that job correctly, they bear no burden for bad loans.

In the alternative path - keeping Fannie/Freddie out of the picture - lenders bear a much higher burden. Now, if loans go bad, the investors look to the lender. So the lender now has an incentive to care about the quality of the loan and not just the quality of the paperwork.

I'd like to get incentives back to making sense. I'd like to see lenders with an incentive to make good loans, not just good paperwork.

Fannie and Freddie did a good job lending money when they were only involved in a smaller fraction of the loans - perhaps up to the 1995 level of 20% quoted in your rather old article. With them basically the only game in town today, mortgage lending is highly irrational - focused almost entirely on getting the right pieces of paper in the file instead of focused on making loans that will be repaid.

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