In 2001, I edited a book entitled Serving Two Masters, Yet Out of Control: Fannie Mae and Freddie Mac--a collection of papers that had been delivered at AEI conferences during the preceding two years. The two masters referred to in the title, of course, were the GSEs’ government mission, on the one hand, and-on the other-the fiduciary duty of their managements to maximize their profitability. I argued that these two masters could not both be served, and the one that was not getting its due was the government mission.

There is no clearer example of this than the subject of today’s conference. If you watch television or read newspapers, you have no doubt seen the photos of the happy African-American or Hispanic family standing in front of their home. Accompanying the photo is a statement such as Fannie’s slogan "We’re in the American Dream Business" or Freddie’s "Opening the Doors to Home Ownership." In your materials is a typical example of this advertising, and copies of pages from the GSEs’ annual reports. The implication is that Fannie and Freddie are focused on providing financing so that otherwise underserved people in the United States have an opportunity for home ownership.

The problem with this, however, is that if it consisted of explicit statements it would be false advertising. As you will see in Jon Brown’s presentation, in city after city, Fannie Mae and Freddie Mac buy smaller percentages of the conventional mortgages made in minority and low income areas than they buy in middle income, generally white, areas. If we take this information seriously, they are doing what is called red-lining-and illegal-when it is done by banks. In your conference materials, we have included some representative city maps which show the discrepancy between the Fannie and Freddie purchases of conventional mortgages in minority and low income communities and their purchases of similar mortgages in middle income communities. This data is for the year 2000, and although we hope it has improved somewhat since then, substantial changes in percentages would be very difficult when the absolute numbers are this large. Again, I want to emphasize that Brown is comparing apples and apples-purchases of conventional mortgages, which meet Fannie and Freddie’s criteria, in both minority and non-minority communities.

Yet, the GSEs announce each year that they met HUD’s standards for making loans to low-income homebuyers, and Fannie advertises a "trillion dollar" commitment for minority and low income housing which they say they are pursuing successfully. How is this possible? As Jon Brown will argue, it is the result of a deficiency in the way HUD’s regulations are drafted. Incidentally, we invited representatives of both HUD and Fannie Mae to participate in this conference but both declined. We are happy that Peter Zorn of Freddie Mac has agreed to comment on Jon Brown’s paper, and presumably he will provide a different perspective on Brown’s data.

Now, I want to be clear about what the problem is. In reality, Fannie and Freddie are not charged by statute with responsibility for increasing minority housing. They were formed for the purpose solely of creating more liquidity in the secondary mortgage market. The closest thing to a mandate to promote minority or low income housing is a requirement in their statutory charters that they "promote access to mortgage credit throughout the nation...including underserved areas."

However, as previous conferences have shown, they are no longer necessary for this original purpose. So, in time-honored fashion, they have made up new missions for themselves. One of these new missions is to reduce the interest rates on conventional mortgages. As the Congressional Budget Office and others have confirmed, the GSEs actually do this, reducing interest rates by about 25 basis points by passing along a portion of the financing advantages they receive as a result of their implicit government backing.

The other mission they claim is an implicit one, and is suggested primarily through their advertising, which features African American and other minority groups. Implicitly, they are claiming that they deserve continued support because they are doing good-providing financing to people who might not otherwise be able to get it. People who wonder whether the government should be backing Fannie and Freddie might think twice, or become supporters, when they believe that government backing is being used for a worthwhile purpose. So, even though Fannie and Freddie may not have a statutory mission to serve minority and low income homebuyers, they have assumed this burden by soliciting our continued support on the basis that they do.

In our last conference, a Census Bureau presentation showed that reducing residential mortgage rates by 25 basis points did not put people in homes. The problem for renters, it was pointed out, is not that they can’t afford the monthly carrying charge of a home mortgage-it’s that they don’t have the down payment. So we have already raised a significant question about whether the GSEs are actually-as they explicitly claim-putting people in homes by slightly reducing mortgage interest rates.

In this conference, we will explore another aspect of the GSEs’ claims-the implicit claim that they are serving minority and low income home buyers. Although they claim that they do this , the data Jon Brown has assembled seems to show that they do not.

Jon Brown’s solution to this problem is better regulation. HUD standards, he argues, should be tightened so that Fannie and Freddie are actually required to do what they say they are doing.

This is one way to enforce a government mission on otherwise recalcitrant companies. The problem, however, is that they will always find ways to reinterpret and avoid the full impact of the rules, and as we have seen the government-and particularly HUD-has not been aggressive in creating or enforcing its rules in this area.

Another way to use government backing to benefit low income homebuyers is what Congress did with respect to the Federal Home Loan Banks. Rather than require the Banks to meet a standard for financing minority or low income housing, Congress simply required that the Banks contribute 10 percent of their profits to an Affordable Housing Program. This amounted to more than $200 million in 2002 and $1.7 billion since 1992. A similar mandatory profit-sharing program for Fannie and Freddie would be about double that for each company.

My solution, from the beginning, has been the opposite. I don’t think it is possible for a single company to serve both its shareholders and a government mission. So I would recommend privatization, the elimination of Fannie and Freddie’s links to the government. If we want a government program that will help minority and low income homebuyers, it should be carried out by a government agency, not companies that owe fiduciary duties to shareholders.

Included in your materials is an interesting paper by Tim Riddiough, a professor at the University of Wisconsin School of Business. He argues that the GSEs buy fewer low income and minority mortgages because they do not vary their interest rates according to risk.. As a result, because low income borrowers are clustered in the higher credit risk categories, they must include fewer low-income mortgages in their pools in order to reduce overall pool risk. This is an interesting hypothesis, and suggests that no amount of regulation can induce Fannie and Freddie to substantially increase their purchases of low income and minority mortgages.

Fannie and Freddie-despite the implications of their advertising-do not appear to be doing the job they say they are doing, and there is no doubt in my mind that this is the result of their conflicting duties.