The U.S. government is, for all practical purposes, becoming the most important bank in America. Two recent measures demonstrate the point. First, the Treasury Department announced yesterday that it was lifting the $200 billion limit it had previously placed on the funding it would provide to each of Fannie Mae and Freddie Mac. It will now back those two firms without limit. Admittedly, $200 billion is pocket change these days, with our multi-trillion dollar federal debt and all that. But the absence of any limit now means that for all practical purposes, the federal government, through its cheery sales staff (Fannie, Freddie, Ginnie Mae and the FHA) is responsible for virtually all the mortgage loans in America. Okay, the government is technically guaranteeing the loans, not funding them. But without the government (and taxpayers) being on the hook for defaults, there would be hardly any mortgages. The government makes today's real estate market (however weak it may be) possible.
Second, the Federal Reserve announced yesterday a new measure to "withdraw" some of the accommodative flood of liquidity it spewed into the financial system over the past year. It will offer interest bearing term deposits (equivalent to certificates of deposit) to member banks. These deposits will take cash out of the financial system for the length of the term, so there is a temporary reduction of liquidity. But what happens when the term ends? The deposit goes back to the member bank, where as part of the money supply it could have inflationary impact.
Why doesn't the Fed simply take back some of the cash it printed and sent out into the financial system? It hasn't said. Remember that much of that money was used to buy asset-backed securities and U.S. Treasury securities. One suspects that the reason is that it can't find buyers for those assets, not without pushing interest rates higher than it wants them to go. Thus, the Fed won't reduce its balance sheet (just as it wouldn't with its previously announced reverse repo idea; see http://blogger.uncleleosden.com/2009/12/will-feds-reverse-repos-reverse.html). The Fed will continue as a major financier of asset-backed securities and U.S. Treasury securities (the latter being really weird because it means the government is printing the money it "borrows" and spends; that would be a pure money print in any place except a rabbit hole).
One also suspects that another reason for the member bank term deposit idea is that these accounts would be treated as part of the bank's capital for regulatory purposes. The banks all know that higher capital requirements are in the picture. If they had to buy, say, U.S. Treasury securities in the bond markets to meet those requirements, they might push interest rates up. By offering special CDs to member banks only, the Fed allows them to meet capital requirements without having to roil the Treasury securities markets. In other words, the federal government would appear to be providing special funding to capitalize banks while keeping interest rates lower.
We've already proposed that Fannie and Freddie be reconstituted as nonprofit organizations whose public purpose would not be entwined with private, profit-seeking shareholder interests that distort incentives. See http://blogger.uncleleosden.com/2009/12/fannie-and-freddie-dont-privatize-them.html. Yesterday's announcement by the Treasury Department that it was lifting its ceiling on federal assistance boosted Fannie's and Freddie's stock prices by about 20% over the last two days. This was a nice belated Christmas present to the speculators who probably comprise most of Fannie's and Freddie's shareholders. But what about the taxpayers, who so generously now guarantee assistance without limit to Fannie and Freddie? They get lumps of coal, as far as we can tell.
There are good reasons for government intervention in times of crisis and panic. But growing mission creep is turning the government into another Bank of the United States. There were two Banks of the United States in the late 18th and early 19th centuries. The federal government twice created a national bank in order to provide financial services on a larger scale than it thought private banks of the day could handle. But the charter of the Second Bank of the United States was allowed to expire by President Andrew Jackson, out of concern that the Bank favored commercial interests of the East Coast, to the detriment of rural interests and the Western states (those now called the Midwest). This may ring bells in light of present day concerns that the federal government is too attentive to Wall Street while ignoring Main Street.
When the government supersedes private industry, market principles become diluted by politics. This isn't wrong by itself. Taxes, police and fire protection, national defense, social safety nets like unemployment compensation, workers compensation, Social Security, Medicare, Medicaid and so on all represent political solutions to problems that market principles were thought to handle poorly. But if the federal government is going to become the most important bank in the country, then we should have a serious, explicit discussion about how it will allocate credit--instead of today's quiet, step-by-step mission creep--and why so much federal support should be given to humongous private banks that compensate their executives munificently but lend so little the government needs to step in and lend in their place at the expense of the soon-to-be-more-heavily-taxed citizenry.
Showing posts with label Fannie and Freddie bailout. Show all posts
Showing posts with label Fannie and Freddie bailout. Show all posts
Tuesday, December 29, 2009
Wednesday, December 16, 2009
Fannie and Freddie: Don't Privatize Them Again
For all practical purposes, Fannie Mae and Freddie Mac now belong to the federal government. They were taken over by the government in the late summer of 2008 and remain under federal control. There has been discussion of re-creating them as private entities with some federal participation (in the form of guarantees of mortgage-backed securities they issue) and a lot of regulation, including profit limitations.
This is weird. The problems at Fannie and Freddie stem to a large degree from their mixed private-public nature. They ostensibly were privatized, but investors assumed that they were implicitly backed by the government. Fannie and Freddie took undue advantage of that assumption and seized a very large part of the mortgage market. They had a competitive advantage from their presumed implicit government protection, and could outcompete truly private mortgage lenders. They used some of their copious profits to hire the biggest lobbying guns in Washington to stave off meaningful regulation and effective private sector competition. By becoming so large with the benefit of a presumed government safety net, they made it unavoidable that the government provide them with a safety net. Yet the profits from their salad days went to their private shareholders and high level executives. Taxpayers only got to hold a bag with some really stinky stuff in it, while their homes sank in value.
Since the 1930s, promotion of home ownership has been a federal policy. Fannie Mae was created in 1938 as a federal mortgage financier, and was publicly owned for 30 years. In 1968, Fannie Mae was privatized, to remove it from the federal balance sheet (and thereby lower the apparent amount of debt carried by the federal government). In 1970, Freddie Mac was created as a private entity whose mission was essentially the same as Fannie Mae's, in order to compete against Fannie Mae. (This was an early sub silentio admission that private mortgage lenders couldn't effectively compete against Fannie.) While these two behemoths were not explicitly included in the federal government's balance sheet, it had to continue backing them up, if only because the market believed it would. Thus, Fannie and Freddie always existed to serve governmental policies and have always been liabilities of the government, regardless of what did or did not appear on the federal balance sheet. The 2008 bailouts and takeovers of Fannie and Freddie only reinforce this reality.
We can't take the federal out of Fannie and Freddie. So we should take the private for profit interests out of them. Doing so would rationalize the way they operate. They'd no longer have the incentive to dominate the mortgage markets in order to pump up their revenues and balance sheets to satisfy the demands of shareholders for ever increasing share prices. Their executives would no longer obtain pecuniary benefits from using aggressive accounting to boost bonuses and stock prices, as was the case in the late 1990s and early 2000s. Nor would they hire droves of expensive and influential lobbyists to protect their franchises from both private sector competition and prudent federal regulation. Shareholders would not profit while taxpayers bore losses.
Fannie and Freddie should be reorganized as nonprofit entities, similar to the Federal Reserve Banks. Mortgage lenders that want to do business with Fannie and Freddie would become members and would capitalize them, like the member banks of the Federal Reserve system. Their boards should have a majority of public members. Current shareholders should be bought out at prices reflecting the ocean of losses the Fannie and Freddie have inflicted on taxpayers.
Such a structure would not impede the flow of capital into the housing markets. Indeed, by making federal backing for Fannie/Freddie underwritten mortgage-backed securities all the more clear, capital would flow more readily. For a point of comparison, look how easily capital flows into U.S. Treasury securities, notwithstanding their very low interest rates.
By removing private profit-seeking interests from Fannie and Freddie, we restore to public control entities that exist primarily to serve public interests. The 30-year mortgage is a creature of government policy--before Fannie, mortgages tended to be in the range of five years, with a 50% downpayment. Fannie was created specifically to make the 30-year mortgage available, and the arguments for continuing federal participation in Fannie and Freddie revolve around the need to ensure the availability of inexpensive 30-year mortgages. While public ownership and control aren't panaceas--it's easy to think of public programs that have been screwed up--the opportunities for private profit made the problems at Fannie and Freddie much larger than they would have otherwise been.
The federal government, through Fannie and Freddie, the FHA, Ginnie Mae, tax deductions and credits, Federal Reserve purchases of mortgage-backed securities, and other measures, has staged a enormous, gigantic, gargantuan intervention in the housing markets. America's capital has been steered toward housing and away from other investments. This intervention won't end; indeed, with the current housing slump, it's becoming even more extreme as buyer tax credits extend and expand. The wisdom of public subsidies for housing can and will be debated until the end of the republic, because that's how long they'll exist. But we can at least eliminate the potential for private profit at taxpayer risk--and the increased distortion of the mortgage markets it can create--and restore what has always been a public policy to public status.
This is weird. The problems at Fannie and Freddie stem to a large degree from their mixed private-public nature. They ostensibly were privatized, but investors assumed that they were implicitly backed by the government. Fannie and Freddie took undue advantage of that assumption and seized a very large part of the mortgage market. They had a competitive advantage from their presumed implicit government protection, and could outcompete truly private mortgage lenders. They used some of their copious profits to hire the biggest lobbying guns in Washington to stave off meaningful regulation and effective private sector competition. By becoming so large with the benefit of a presumed government safety net, they made it unavoidable that the government provide them with a safety net. Yet the profits from their salad days went to their private shareholders and high level executives. Taxpayers only got to hold a bag with some really stinky stuff in it, while their homes sank in value.
Since the 1930s, promotion of home ownership has been a federal policy. Fannie Mae was created in 1938 as a federal mortgage financier, and was publicly owned for 30 years. In 1968, Fannie Mae was privatized, to remove it from the federal balance sheet (and thereby lower the apparent amount of debt carried by the federal government). In 1970, Freddie Mac was created as a private entity whose mission was essentially the same as Fannie Mae's, in order to compete against Fannie Mae. (This was an early sub silentio admission that private mortgage lenders couldn't effectively compete against Fannie.) While these two behemoths were not explicitly included in the federal government's balance sheet, it had to continue backing them up, if only because the market believed it would. Thus, Fannie and Freddie always existed to serve governmental policies and have always been liabilities of the government, regardless of what did or did not appear on the federal balance sheet. The 2008 bailouts and takeovers of Fannie and Freddie only reinforce this reality.
We can't take the federal out of Fannie and Freddie. So we should take the private for profit interests out of them. Doing so would rationalize the way they operate. They'd no longer have the incentive to dominate the mortgage markets in order to pump up their revenues and balance sheets to satisfy the demands of shareholders for ever increasing share prices. Their executives would no longer obtain pecuniary benefits from using aggressive accounting to boost bonuses and stock prices, as was the case in the late 1990s and early 2000s. Nor would they hire droves of expensive and influential lobbyists to protect their franchises from both private sector competition and prudent federal regulation. Shareholders would not profit while taxpayers bore losses.
Fannie and Freddie should be reorganized as nonprofit entities, similar to the Federal Reserve Banks. Mortgage lenders that want to do business with Fannie and Freddie would become members and would capitalize them, like the member banks of the Federal Reserve system. Their boards should have a majority of public members. Current shareholders should be bought out at prices reflecting the ocean of losses the Fannie and Freddie have inflicted on taxpayers.
Such a structure would not impede the flow of capital into the housing markets. Indeed, by making federal backing for Fannie/Freddie underwritten mortgage-backed securities all the more clear, capital would flow more readily. For a point of comparison, look how easily capital flows into U.S. Treasury securities, notwithstanding their very low interest rates.
By removing private profit-seeking interests from Fannie and Freddie, we restore to public control entities that exist primarily to serve public interests. The 30-year mortgage is a creature of government policy--before Fannie, mortgages tended to be in the range of five years, with a 50% downpayment. Fannie was created specifically to make the 30-year mortgage available, and the arguments for continuing federal participation in Fannie and Freddie revolve around the need to ensure the availability of inexpensive 30-year mortgages. While public ownership and control aren't panaceas--it's easy to think of public programs that have been screwed up--the opportunities for private profit made the problems at Fannie and Freddie much larger than they would have otherwise been.
The federal government, through Fannie and Freddie, the FHA, Ginnie Mae, tax deductions and credits, Federal Reserve purchases of mortgage-backed securities, and other measures, has staged a enormous, gigantic, gargantuan intervention in the housing markets. America's capital has been steered toward housing and away from other investments. This intervention won't end; indeed, with the current housing slump, it's becoming even more extreme as buyer tax credits extend and expand. The wisdom of public subsidies for housing can and will be debated until the end of the republic, because that's how long they'll exist. But we can at least eliminate the potential for private profit at taxpayer risk--and the increased distortion of the mortgage markets it can create--and restore what has always been a public policy to public status.
Thursday, July 24, 2008
Is the Federal Bailout of Fannie and Freddie Too Clever?
Today, July 24, 2008, the Dow Jones Industrial Average fell 283 points. Fannie Mae stock dropped almost 20% and Freddie Mac stock fell more than 18%. The financial press attributed the stock market's swoon to bad news on the housing and unemployment fronts.
The downturn in Fannie's and Freddie's stock wasn't supposed to happen. Late last week, the Bush 43 administration announced with great fanfare policies to prop up Fannie and Freddie. Prominent among these policies was a proposal that the Treasury Department be given wide discretion to lend to and invest in Fannie and Freddie as much as it wanted on whatever terms it considered appropriate. The announcement of the bailout plan sent Fannie's and Freddie's stock, along with bank stocks, bounding upwards. It appeared that the administration meant to protect not only Fannie's and Freddie's creditors, but their stockholders as well. Who wouldn't buy a stock that has government protection?
But this plan may have been too clever by half. The idea is that by supporting Fannie's and Freddie's stock prices, the two companies would be able to raise capital by issuing more equity, which would absorb the mortgage losses that we all know are coming. The cost to the taxpayers would supposedly be relatively small because taxpayer dollars would only provide support while private equity would do the heavy lifting (and take the big hits). Presumably, private equity would get greater profit potential to compensate it for taking the risks of the big hits.
The problem, though, is that we all know the big hits are coming. Estimates of the losses from the mortgage mess and credit crunch tend to run over $1 trillion, and have gone as high as $2 trillion. Most of these losses haven't been realized yet. Fannie and Freddie, who either hold or underwrote about half of all mortgages issued in the U.S., have some serious exposure. It won't be a small number. Many tens of billions seem almost a certainty. Over $100 billion wouldn't be surprising.
Private, often foreign, investors have done poorly investing in mortgage-bedeviled banks over the past year. Many of the major banks are looking for more capital as the flood of write downs continues. The foreign investment funds that got burned the first time around may be just a wee bit hesitant to step forward and accept Treasury's invitation to take a bullet for Fannie or Freddie. It's one thing to invest with the risk of further losses. It's another when further losses are a virtual certainty. At some point, when the mortgage and credit crunch losses loom large enough, the Euro, yuan, rupee, won, baht, yen and so on begin to look like better bets than the dollar.
If private investors shy away from providing fresh equity to Fannie and Freddie, the Treasury Department's plan could be in serious trouble. The Congressional Budget Office estimated the likely cost to taxpayers of the Fannie and Freddie bailout at $25 billion. But this seems low, especially considering that the Treasury Department requested that the borrowing it did to bail out Fannie and Freddie not count against the federal government's debt ceiling. The debt ceiling is currently $9.815 trillion, with $9.5 trillion in debt outstanding. If the cost of bailing out Fannie and Freddie could so seriously implicate this ceiling that Treasury wants it excluded, that would mean that the current buffer of $315 billion probably isn't enough. Not a good sign.
Private investors might indeed refrain from investing in Fannie and Freddie even with Treasury warming up in the bullpen. Perhaps the stock market figured this out, and decided that discretion would be the better part of valor. That would explain the sharp dropoff in financial stocks today.
The baseline problem for the current financial crisis is that a shipload of losses remain to be recognized. These losses were created by the reckless and downright stupid lending done in the Fed-fueled credit bubble. The crisis won't pass until the losses are booked. One way of doing this would be to create a new mortgage agency, which could implement federal policy with a clean slate and no pile of liabilities that may be known or unknown. Fannie and Freddie could be gradually liquidated, with their stockholders, bondholders and other creditors taking losses that would be appropriate to their standing in the companies' capital structures.
Treasury's current approach of throwing taxpayer dollars at these losses is reminiscent of the mistakes Japan made in the 1990s, trying to squirm its way out of its stock market and real estate bubbles. Among its policies were government subsidies to failing banks and businesses that were called "zombie businesses." The Japanese economy stagnated, and then stagnated some more, only to continue stagnating, even to this day. The Japanese finally figured out what they had to do and booked their losses. But they took so long to do it (and wasted so much national wealth subsidizing zombie businesses) that they still are going sideways economically speaking.
We can learn from Japan's mistakes. But that would require putting expediency aside and doing the right thing. In Washington, especially in an election year, that's definitely not something to bet on.
The downturn in Fannie's and Freddie's stock wasn't supposed to happen. Late last week, the Bush 43 administration announced with great fanfare policies to prop up Fannie and Freddie. Prominent among these policies was a proposal that the Treasury Department be given wide discretion to lend to and invest in Fannie and Freddie as much as it wanted on whatever terms it considered appropriate. The announcement of the bailout plan sent Fannie's and Freddie's stock, along with bank stocks, bounding upwards. It appeared that the administration meant to protect not only Fannie's and Freddie's creditors, but their stockholders as well. Who wouldn't buy a stock that has government protection?
But this plan may have been too clever by half. The idea is that by supporting Fannie's and Freddie's stock prices, the two companies would be able to raise capital by issuing more equity, which would absorb the mortgage losses that we all know are coming. The cost to the taxpayers would supposedly be relatively small because taxpayer dollars would only provide support while private equity would do the heavy lifting (and take the big hits). Presumably, private equity would get greater profit potential to compensate it for taking the risks of the big hits.
The problem, though, is that we all know the big hits are coming. Estimates of the losses from the mortgage mess and credit crunch tend to run over $1 trillion, and have gone as high as $2 trillion. Most of these losses haven't been realized yet. Fannie and Freddie, who either hold or underwrote about half of all mortgages issued in the U.S., have some serious exposure. It won't be a small number. Many tens of billions seem almost a certainty. Over $100 billion wouldn't be surprising.
Private, often foreign, investors have done poorly investing in mortgage-bedeviled banks over the past year. Many of the major banks are looking for more capital as the flood of write downs continues. The foreign investment funds that got burned the first time around may be just a wee bit hesitant to step forward and accept Treasury's invitation to take a bullet for Fannie or Freddie. It's one thing to invest with the risk of further losses. It's another when further losses are a virtual certainty. At some point, when the mortgage and credit crunch losses loom large enough, the Euro, yuan, rupee, won, baht, yen and so on begin to look like better bets than the dollar.
If private investors shy away from providing fresh equity to Fannie and Freddie, the Treasury Department's plan could be in serious trouble. The Congressional Budget Office estimated the likely cost to taxpayers of the Fannie and Freddie bailout at $25 billion. But this seems low, especially considering that the Treasury Department requested that the borrowing it did to bail out Fannie and Freddie not count against the federal government's debt ceiling. The debt ceiling is currently $9.815 trillion, with $9.5 trillion in debt outstanding. If the cost of bailing out Fannie and Freddie could so seriously implicate this ceiling that Treasury wants it excluded, that would mean that the current buffer of $315 billion probably isn't enough. Not a good sign.
Private investors might indeed refrain from investing in Fannie and Freddie even with Treasury warming up in the bullpen. Perhaps the stock market figured this out, and decided that discretion would be the better part of valor. That would explain the sharp dropoff in financial stocks today.
The baseline problem for the current financial crisis is that a shipload of losses remain to be recognized. These losses were created by the reckless and downright stupid lending done in the Fed-fueled credit bubble. The crisis won't pass until the losses are booked. One way of doing this would be to create a new mortgage agency, which could implement federal policy with a clean slate and no pile of liabilities that may be known or unknown. Fannie and Freddie could be gradually liquidated, with their stockholders, bondholders and other creditors taking losses that would be appropriate to their standing in the companies' capital structures.
Treasury's current approach of throwing taxpayer dollars at these losses is reminiscent of the mistakes Japan made in the 1990s, trying to squirm its way out of its stock market and real estate bubbles. Among its policies were government subsidies to failing banks and businesses that were called "zombie businesses." The Japanese economy stagnated, and then stagnated some more, only to continue stagnating, even to this day. The Japanese finally figured out what they had to do and booked their losses. But they took so long to do it (and wasted so much national wealth subsidizing zombie businesses) that they still are going sideways economically speaking.
We can learn from Japan's mistakes. But that would require putting expediency aside and doing the right thing. In Washington, especially in an election year, that's definitely not something to bet on.
Sunday, July 13, 2008
A Fair Bailout for Fannie and Freddie: Create a New Mortgage Agency
The Bush administration is once again winging its way through a financial crisis, this time trying to keep Fannie Mae and Freddie Mac on their feet. The Fed has announced that it's given the Federal Reserve Bank of New York the authority to make loans to Fannie and Freddie. The Treasury Department has announced a plan to seek authorization from Congress to increase the credit line Fannie and Freddie have with the Treasury Department (currently at $2.25 billion, lunch money in today's mortgage markets), give Treasury the authority to make equity investments in Fannie and Freddie, and give the Fed greater regulatory authority over Fannie and Freddie.
These proposals look like more rubber bands and chewing gum. The Treasury Department plan is just a proposal. Treasury currently has no authority to do anything except lend Fannie and Freddie $2.25 billion, which may be enough to keep them going for a day or two. The Fed's loan authorization is a tad misleading. It says that the loans will be collateralized by "U.S. government and federal agency securities." How much in the way of U.S. Treasury bills and notes do we think Fannie and Freddie hold? Not much, we'd guess. But if Fannie and Freddie submit agency securities as collateral to the Fed, those securities could be obligations of Fannie and Freddie (which are among the biggest issuers of agency securities). In other words, such collateral would be impaired in value, just like Fannie and Freddie. That's a great deal for Fannie and Freddie, but the taxpayers may be getting yet another stick in the eye from the bailout boys of the Bush administration.
The Fed's loan authority may be enough to keep Fannie and Freddie afloat for the near term. But that would likely be at the expense of more socializing risk while privatizing rewards for wealthy people.
The Treasury Department's plan is aimed at working with Fannie and Freddie as they now exist. That seems more expedient than sensible. Fannie and Freddie's financial conditions remain unclear years after accounting scandals left them unable for a number of quarters to report their financial condition. They've also sent hundreds of billions of dollars worth (or more) of mortgages into special purpose entities, investment vehicles that for accounting purposes are supposed to be separate from Fannie and Freddie. But these vehicles are cousins of the SIVs and conduits that bedeviled banks, and which some banks eventually had to bring onto their balance sheets at great cost. Will Fannie and Freddie have to take on some undisclosed liabilities from these special purpose entities? If so, how many billions are we talking about?
The truth is that Fannie and Freddie are pigs in a poke. The taxpayers shouldn't have to bail them out or prop them up any more than absolutely necessary to prevent a collapse of the financial system. But Fannie's and Freddie's shareholders should have to take their lumps (taxpayers shouldn't protect the value of private equity investments). And Fannie's and Freddie's creditors should have to assume the credit risk that can fairly be laid on them for lending to such severely undercapitalized and mismanaged institutions. In other words, they should take their fair share of losses.
The people who really deserve a bailout here are America's future homeowners, the ones that Fannie and Freddie are supposed to be helping. If they have to borrow through mortgages bought by Fannie or Freddie, the interest rate they'd pay would be elevated because creditors would demand greater returns on account of Fannie's and Freddie's past miscalculations, shenanigans and mismanagement. Why should a young family, starting out, in Indiana, Mississippi or Oregon, have to pay higher interest rates because Fannie or Freddie messed up?
The best thing for the future would be a new mortgage agency, one that starts with a clean slate: new management, prudential lending standards, clean accounting process, no undisclosed liabilities from special purpose entities overhanging the picture, and no loss of credibility with investors. Fannie and Freddie have botched things up badly, and in a free enterprise system, those who botch things up should pay the price. Of course, this proposal is just a pipe dream. If anyone in Congress or the administration actually seriously pushed this idea, Fannie and Freddie would roll out their lobbying juggernauts and quash any attempt to give taxpayers and new homeowners a square deal. After all, in Washington, insiders always win.
These proposals look like more rubber bands and chewing gum. The Treasury Department plan is just a proposal. Treasury currently has no authority to do anything except lend Fannie and Freddie $2.25 billion, which may be enough to keep them going for a day or two. The Fed's loan authorization is a tad misleading. It says that the loans will be collateralized by "U.S. government and federal agency securities." How much in the way of U.S. Treasury bills and notes do we think Fannie and Freddie hold? Not much, we'd guess. But if Fannie and Freddie submit agency securities as collateral to the Fed, those securities could be obligations of Fannie and Freddie (which are among the biggest issuers of agency securities). In other words, such collateral would be impaired in value, just like Fannie and Freddie. That's a great deal for Fannie and Freddie, but the taxpayers may be getting yet another stick in the eye from the bailout boys of the Bush administration.
The Fed's loan authority may be enough to keep Fannie and Freddie afloat for the near term. But that would likely be at the expense of more socializing risk while privatizing rewards for wealthy people.
The Treasury Department's plan is aimed at working with Fannie and Freddie as they now exist. That seems more expedient than sensible. Fannie and Freddie's financial conditions remain unclear years after accounting scandals left them unable for a number of quarters to report their financial condition. They've also sent hundreds of billions of dollars worth (or more) of mortgages into special purpose entities, investment vehicles that for accounting purposes are supposed to be separate from Fannie and Freddie. But these vehicles are cousins of the SIVs and conduits that bedeviled banks, and which some banks eventually had to bring onto their balance sheets at great cost. Will Fannie and Freddie have to take on some undisclosed liabilities from these special purpose entities? If so, how many billions are we talking about?
The truth is that Fannie and Freddie are pigs in a poke. The taxpayers shouldn't have to bail them out or prop them up any more than absolutely necessary to prevent a collapse of the financial system. But Fannie's and Freddie's shareholders should have to take their lumps (taxpayers shouldn't protect the value of private equity investments). And Fannie's and Freddie's creditors should have to assume the credit risk that can fairly be laid on them for lending to such severely undercapitalized and mismanaged institutions. In other words, they should take their fair share of losses.
The people who really deserve a bailout here are America's future homeowners, the ones that Fannie and Freddie are supposed to be helping. If they have to borrow through mortgages bought by Fannie or Freddie, the interest rate they'd pay would be elevated because creditors would demand greater returns on account of Fannie's and Freddie's past miscalculations, shenanigans and mismanagement. Why should a young family, starting out, in Indiana, Mississippi or Oregon, have to pay higher interest rates because Fannie or Freddie messed up?
The best thing for the future would be a new mortgage agency, one that starts with a clean slate: new management, prudential lending standards, clean accounting process, no undisclosed liabilities from special purpose entities overhanging the picture, and no loss of credibility with investors. Fannie and Freddie have botched things up badly, and in a free enterprise system, those who botch things up should pay the price. Of course, this proposal is just a pipe dream. If anyone in Congress or the administration actually seriously pushed this idea, Fannie and Freddie would roll out their lobbying juggernauts and quash any attempt to give taxpayers and new homeowners a square deal. After all, in Washington, insiders always win.
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