Time for Freddie and Fannie to go on a diet
By DAVID NICKLAUS
A few fearmongers have predicted that the mortgage-related credit crunch of the last year might degenerate into a 1929-style financial debacle.
The collapse of Bear Stearns wasn’t enough to make that happen. Nor was the closing of IndyMac Bancorp, the second-largest bank failure in U.S. history. The erosion of confidence in mortgage giants Fannie Mae and Freddie Mac, though, truly had the potential to take down a big chunk of our financial system.
If those companies had been unable to honor their debts, comparisons to 1929 would have been on the tips of everyone’s tongues. “What would have happened, if they couldn’t honor their obligations, is that thousands of banks around the world, and other financial intermediaries, would have had their capital wiped out,” said Peter J. Wallison, a fellow at the American Enterprise Institute. “A lot of this capital consists of Fannie and Freddie securities.”
It’s precisely such a doomsday scenario that Henry Paulson and Ben Bernanke were trying to prevent when they unveiled their extraordinary plan to give the mortgage giants a government line of credit, and possibly even allow the government to make an equity investment in Fannie and Freddie.
Uncle Sam
Such an open-ended commitment would be unthinkable for any other private company. Fannie and Freddie, though, have always had a special relationship with Uncle Sam.
Fannie, in fact, was a government agency before being privatized in 1968. Freddie was created in 1970 to give it a bit of competition. Among other privileges, the companies don’t pay state and local taxes and don’t have to register with the Securities and Exchange Commission. The big secret to their success was this: The market was allowed to presume that, in a pinch, the government would stand behind the companies’ billions of dollars in debt.
The promise was always vague — until now. The loss of confidence in these two giants was so swift and so complete that Paulson, the Treasury secretary, and Bernanke, the Federal Reserve chairman, had to list chapter and verse on how far they’d go to keep Fannie and Freddie afloat.
It worked, Wallison said. “As long as the U.S. is seen as backing their debt, the markets will continue to feed money to them so they can continue to operate. Fannie and Freddie have, in effect, been rescued at this point.”
The rescue work isn’t over yet. Some of Paulson’s and Bernanke’s promises will require congressional action, so we can expect hearings soon on a bailout bill.
Fannie and Freddie employ armies of lobbyists and usually get their way on Capitol Hill, but Congress should use this opportunity to ask some tough, basic questions.
Do we need these government-sponsored enterprises anymore? Or could we wind them down and lessen the risk for future taxpayers?
Some scholars believe mortgages would be slightly more expensive if Fannie and Freddie were to vanish. Wallison disputes that. In the absence of a government-sponsored duopoly, he believes, competing private firms would find ways to drive down the cost of issuing mortgages.
Rotting industry
Even if you don’t buy into his free-market thinking, it’s obvious that something is rotten in this industry.
Because of their implicit taxpayer guarantee, Fannie and Freddie were able to grow larger, with less capital, than any private banker would have thought prudent.
If Congress isn’t willing to privatize these out-of-control giants, it at least needs to bring them down to size.
X David Nicklaus is a columnist for the St. Louis Post-Dispatch. Distributed by McClatchy-Tribune Information Services.