Failure to heed warnings brings disastrous results

Failure to heed warnings brings disastrous results

The most frightening possibility about the federal government’s bailout of Fannie Mae and Freddie Mac, the largest holders of mortgages in the United States, is that even after the federal government invests tens of billions of dollars in shoring the companies up, it won’t be enough.

It may not be enough to calm the jitters of huge foreign investors. It may not be enough to stop the slide in home values or head off tens of thousands of additional foreclosures.

Certainly the bailout won’t do anything to protect the private investors who stand to lose tens of billions of dollars in what was once equity in Fannie Mae and Freddie Mac. And while, correctly, it is not the government’s job to protect private investors from losses on risky ventures, those private investors could include almost anyone with a 401-K, a defined pension plan or sizeable mutual fund holdings.

Time to hold breath

The government obviously timed Treasury Secretary Henry Paulson’s announcement of the takeover over the weekend so as to give big investors at least a little more time to digest the implications of a monumental financial development. As Paulson said, “Fannie Mae and Freddie Mac are so large and so interwoven in our financial system that a failure of either of them would cause great turmoil in our financial markets here at home and around the globe.”

There may yet be turmoil in the domestic and global financial markets, which were not open as this was being written.

In the short term, the government will have to work to assure those markets that this bailout is going to do what it was intended to do — restore confidence. That requires President Bush, the leaders of Congress and the presidential candidates for both political parties to speak honestly about what has happened and convincingly about what they are going to do next.

In the longer term, there will be an important debate over the level of oversight government should have over those institutions that are recognized as “too big to fail.” They not only include mortgage lenders, banks and insurance companies, but some of our largest and oldest industrial giants that are sitting on trillions of dollars in retirement and promised health care liabilities.

Part of a pattern

Just 10 days ago, we decried in this space the tendency of the American people in general and our leaders in politics and business specifically to focus on danger, even when the danger is pointed out and when the potential damage is near catastrophic.

The collapse of Fannie Mae and Freddie Mac are two more examples of the same phenomenon.

The New York Times reported a month ago that the chief executive of Freddie Mac, Richard F. Syron, ignored internal warnings in 2004 from his own chief risk officer that the company was financing questionable loans that threatened its financial health.

Syron rejected advice that the company become more conservative, arguably because he was pursuing short term returns that brought shareholder approval at the risk of long-term survivability. Today, Syron is out (we can only hope without a golden parachute) and the shareholders are left with worthless paper.

And President Bush and other leaders are left with the monumental task of rebuilding investor confidence, figuring out how to finance this latest bailout and protecting the dollar from further erosion of its value.