Monday, July 14, 2008

Fannie Mae and Freddie Mac

The Federal Reserve and the Treasury announced steps Sunday to shore up mortgage giants Fannie Mae and Freddie Mac. The steps are intended to send a signal to nervous investors worldwide that the government is prepared to take all necessary steps to prevent the credit market troubles from engulfing financial markets and further weakening the economy and housing markets.

In a well-written piece in today's WSJ, Peter. J. Wallison states:
If Fannie Mae and Freddie Mac were ordinary corporations, the sudden collapse of investor confidence last week would have set them to work on their bankruptcy applications. But they are not ordinary corporations -- and they are likely to survive because their debt securities have been viewed for decades as ultimately backed by the U.S. government. Barring the unlikely event of a credit market loss of confidence in the U.S. government itself, they should be able to attract the necessary financing for continued operations.
Fannie Mae and Freddie Mac hold $5.3 trillion in liabilities (out of $11.3 trillion total outstanding) They have lines of credit, at least they did, of $2.25 billion each.

Whereas I see the value of the premise behind these social institution, it questions why these government-sponsored enterprises (GSEs), chartered by Congress, should also be allowed to sell equity. GSEs, almost by definition, imply government backing. So with that type of backing, investor risk is not traditional. You'll never lose it all because the government will back the GSE in a crisis.

It was a foregone conclusion that the federal government would come to the rescue, but at what cost to the taxpayer and the US and global economies? With those dollar amounts, Fannie and Freddie liabilities are present in most major investment portfolios all over the world. The problem becomes exacerbated with the declining dollar, because so many national economies are dollar-based.

While Fannie and Freddie loses are small relative to their entire portfolio, it does not take much to wipe out billions in liquidity.

Fannie and Freddie obviously grew out of control. The government bailed them out. They almost did that same with Bears Stern. They actually want more government regulation within the investment banking industry.

Some safeguards are prudent government but most of the time the federal government socializes an industry, it creates huge, costly bureaucracies and makes all of us more enslaved to bad government.

1 comment:

Anonymous said...

This bailout of Freddie and Fannie is counterproductive. Another congressional initiative, the Mortgage Bailout, will tax Freddie and Fannie to the tune of $530 million/ YEAR. So Congress wants to bail out an institution and tax it as well? What’s going on? Call your senators/representatives and tell them: Back off the Mortgage Bailout Bill and Back off Bailing out Fannie and Freddie Mac!
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