Finance And Fear

July 18, 2008

Congressional action to assist mortgage giants Fannie Mae and Freddie Mac, and the failure of California bank IndyMac, gave bloggers plenty of targets this week. A sampling of the commentary:

Q.: What's your diagnosis of what happened to Fannie Mae and Freddie Mac?

A.: First of all, they had too little capital to withstand adverse circumstances. And the adverse circumstances were the severe downturn in housing, the decline in house prices, and the rising default rate on mortgages. I don't know of anyone who early enough was saying that there would be a major national decline in house prices, so I can't hold them to that standard, but I can hold them to a standard of holding adequate capital to be able to withstand unforeseen circumstances. That's what capital is for.

- William Poole, former president of the Federal Reserve Bank of St. Louis, on Economists View ( www.uoregon.edu/~mthoma/)

This weekend, Treasury Secretary Henry Paulson, former head of the Goldman Sachs investment house, provided us with a perfect demonstration of Wall Street socialism. He announced that the Bush administration would seek congressional approval to bail out Fannie Mae and Freddie Mac, the government-created but privately owned, profit-making housing finance companies that hold or guarantee nearly half of the U.S. mortgage market - some $5 trillion in debt. Paulson seeks and will get an unlimited line of credit to guarantee their debt, as well as authority to purchase their shares to supplement their capital base.

... These enterprises are operating on our tab now - completely. Why not just nationalize them, as even that font of economic convention, Sebastian Mallaby, suggested in the The Washington Post. Sure, we'd have to add the $5 trillion in debt to the federal balance sheet, but we could add the assets.

- Robert L. Borosage on www.huffingtonpost.com

In the end, it does not appear that the perception of an explicit government guarantee is sustainable (and certainly the government would have no credibility were it to now say, "After this bailout, no more bailouts"). As such, the current Treasury plan should rightly be only a way-station en route to a permanent de-privatization of Fannie and Freddie (or, if you must, nationalization). The government-sponsored enterprise model ultimately proved to be a failed one. Time now to try and minimize public losses, recognizing (again) that regulatory changes will be required once this mess has all sorted itself out.

- GSEs Louise on www.economist.com/blogs/freeexchange

The government is opening the purse strings to prop up Fannie Mae and Freddie Mac, but obituaries may still be in order for the mortgage giants. ... It's hard to argue that the companies could go under tomorrow without a major disruption in the economy. But that doesn't mean they can continue doing business as usual. Major problems, like risk-filled books and tiny capital cushions, are symptomatic of Fannie and Freddie's structure: They're both government-sponsored and publicly traded. And that model looks broken, possibly beyond repair.

- Katie Benner, Fortune Magazine writer, on http://money.cnn.com/2008/07/15/news/

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