Fanning the Fannie/Freddie flames
Noting the housing bill that House and Senate negotiators were rushing to complete last week, my colleague and intellectual superior Tim Cavanaugh asked in a recent post why taxpayers should foot the bill for bailing out Fannie Mae and Freddie Mac. President Bush signed the measure this morning, so there's no turning back now. But I thought I'd try to answer Tim by saying he asked the wrong question.
Fannie and Freddie were created by Washington to serve a mission dictated by Washington with policies largely dictated by Washington. They operated with the implicit backing of the federal government. It's wildly unrealistic to think that either institution could run into financial trouble without the feds rushing to the rescue. So when Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke announced their proposal to extend bigger credit lines to the companies and possibly buy some of their shares, they were merely making explicit a promise long understood by investors (and policymakers).
Rather than debating the merits of propping up Fannie and Freddie, we're better off figuring out how to get them through the downturn intact. Then we can debate what role they should play, if any, in the future. The panicky run on their shares reflect investors' fear of dilution (as Fannie and Freddie sell huge numbers of shares to raise capital) or nationalization (in the event of a government rescue) more than any worries about insolvency. Yes, their capital reserves are low in comparison to their exposure. Yet it would take a huge wave of foreclosures to burn through those funds. By stopping the run on the companies' stocks, the actions by Treasury, the Fed and Congress should make it easier for them to raise more capital and gird against larger losses. Oh and yes, the bill includes important and overdue improvements in the feds' oversight of Fannie and Freddie.
So, Tim, as much as I'd like your every wish to come true, I don't think we're watching "the U.S. government commit collective suicide." Well, not on this issue, at least. But the housing mess hasn't hit bottom yet, and Congress just raised the FHA's potential exposure by hundreds of billions of dollars. So don't give up hope.
Photo courtesy of AP/Manuel Balce Ceneta
Jon,
You wrote, "Oh and yes, the bill includes important and overdue improvements in the feds' oversight of Fannie and Freddie", but you neglected to mention that Majority Leader Harry Reid refused to allow a vote on Republican Jim DeMint's amendment to bar political donations and lobbying by Fannie and Freddie's political action committees, which have already donated roughly $800,000 to U.S. House and Senate Members this election cycle. That figure does not include the grant and charity money funnelled to ACORN and other Democratic party front groups. (BTW, when will any MSM organization do a story on ACORN?). Also, my understanding is that plans for future regulation and insulation from political meddling have yet to be decided.
Before Arnold Schwarzenegger took over the California governorship from Gray Davis and made some modest reforms, the Workers Compensationsation system here in California charged the highest employer premiums in the country and paid out almost the lowest benefits to workers. That was because the system was not designed to benefit workers. The system was designed to benefit workers comp attorneys and chiropractors who happened to be among the largest donors to Democratic state legislators. The legislators who benefitted from this arrangement defended the system against any attempt to impose cost controls by citing the plight of injured workers.
I mention all this because Fannie Mae and Freddie Mac work the same way. Studies have shown that they are not effective at achieving their ostensible purpose of making housing more affordable. They have simply become vehicles for laundering government tax dollars to Democratic politicians, former office-holders like Jamie Gorelick (famous for "The Wall" that prevented inter-agency cooperation against terrorism threats) and front groups like ACORN. None of this information has or will find its way into the LAT coverage of the issue. Instead, the Times coverage has repeatedly hinted that the debacle points to a failure of the free market and the need for more government involvement in running the economy.
Posted by: Aldo | July 31, 2008 at 08:55 AM
Hey, thanks for the comments. Jeff, I'll own up to soft-pedaling how deep the muck is in the housing market. But as this analysis (http://knowledge.wpcarey.asu.edu/article.cfm?articleid=1644) from a couple of Arizona State professors shows, Fannie and Freddie are actually in better shape than the mortgage market as a whole. Here's the money graf:
"As of April, Sanders said, the rate of serious delinquencies on loans held by Freddie Mac was 0.81 percent. Fannie Mae's rate of serious delinquencies was 1.15 percent. Those rates compare to market-wide rates of serious delinquency of 1.47 percent for prime mortgages, 8.35 percent for Alt-A mortgages, and 20.74 percent for subprime mortgages."
I also think your estimate of Fannie's ability to withstand losses is excessively grim. According to Mark Zandi of Economy.com, Fannie and Freddie had combined capital of $80 billion. If all of those delinquencies have to be written off completely, with zero recovery, that would cost $40 to $50 billion. But zero recovery is unlikely, 'cause reposessed homes still have value. In other words, things are bad at Fannie and Freddie but not apocalyptic, IMHO. Clip 'n' save this post so you can mock me authoritatively in a year if Fannie and/or Freddie bite the dust.
Posted by: Jon Healey | July 30, 2008 at 10:19 PM
Wrong.
Fannie and Freddie are already insolvent, as many, including Barron's and Bloomberg, have pointed out.
Any further dividends paid to shareholders are theft from the taxpayers.
The shareholders should be zeroed out and Treasury should buy back Fannie and Freddie bonds at a huge discount.
Posted by: W.C. Varones | July 30, 2008 at 09:30 PM
For the free market to work efficiently, the market must be allowed to work. I had not thought that Bush and Congress could make a bigger error than the debacle in Iraq. However, not allowing banks and companies to fail, is why people talk about moral hazards. I believe with lots of evidence from thousands of examples that when the government steps in to "help" an inefficient company that the cure is worse than the disease. Fannie and Freddie will eventually fail, and because the new rules allow them to get even BIGGER AND to continue to make stupid loans, such that the failure next time will be even more devastating to the economy.....if we get to next time.
Let companies and banks fail. Let recessions happen. Not letting them fail or happen has gotten us to where we are today, i.e. on the verge of a depression.
To quote a popular pundit: "We are freaking doomed." And thanks to Bush and Congress, we are going to be REALLY REALLY doomed. To top all of this off, we are saving a rich company and its management. The bill will do VERY little for the 400,000 people who have bad loans, primarily because of too easy credit from the Fed...instituted the last time we should have had a recession as part of a normal business cycle, in order to prevent the recession. This will just make the next boom and bust, that MUCH worse the next time. We need to stop this nonsense and let the market clear out the bad decisions in the economic down times. To add insult to injury, the people who were saving to buy a house with 10-20% down will now not get a chance to buy a cheaper house and most of the country would say, reasonably priced house. So the people with houses will have their property values temporarily protected, and the people without houses will be hesitant to buy a house. And obviously rightly so. It is silly to think that a $7500 tax credit is going to make ANY difference. The folks in DC must think we are fools to think that this bill is for anyone other than to help the big banks with all the property-based fancy leveraged upside down credit problems. We will not even get into the clause in the bill that automatically requires credit card companies to report everyone's charges to the IRS!! I am hard pressed to see anything of any positive net long term use for America. God help us all when the bill mounts to a $trillion plus dollars and continues to add more to the national debt. Do you know what will happen when the Fed needs to curb inflation by raising rates above 10% when we will have to pay 10 +% interest on a $10 trillion dollar national debt? I fail to see what Bush and Congress are hoping for. ...perhaps for the tooth fairy or Santa Claus to come to get us out of this mess. Just madness.
Posted by: DenisL | July 30, 2008 at 07:47 PM
Jon, your comments belie a miscomprehension of the magnitude of the problem. You write, "... it would take a huge wave of foreclosures to burn through those funds." Do you realize that Fannie Mae just announced their seriously delinquent loans as of the end of May were $39 billion, up $2.7 billion from April? Against this Fannie Mae has reserved $5 billion. The huge wave is here and will be a large multiple of what you, and Fannie and Freddie managements, are pretending will not occur. Tim's right on this one.
Posted by: Jeff Saye | July 30, 2008 at 07:34 PM