Fannie And Freddie

The rumors were true, and Fannie and Freddie are getting the bailout treatment.

The Bush administration yesterday prepared to take over the troubled housing finance companies Fannie Mae and Freddie Mac, after concluding the companies don't have enough capital to continue to play their crucial role funding home mortgages.

Under the plan, engineered by Treasury Secretary Henry M. Paulson Jr., the government would place the two companies under "conservatorship," a legal status akin to Chapter 11 bankruptcy. Their boards and chief executives would be fired and a government agency, the Federal Housing Finance Agency, would appoint new chief executives.

The action, which would be one of the most sweeping government interventions in private financial markets in decades, is planned for today, according to several sources.

These GSE's, these hybrid private-public entities, aren't bound to be successful anyway in an economic downturn or sector-wide collapse, because they remove the element of risk and organically move toward a bailout. You can either nationalize or privatize, the blend doesn't work. This is not about saving Fannie and Freddie but saving the banks that hold all these Fannie and Freddie-issued bonds.

Ian Welsh is someone I look to on these issues. Here he is:

From a public policy point of view this is a bad way of doing something that's necessary. There's no particular reason why preferred shareholders shouldn't be wiped out along with common shareholders - owners of companies that go belly up should lose everything. Likewise, men like Pimco's Bill Gross made big bets by piling into Freddie and Fannie's debt in the expectation of a government bailout, when they knew that the debt was bad if the government didn't bail Freddie and Fannie out, and they are going to win those bets. Again, when normal companies go belly up, debtors don't get all their money up and one shouldn't be rewarding men who deliberately bought debt they knew was bad. Going into conservatorship is the equivalent of going belly up. Bondholders should take a haircut—they shouldn't lose everything, but they should certainly lose whatever they would have lost if Freddie and Fannie had been allowed to go bankrupt like normal companies. To not do so is a clear case of moral risk; a clear case of bailing investors out of their own bad decisions; and a clear case of shifting money from taxpayers to private interests [...]

Freddie and Fannie had to be bailed out, don't get me wrong, but this is about the worst way of doing it if your idea was to avoid moral risk and to protect the taxpayer's pocketbook, rather than those of investors.

It's really about where we go from here. A nationalized agency that encourages homeownership, maybe underwriting loans with clear restrictions and guidelines, isn't necessarily a bad thing, at first blush. But let's not stray from the fact that free-market, unregulated capitalism failed in this regard, and failed miserably. Some Republican flaks are trying to pin this on the Democrats, but deregulation in the markets led to the sector-wide housing failure, and they have to own that.