The widespread rumors of a government bailout of Fannie Mae and Freddie Mac have already had dramatic consequences, perhaps creating a self-fulfilling prophecy. Iain Dey and Dominic Rushe, writing for The Times of London, note that, “The two companies lost almost half their market value last week as rumours of a government bail-out swept the stock markets, hammering share prices around the world.”
Julie Creswell of the NYT notes that many have seen this coming for years.
Among them is Jim Leach, a Republican former representative from Iowa, who began arguing two decades ago in Congress that the government-chartered mortgage companies, Fannie Mae and Freddie Mac, were unfairly insulated from the real world. They were not subject to the same financial standards and tax burdens as their competitors, he warned, and if they ran into trouble, an implicit government guarantee to back them up meant taxpayers would be left with the losses.
The size of the problem is enormous.
Today they own or guarantee about half of the country’s $12 trillion in mortgage debt, so the free fall of their share prices last week amid concerns that they were undercapitalized has created chaos for Wall Street and Washington.
The dominant role Fannie and Freddie play today is no accident. The companies, Wall Street firms, mortgage bankers, real estate agents and Washington lawmakers have built up an unusual and mutually beneficial co-dependency, helped along by robust lobbying efforts and campaign contributions. In Washington, Fannie and Freddie’s sprawling lobbying machine hired family and friends of politicians in their efforts to quickly sideline any regulations that might slow their growth or invite greater oversight of their business practices. Indeed, their rapid expansion was, at least in part, the result of such artful lobbying over the years. And as Fannie and Freddie grew, so did the fortunes of Wall Street, which reaped rich fees from issuing debt for the two companies, as well as the mortgage and housing industries, which banked billions of dollars as the housing market boomed.
UCLA business law professor Steve Bainbridge has been warning about this for years, too. He points to some analysis from LAT Market Beat columnist Tom Petruno:
[I]t is triggering worries that would have been unthinkable even a year ago — including that the U.S. Treasury’s debt might lose its AAA credit grade because of heavy blows to the nation’s fiscal health from the housing mess.
[…]
Because of their size and importance to the mortgage market, it’s inconceivable that Fannie and Freddie would be allowed to fail. But an outright takeover of the companies by the government, as some experts have suggested, could frighten foreign investors — who are big lenders to the Treasury — by, in effect, adding the companies’ $5-trillion debt load to the Treasury’s massive debt of $9.5 trillion. Nationalizing the companies “would put the full faith and credit of the Treasury at risk,” [Allen] Sinai [of Decision Economics] said. “It would make foreign investors think hard about buying U.S. Treasury debt.”
Bainbridge sees a “worst case scenario” in which “Foreigners abandon the dollar for the euro, dumping treasuries. The collapse of foreign investment in Treasuries makes our massive current account deficit unsustainable. At which point, things really go to pot. “ Uh-oh, indeed.
What’s not clear to me, even in the case of a government absorption of Fannie and Freddie, is why we’d add an additional $5 trillion in “debt” by so doing. Sure, we’d be adding some unknown amount of risk. But, presumably, the overwhelming majority of people will be paying back their home loans. So, isn’t most of that $5 trillion, then, an asset?
