What’s Next for Fannie Mae, Freddie Mac, Mortgage Industry?
Fannie Mae and especially Freddie Mac, the government backed purchasers of most of our country’s mortgages, are believed to be insolvent by many (including St. Louis Fed President William Poole) to be insolvent. Markets continue to punish both organizations this week, bringing FNMA down 76% in the past 12 months, and FHLMC down 83%. They back about $5 trillion or half of the mortgages in the U.S., and it’s widely agreed that they will get bailed out because their failure would lead to the demise of the mortgage market. One WSJ report on FNMA and FHLMC said this:
“They can’t be allowed to fail,” said Peter Wallison, a former Treasury Department general counsel. “The losses would extend through so much of our economy, and so much of the world economy. There is simply no way that the United States government can let it happen.”
And another WSJ report said this:
What Americans need to know is how damaging such a failure would be. This wouldn’t merely be a matter of the Federal Reserve guaranteeing $29 billion in dodgy mortgage paper, a la Bear Stearns. Fannie and Freddie are among the largest financial companies in the world. Their liabilities – mortgage-backed securities (MBSs) and other debt – add up to some $5 trillion.
To put that in perspective, consider that total U.S. federal debt is about $9.5 trillion, compared to a total U.S. GDP of $14 trillion. About $5.3 trillion of that debt is held by the public (in the form of Treasury bonds and the like), while $4.2 trillion is intragovernment debt such as Social Security IOUs. This is the liability side of America’s federal balance sheet, and its condition influences how much the government can borrow and at what rates.
Treasury Secretary Henry Paulson told the House Financial Services Committee today that “they are adequately capitalized,” but this is questionable at best, as most market participants continue to disagree and punish the share prices. He also maintains that the government won’t assume their debt. Aside from the Fed extending a credit line in the same manner they did to Bear Stearns, it remains to be seen what the solution is. And given the perspective above, a Fed credit line won’t be enough to get the job done. Ultimately, it might come back on the taxpayers. This is again from the WSJ who has been a credible follower of this issue:
The worst option would be to let the situation erode until the Fed and Treasury panic amid market pressure and issue an explicit taxpayer guarantee. The consequences from putting $5 trillion in liabilities on the federal balance sheet would raise America’s borrowing costs and jeopardize the Treasury’s AAA credit rating. The dollar could face greater selling pressure, especially if the Fed tried to inflate away this greater debt burden. And all without a single Congressional appropriation or public debate.
Our own proposal, made months ago, is to require a more honest form of socialism by injecting taxpayer money now into both companies (say, in the form of subordinated debt or preferred stock) to recapitalize them enough to weather the current storm. This would help prevent a U.S. balance sheet debacle, and it would force the politicians to acknowledge the mess they have created. Then as the crisis passed, the taxpayers would at least get something for their money, while regulators could work to unwind Fan and Fred’s liabilities and shrink these monsters to a less dangerous size.
This would be real “change” in Washington. Instead, the political class continues to promote the status quo illusion that Fannie and Freddie are risk-free purveyors of the American housing dream. It is one of the great political scandals of our age, and it has unfolded in broad daylight. As usual, the American taxpayer will get stuck with the bill.