No more need for Freddie and Fannie Published: August 20 2008 19:53

No more need for Freddie and Fannie

Published: August 20 2008 19:53 - Financial Times: Editorial Comments

Freddie Mac and Fannie Mae are the platypuses of the financial world. As shareholder-owned companies which rely on state guarantees, the two government-sponsored enterprises are neither public fish nor private fowl. They are also evolutionary relics from another time. The US Treasury looks increasingly likely to bail out the two mortgage giants. But before it does so, Hank Paulson, the Treasury secretary, must think about an intelligent design for what he would like the GSEs to evolve into.

Fannie and Freddie are vast institutions, guaranteeing $5,300bn of US mortgages, of which 15 per cent are from riskier categories of lender. The credit squeeze and the housing slump mean borrowers are defaulting and Fannie and Freddie have run up significant losses.

Last month, responding to fears about their solvency and liquidity, the Federal Reserve gave the GSEs permission to borrow from the Fed’s discount window. Mr Paulson sought powers from Congress to allow him to, one day, bail out Fannie and Freddie, making their implicit state guarantee explicit. It had been hoped this would be enough to save them and that action would not be necessary. This bluff, alas, does not seem to be working.

Indeed, Freddie and Fannie are now finding it hard to raise new capital precisely because investors are worried about losing out in the event of a public bail-out.

The lumbering GSEs are too big to fail several times over. If Mr Paulson needs to save them, he may need to act very quickly. But he should not be thinking about simply keeping them as they are but on tighter regulatory leashes. The GSEs are set up to socialise losses and privatise profits. This is clearly ridiculous. In the short term it would be better to nationalise them to align risk and reward. In the long run, the government should get rid of Fannie and Freddie.

There is no need for the government to engage in the secondary mortgage market, not least because doing so provides perverse incentives for the state to prop up US house prices. The GSEs should be cut into small-enough-to-fail pieces before a real privatisation. Winding down the GSEs as we know them need not be immediate or rapid, but it should begin now, when it is easier to gather the will for reform.

The Federal Reserve and the Treasury are right to try to prevent the collapse of the GSEs. But they must now work to get rid of them. Conservation efforts have kept the duck-billed platypus alive. Freddie and Fannie do not deserve the same protection.

The Financial Times Limited 2008

Comments

Another Point of View: I printed the entire article because a variety of points are being raised about what to do with Freddie Mac and Fannie Mae. It appears some individuals think the two agencies should be dismantled and fade away due to the dramatic readjustment in the mortgage markets. Because they are the biggest, they are stuck with alot of Monday Morning Quarterbacks who are ready to throw them off the plane.

Workingman's Mortgages: For decades the two agencies have been the pulse of the workingman's mortgage either directly or indirectly. This never agreed well with many of their competitors (Large Banks, Mortgage Companies, and later financial Institutions who got into the game). Narrowed their profit margins. Certainly a big success for the average homeowner trying to purchase a home and the envy of the World.

Large Size: Is the reason why many or Freddie Mac and Fannie Mae competitors want to take them apart. It is also the reason why they have been so successful in the past. They could and did make a difference in the market.

Countrywide /Bank of America Merger: Not sure the consolidation of; Private Banking, Mortgage Banking, and Failing Financial Investment firms (JP Morgan/Bear Stearns) solves any problems or just kick's the can down the road another 12 to 18 months. But I do understand the global strategies which keep on growing market share and lowering execution costs/ overhead.

Merging Frannie Mae and Freddie Mac: Rather than dismantling, I believe, we should be talking about merging the two agencies together. Understanding that as stated above "In the short term it would be better to nationalise them to align risk and reward."

In an age of Global Consolidations: and mega size Corporations someone has to look out for the best interests of the working class citizens. I am sorry to say I don't trust the private sector to regulate themselves. We are experiencing world wide financial contagion and solutions will not be accomplished only though mergers or break ups.

Law of the Jungle: Works well for the animal kingdom but not so well in an evolved society. Without oversight/regulations in the financial markets we find an easy exit for the guilty parties and huge debt burden for the citizens in the end.

Jim