Caroline Baum: Fannie and Freddie need better makeovers

Caroline Baum is one of the more insightful financial market pundits around. In her column she takes aim at Fannie and their private reward, public risk corporate setup. Basically, the Fannie-Freddie bailout is a simple case of “heads and management wins, tails and taxpayers lose.”

Two weeks ago, with their stock prices plummeting and accusations of insolvency swirling through the marketplace, Fannie Mae and Freddie Mac, the two giant mortgage-finance companies, stared into the abyss.

What looked like a black hole turned out to be a blank check from the U.S. Treasury: an unspecified and unlimited credit line, borrowing privileges at the Federal Reserve’s discount window, and a pledge of a capital injection from the government if needed.

The Securities and Exchange Commission coughed up additional protection, tightening the rules for short-selling of Fannie and Freddie, along with 17 other financial stocks.

Mission accomplished? With the government making explicit the implicit guarantee of the two government-sponsored enterprises, which together own or guarantee $5.2 trillion of the nation’s $12 trillion of mortgage debt, the hope is that Fannie and Freddie won’t have to tap the emergency backstops.

The fear is that the needed makeover will stop there.

If these public-private hybrid companies are too big to fail — and everyone from the Bush administration to Congress to businesses and homeowners agrees that they are — then by definition they are too big to survive in their current state, a paradox voiced by William Poole, former president of the Federal Reserve Bank of St. Louis, in a July 27 New York Times op-ed.

As a result, Baum says the Bush administration should stop dithering on making the Fed a super regulator and address the Fannie and Freddie problem head on.

A “world class” regulator isn’t the solution. Eliminating the asymmetric risk/reward from Fannie and Freddie is.

If the taxpayer is going to shoulder the burden for bailing out Fannie and Freddie, the taxpayer should stand to benefit. It makes no sense to guarantee the debt of a private company, the benefit of which accrues to the shareholders, and not own the equity.

The Bush Administration and Congress cannot leave the GSEs as they are. They have two options:

  • Break them up and fully privatize the two organizations, diminishing their market role and leverage and taking away the government backstop. Private companies do not have implicit or explicit government backing
  • Nationalize them in full

The present state of affairs is a sham.

Fannie Mae, Freddie Mac Live to Die Another Day: Caroline Baum, Bloomberg News, 30 Jul 2008

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