Federal takeover of GSEs now in the works

By Edward Harrison On Jul 11, 2008

As I said in an earlier post, taking over Fannie and Freddie has been the plan all along for the Bush Administration. They have been planning this since at least March. Coincidentally, I have confirming evidence now. The New York Times reports that they are unveiling this plan for a bailout now.

They are only doing so because market events dictate it. In the wake of the Lehman Brothers analysis suggesting $75 billion in additional capital is needed at the two GSEs there is no choice but to deploy the secret plan.

I find it an ironic coincidence that the report comes from Lehman Brothers. Lehman was saved in part by the GSEs’ having provided liquidity to the mortgage markets since March. In another ironic twist, the resulting market turmoil might send Lehman to the wall as well.

Alarmed by the growing financial stress at the nation’s two largest mortgage finance companies, senior Bush administration officials are considering a plan to have the government take over one or both of the companies and place them in a conservatorship if their problems worsen, people briefed about the plan said on Thursday.

The companies, Fannie Mae and Freddie Mac, have been hit hard by the mortgage foreclosure crisis. Their shares are plummeting and their borrowing costs are rising as investors worry that the companies will suffer losses far larger than the $11 billion they have already lost in recent months. Now, as housing prices decline further and foreclosures grow, the markets are worried that Fannie and Freddie themselves may default on their debt.
–New York Times, 11 Jul 2008

This is a very palatable way out from a political perspective, because it helps do an end run around on some of the mortgage bailout chatter. In addition, the Bush administration can get credit for tackling the problem. They also get to offer a backdoor bailout to mortgage companies and homeowners at taxpayer expense without having to explicitly do so.

Under a conservatorship, the shares of Fannie and Freddie would be worth little or nothing, and any losses on mortgages they own or guarantee — which could be staggering — would be paid by taxpayers.

The government officials said that the administration had also considered calling for legislation that would offer an explicit government guarantee on the $5 trillion of debt owned or guaranteed by the companies. But that is a far less attractive option, they said, because it would effectively double the size of the public debt.

The officials also said that such a step would be ineffective because the markets already widely accept that the government stands behind the companies.