James Surowiecki: The Fannie Mae & Freddie Mac debacle
["James Michael Surowiecki ("soo-ro-wiki") (b. 1967) is an American journalist. He is a staff writer at The New Yorker, where he writes a regular column on business and finance called 'The Financial Page.' "--Wiki]
... [Government Sponsored Enterprises like Fannie Mae and Freddie Mac] are curious, because there’s no obvious reason for them to exist in the form they do: instead of creating private companies to do all these jobs, the government could just do them itself. In fact, that’s how Fannie Mae got started, back in 1938: originally, it was a government agency endowed with the authority to buy mortgages, in the hope that this would expand the supply of credit to homeowners. It wasn’t until 1968 that Fannie was privatized. (Freddie Mac was created two years later, and was private from the start.) The main reason for the change was surprisingly mundane: accounting. At the time, Lyndon Johnson was concerned about the effect of the Vietnam War on the federal budget. Making Fannie Mae private moved its liabilities off the government’s books, even if, as the recent crisis made clear, the U.S. was still responsible for those debts. It was a bit like what Enron did thirty years later, when it used “special-purpose entities” to move liabilities off its balance sheet.
Making Fannie and Freddie into these weird hybrids may have spruced up the budget, but in the long run it also made it easy for the companies to grow too big, too fast. Because everyone assumed that the government would make good on Fannie’s and Freddie’s debts, they could borrow money more cheaply than their competitors. They used this cheap debt to increase the number of mortgages they bought. Had Fannie and Freddie been ordinary private companies, there would have been a natural check: companies with more debt are usually seen as riskier, and that makes shareholders and bondholders less willing to invest in them. Or, had Fannie and Freddie been government agencies, budget constraints would likely have limited the scope of their lending. Since neither the market nor the state checked their growth, they were able to swell extravagantly. (Regulators might have reined the companies in, but, thanks in part to ardent lobbying by Fannie and Freddie, Congress failed to provide them with sufficient power to do so.)
The result of all this was that the companies reaped the rewards of the private sector while enjoying the security of the public sector. Seemingly insulated from all harm, they became reckless. They constructed a giant pyramid of debt on a very small base of capital (eighty-one billion dollars, by the most recent publicly available figures), and by May, 2008, either owned or guaranteed more than five trillion dollars in mortgages. As a result, even though just a small percentage of Fannie’s and Freddie’s mortgages are delinquent, the potential losses are huge. That’s why, in recent weeks, investors finally lost faith in them.
Whatever their sins, Fannie and Freddie clearly couldn’t be allowed to fail, but that’s no argument for letting them go on as they are. Either they should be forced to make it as private companies or they should be nationalized. ...
Read entire article at New Yorker
... [Government Sponsored Enterprises like Fannie Mae and Freddie Mac] are curious, because there’s no obvious reason for them to exist in the form they do: instead of creating private companies to do all these jobs, the government could just do them itself. In fact, that’s how Fannie Mae got started, back in 1938: originally, it was a government agency endowed with the authority to buy mortgages, in the hope that this would expand the supply of credit to homeowners. It wasn’t until 1968 that Fannie was privatized. (Freddie Mac was created two years later, and was private from the start.) The main reason for the change was surprisingly mundane: accounting. At the time, Lyndon Johnson was concerned about the effect of the Vietnam War on the federal budget. Making Fannie Mae private moved its liabilities off the government’s books, even if, as the recent crisis made clear, the U.S. was still responsible for those debts. It was a bit like what Enron did thirty years later, when it used “special-purpose entities” to move liabilities off its balance sheet.
Making Fannie and Freddie into these weird hybrids may have spruced up the budget, but in the long run it also made it easy for the companies to grow too big, too fast. Because everyone assumed that the government would make good on Fannie’s and Freddie’s debts, they could borrow money more cheaply than their competitors. They used this cheap debt to increase the number of mortgages they bought. Had Fannie and Freddie been ordinary private companies, there would have been a natural check: companies with more debt are usually seen as riskier, and that makes shareholders and bondholders less willing to invest in them. Or, had Fannie and Freddie been government agencies, budget constraints would likely have limited the scope of their lending. Since neither the market nor the state checked their growth, they were able to swell extravagantly. (Regulators might have reined the companies in, but, thanks in part to ardent lobbying by Fannie and Freddie, Congress failed to provide them with sufficient power to do so.)
The result of all this was that the companies reaped the rewards of the private sector while enjoying the security of the public sector. Seemingly insulated from all harm, they became reckless. They constructed a giant pyramid of debt on a very small base of capital (eighty-one billion dollars, by the most recent publicly available figures), and by May, 2008, either owned or guaranteed more than five trillion dollars in mortgages. As a result, even though just a small percentage of Fannie’s and Freddie’s mortgages are delinquent, the potential losses are huge. That’s why, in recent weeks, investors finally lost faith in them.
Whatever their sins, Fannie and Freddie clearly couldn’t be allowed to fail, but that’s no argument for letting them go on as they are. Either they should be forced to make it as private companies or they should be nationalized. ...