Fannie Mae and Freddie Mac
They don’t come much tougher than Hank Paulson, but even the doughty US Treasury chief admits to suffering sleepless nights while wondering what to do about Fannie Mae and Freddie Mac. As well he might. Fannie and Freddie own or guarantee around half the $12trn US mortgage market, and they were headed towards insolvency. Had that been allowed to happen it could have brought on the collapse of the US mortgage market, if not the entire financial system.
Paulson had to step in and take them under federal control – even though the move will add countless billions to the national debt. They were simply too big to fail.
Fannie and Freddie were originally devised to ease the US housing market, so who exactly are they and what folly or misfortune has brought them from prim respectability to this apparently shameful turn of events?
Fannie Mae (the Federal National Mortgage Association) was born out of the Depression, as part of a series of measures introduced by F.D. Roosevelt to kick-start the housing market. The idea was to introduce a secondary market in mortgages. Fannie would purchase them from their original lenders and package them together in bonds for sale to investors – thus providing more lenders with more liquidity to make more mortgages.
Freddie Mac (the Federal Home Loan Mortgage Company) was introduced has a competitor in 1970. Both were ostensibly private organisations, with ordinary shareholders, but having been chartered by Congress, they had the status of government-sponsored enterprises. And therein lay their downfall.
Bolstered by an implicit government guarantee, Fannie and Freddie became increasingly aggressive and took unnecessary risks – ending up with more than $5trn in mortgages on their books, backed by an absurdly slender capital cushion.
The Fannie-Freddie bailout is one of the great political scandals of our age. Paulson’s action may get the companies through the current crisis – albeit at enormous cost to US taxpayers – but it doesn’t go far enough. Until he takes action to kill of the Fannie and Freddie business model, these corpses could still return to haunt us. Once house prices have stabilised, the Treasury should break up and privatise these hybrid monsters as swiftly as possible.
Financial rescues do not come any bigger than this, but there may be some catharsis in the Fannie and Freddie bailout as a turning point for the global banking system. It signals that the most acute phase of the financial crisis is past, but the long convalescence has not yet begun.