The stock market took another tumble today on the work that Fannie Mae and Freddie Mac, which guarantee a large percentage of the mortagages in the United States, are in crisis and may be nearing collapse. Word is that the Bush Administration may have to step in with a bailout plan that could compare with the massive S&L bailout of the early 1990s.
Why are the two giant corporations, without which the entire housing market could collapse, in so much trouble? Dave Iverson discussed that on forum this morning, and some interesting points came out. According to his guest, Thomas Davidoff, a business-school professor at Berkeley, Fannie Mae and Freddie Mac were doing what short-term profit-seeking companies do — investing in instruments that do well when the economy is doing well, particularly, and ironically, in mortage-backed securities. Now that the housing markets are tanking, and those securities have fallen in value, and the two companies are facing huge liabilities for the mortgages they guaranteed, the taxpayers are going to have to step in.
But here’s what a lot of people forget: Fannie Mae, the Federal National Mortgage Association, was originally a government agency, created by Roosevelt as part of the New Deal. In 1968, it was privatized. Freddie Mac, the Federal Home Loan Mortgage Corporation, was never a public entity, but was created to provide competition in the market when Fannie Mae was privatized. (By the way, these are the outfits that have made the securitization of morgtages possible.)
But of course, both have operated with what finance experts call an “implicit guarantee” of federal backing. Everyone assumes that if they screw up, Uncle Sam will come to the rescue.
So we have the worst of both worlds: A private outfit making bad investment decisions because there’s no real downside fear — and the taxpayers, who have little control over it, having to foot the bill.
Privatization has done such wonders for the mortgage-finance market, eh? Perhaps President Obama and Speaker Pelosi will have enough sense to stop bailing these companies out and turn them back into government agencies.