|
|
|
Last Updated: Jul 17, 2008 - 7:49:33 AM |
The taxpayers’ predicament over Fannie Mae and Freddie Mac is already
grave enough. The Bush administration has asked Congress for a massive
rescue package for the twin “government-sponsored” mortgage investors
and insurers, and the Fed has announced that it will extend short-term
lending to both Fannie and Freddie. Graver still, though, is the fact
that the rest of the world of supposedly “high” finance is becoming
more like Fannie and Freddie, with potentially disastrous consequences
for the American economy and taxpayer.
What are Fannie and Freddie—and why should we care? The two behemoths
sponsor about half of the nation’s home mortgages, mostly of the
old-fashioned, fixed-rate variety. They’ve guaranteed three-quarters of
recent mortgages since the credit crisis began, up from 40 percent a
couple of years ago, when investors were so optimistic about housing
prices that they didn’t find the guarantees necessary. These mortgage
guarantees, as well as the companies’ borrowing to support their own
investments in mortgages, account for virtually all of Fannie’s and
Freddie’s $5.4 trillion in liabilities.
A trillion here, a trillion there, and soon you’re talking about real
money—more than one-third of the annual gross domestic product, in
fact. Yet this mass of obligation sits on a razor-thin base. Fannie and
Freddie hold only about $80 billion in actual capital, or under 2
percent of all of those potential liabilities. They get the rest of
their money through borrowing. And because their borrowing matures
regularly, they must raise new billions every month.
What this precarious capital structure means is that Fan and Fred have
scarily little room for error. If the value of the mortgage loans they
hold or guarantee declines by just a few percent, their capital is
wiped out. William Poole, former chief of the St. Louis Fed, helped set
off a run on the firms’ shares last week by noting that Freddie was
already technically insolvent, thanks to the decline in home values
over the past two years (though the situation had been clear in May).
Why did lenders and shareholders, then, give such dangerous companies
money to play with, especially on Fan’s and Fred’s customarily cheap
terms?
The answer is that while Fannie and Freddie are technically private
firms, their debt has come with an implied government guarantee.
Everyone has long believed that Fannie and Freddie are “too big to
fail”: that is, that the feds would never let them fall into
bankruptcy, for two reasons. One, they’re crucial to the nation’s
mortgage markets, partly because it’s hard for other firms to compete
with their once-implicit government backing. Two, they’re crucial to
the nation’s broader financial markets, having wrapped themselves in a
web of guarantees, insurance contracts, and derivatives that makes Bear
Stearns’s business look as straightforward as a lemonade stand.
As for shareholders, sure, back in March the Fed allowed Bear Stearns’s
shareholders to lose nearly everything while rescuing its bondholders,
and Treasury Secretary Hank Paulson has said that he doesn’t want Fan’s
and Fred’s shareholders to benefit from any bailout. But the
government’s role is more complicated in this case. Uncle Sam could
never find someone to buy Fannie or Freddie in a crisis at a cut-rate
price the way JPMorgan bought Bear; Fannie and Freddie are just too
big. The financial disaster that their failure would create, however,
would mean near-certain depression, and the government’s alternative, a
federal takeover that would mean increasing the national debt by half,
is only slightly more attractive. The Bush administration’s move this
week—asking Congress to allow the federal government to step in, if
necessary, to buy shares of the two companies and lend them potentially
hundreds of billions of dollars—bears out this stark reality.
But how did the government get into the business of protecting Fannie
and Freddie? Back in the 1930s, private lending for most activities,
including home building and buying, had pretty much stopped, partly
because banks had lent heavily against both stock-market and
real-estate securities in the twenties and simply had no money left to
lend once the value of that collateral evaporated. John Fahey, the
chair of the Federal Home Loan Bank, said in 1938 that “overspeculation
in real estate” had proven “as dangerous to the general welfare as is
overspeculation in securities.” The solution to the problem of banks’
inability and reluctance to lend was to create a new federal home-loan
agency that would, in the words of the National Association of Real
Estate Boards’ finance chair, Edward A. MacDougall, provide a “balance
wheel.” The lender “wants stabilized practice as the best assurance of
the safety of his loan,” while the borrower “wants assurance against
getting caught in any such dearth of mortgage funds as was experienced
in recent years.” The Federal National Mortgage Association—the parent
of today’s Fannie Mae—was born in 1938, and the New York Times reported
that “a better and sounder mortgage structure is being built out of the
experience of past mortgage difficulties.”
Fannie and Freddie are close to the government, then, partly because
Fannie used to be part of the government, from its creation until the
feds quasi-privatized it in the late sixties. Today, though, the
American taxpayer faces the worst of both worlds. Government
involvement in the mortgage industry through modern history made all
mortgages seem safer than they were, while private-sector speculation
over the past decade infected Fannie’s and Freddie’s
government-supported mortgage market with huge risk.
Fannie and Freddie weren’t responsible for most of the mortgage
industry’s worst excesses over the past decade. Neither led the way in
risky subprime or exotic mortgages (though they were hardly innocent
victims). But part of the reason private investors were so happy to
lend all that money to customers of Countrywide and IndyMac—two major
private mortgage lenders—was that the long history of largely
government-backed mortgage bonds lulled them into thinking that any
mortgage was a safe investment. Last week, the FDIC took over IndyMac,
a huge California bank that specialized in mortgages not backed by
either Fannie or Freddie, while Bank of America’s purchase of
Countrywide, which threw itself into the most exotic mortgages, likely
saved the feds from intervening there.
Though most of Fannie’s and Freddie’s loans didn’t seem as risky as
those held by the banks, the collateral that backs them—that is,
homes—was bloated by the asset speculation fueled largely in the
private markets. Today, Fannie and Freddie, and thus taxpayers, face
the risk that as property values fall, even borrowers of the 30-year,
fixed-rate mortgages that Fannie and Freddie guarantee will walk away
from assets that aren’t worth anywhere near what they owe on them.
Because Fannie and Freddie operate on such razor-thin margins, only a
relative few homeowners have to make this decision, or be forced into
it by economic straits, to plunge the companies into catastrophe. Just
as worrisome is the fact that Fannie and Freddie are actually loosening
their lending standards today to help the government in its effort to
stem foreclosures. If even moderate losses force Fannie to conserve its
cash, then it can’t make new mortgages, even to good borrowers—freezing
an already chilly market.
So the government has put taxpayers in an unenviable position. It’s
true that we’ve made Fannie and Freddie so powerful that we can’t let
them fail. But if home prices continue to drop, the government’s
now-explicit backing of Fannie and Freddie, into the trillions,
imperils the sterling credit rating of the U.S. government itself, just
as that government needs to conserve its resources to pay the coming
bill for retiring baby boomers’ Social Security and Medicare benefits.
Even if Fannie and Freddie were isolated cases, the situation would be
bad. But the squeeze gets worse. The U.S. government has spent the past
few months creating mini-Fannies and mini-Freddies out of the nation’s
supposedly risk-taking investment banks. The Fed’s engineering of the
Bear Stearns bailout and its decision to allow surviving investment
banks to borrow from the Fed—a privilege previously reserved for
tightly regulated commercial banks—demonstrates that Uncle Sam won’t
let a big investment bank go bankrupt. Now, just as lenders to Freddie
and Fannie never worried much about what the companies were doing with
all that money, lenders to the investment banks can worry less about
the risks those banks are taking. And as the Fed’s guarantee of $28
billion of Bear Stearns’s riskiest assets and its lending to other
investment banks shows, it’s taxpayers who will bear the ultimate cost.
As for the idea that better regulation of investment banks can cut this
new risk for taxpayers: armies of Washington regulators have long
overseen Fannie and Freddie. Those regulators didn’t stop the current
meltdown. Instead, they contributed to it by making the
government-coddled mortgage industry seem insulated from speculation.
Fannie and Freddie artfully captured their regulators long ago,
seducing them into allowing tiny capital margins and greater risk. Does
anyone doubt that the investment banks, with immense wealth and
sophistication, can do the same? Giving the Fannie and Freddie
treatment to investment banks, along with the attendant government
regulation, could make investment-bank risk-taking seem risk-free—just
as it made homeownership seem bulletproof. Meanwhile, even riskier
activity will escape such regulation, moving into new areas that
financiers will enlarge or invent to escape regulators, until it, too,
becomes “too big to fail.”
The government long ago painted itself into such a tight corner with
its socialization and ratification of market risk via Fannie and
Freddie that we’ll need luck to escape the current crisis without
serious long-term damage to our economy and national finances. At this
point, the government can’t do much to reduce the risk that the two
mortgage giants—and the investment banks—have already taken on. Its
recent actions only transfer that risk to taxpayers. All of that
concentrated risk could go sour as the values of the assets backing
existing loans continues to decline, pushing ever more borrowers and
guarantors into default. If the government’s responsibility for this
risk starts to fray America’s finances in earnest, its backup plan is
apparently to hope that the taxpayers’ creditors—including the Chinese
government—continue to consider America too big to fail.
Source:Ocnus.net 2008
Top of Page
|
|
|
|