What's Next for Fannie and Freddie?

The Washington Post reported yesterday morning on discussions within the American government over the fate of quasi-governmental mortgage firms Fannie Mae (FNM) and Freddie Mac (FRE). Readers may recall that the two companies were placed in government conservatorship late last summer after doubts about the financial sustainability of the firms increased. Now, it seems, officials are trying to figure what to do with them.

Apparently, the leading option is a split of the companies into good and bad banks:

The bad debts the firms own would be placed in new government-backed financial institutions -- so-called bad banks -- that would take responsibility for collecting as much of the outstanding balance as possible. What would be left would be two healthy financial companies with a clean slate.

Two healthy private financial companies? The issue with Fannie and Freddie was that as private firms with shareholders to please the businesses sought to maximise profits, while at the same time their quasi-governmental status led markets to conclude that the companies were supported by an implicit government guarantee. This allowed Fannie and Freddie to make enormous sums of money by borrowing at very cheap rates, but it also created nasty incentives for firm managers and let the companies grow much too large.

It seems remarkable that the government would move forward on a solution that doesn't resolve this issue—either by re-privatising the firms and heavily regulating their activity or simply making them regular old government agencies. It's difficult to believe that the government could just turn Fannie and Freddie loose upon markets and in any way signal a credible commitment not to back the firms in the event they get themselves in trouble at some future date.

But looking through the Post story, it's difficult to see how government officials plan to handle this problem. It is mentioned that the good bank/bad bank plan is one of several options on the table, and Larry Summers' earlier criticisms of the firms' implicit guarantees are noted, but the piece repeatedly suggests that the challenge occupying policymaker minds is how to handle the firms' current financial troubles. That is a big mess, it's true, and there will be more messes like it if their status as quasi-private firms isn't addressed.

The story concludes on a worrying note:

The revamping of the firms was almost included in the administration's June white paper that proposed an overhaul to the federal regulation of the financial system. But after determining that they had to craft a careful exit of the government's aid for those companies, Summers and Geithner decided to put the issue off.

If there is to be a government exit, it had better be very careful indeed.

original post

Comments

[john s. gordon:]

the scrap yard - is what's next.
> jack

Aug 07 09:41 AM

[freefannien...:]

You leave out very important FACTS in your article (as with most "Financial Journalists" I doubt you even bothered to research the history of the GSE's): Congress (both sides) has dictated what FNM/FRE must do (take on crap loans from truly private banks), all the while Congress (both sides) has also had their hand out taking hundreds of millions in "contributions" (in a Third World Country you'd call these "bribes"). Meanwhile no one, including you can come up with any plan to replace the GSE's...

Aug 07 10:19 AM

[MichaelAK:]

Their is not good bank only a bad bank. They should be closed down period and just try to collect what is owed them/us the taxpayers on the outstanding debt. Liquidation is the preferred method. Private charities should be handling any of the previous social mission of these 2 government agencies.

Aug 07 04:39 PM

[Duude:]

What's next for Fannie and Freddie? Certainly, not the options represented here in this blog. Fannie and Freddie will do what they have always done but at a greater speed and a greater lack of transparency. That is buy every piece of crap mortgage that comes their way. After all, now more than ever, cash flow means NOTHING. Fannie and Freddie are now and will forever be a social engineering arm of the federal government. Very little will be said about the low interest, bad credit fixed loans they reward holders of liar loans. We have more moral hazard being baked into the system than ever before. Taxpayers are oblivious, politicians are complicit, and the President is duplicitous. Campaign finance is at the root of this issue. Too many politicians for far too long have had their hand open in the quest for cash and rewards. Its rather disturbing to know that while only 1/2 of the world's bad credit MBS were once with the GSEs, now Fannie and Freddie are buying them all back from foreign ownership. Its a process of buying back all the crap we spread around the world and placing it upon the backs of American taxpayers. One day, smarter minds will prevail. On that day, the GSEs will be reformed but the wooden supports of our real estate bubble will fold and real estate will be seen as a loser for a decade or more.

Aug 08 05:38 PM

[Jimmy Lathrop:]

Freddie paid back 1.1. billion dollars to the government this quarter, otherwise, they would have posted a profit. Put next to each other, Freddie loans default at a lower rate than Fannie loans and consequently, Freddie has had to post less capital reserves. I was disappointed the author did not distinguish between the two GSEs,

Aug 09 11:15 AM