The Cost of Bailing Out Frannie

Includes: FMCC, FNMA
by: Felix Salmon

Let’s say I buy a $3,000 pair of handmade shoes but don’t have that kind of cash to hand, so I put them on my credit card. I then rack up another $2,000 in penalties and interest before I’ve paid them off. Then the total cost associated with my poor investment in footwear is $5,000. The credit card company bailed me out but charged through a lot of money for doing so, and the money is absolutely part of the total sum I end up paying for those shoes.

Weirdly, Jeffrey Goldstein, the under secretary for domestic finance at Treasury, doesn’t seem to think that way. Fannie (OTCQB:FNMA) and Freddie (OTCQB:FMCC) have already borrowed $151 billion from Treasury, and they’re set to borrow another $90 billion by the end of 2013. That’s hardly chump change. Yet Goldstein says, with a straight face, that “the GSEs have already absorbed the vast majority of costs associated with the poor investments they made during the housing boom”. His argument:

Under the baseline scenario, FHFA projects that $90 billion in additional draws will be necessary through 2013. But this is why accounting for dividends is important – $71 billion of those additional draws will be used to pay dividends back to Treasury. This means that nearly 90 percent of total GSE losses have already been absorbed, since these future draws will primarily be returned through dividend payments.

This just doesn’t make any sense to me. Every business has money coming in, from various sources, and money going out, to various sources. If at the end of the day you end up having to borrow $90 billion from Treasury, then that means the money going out exceeds the money coming in by $90 billion. Most of us would consider that a “loss”. But not Goldstein. The way he sees it, if $71 billion of the money-going-out is going to Treasury, then it doesn’t count towards the GSEs’ total loss. But why is Treasury special in that way? If the interest payments were going to anybody else, then they would count towards Frannie’s losses.

Goldstein is right that from Treasury’s point of view, the net amount of money being pumped in to the GSEs is decelerating, even if the total cost of the GSE bailout is still going up rather than down. And it’s probably nice to be getting $71 billion in dividend payments from the agencies, even if that money has to be turned around and sent straight back again. What’s more, to be fair to Treasury, if it just reduced the interest rate on its bailout funds, it could reduce the headline cost substantially, even if the actual net cost to taxpayers went up.

But in the context of a world where all the other bailouts — even AIG, amazingly — look set to be paid back in full, the fact that we’re still pumping billions of new dollars into Frannie only serves to underline how massive and disastrous the agencies’ failure was. I’m glad they’re still around to make their interest payments. But the only reason they’re still around is because Treasury has promised them unlimited funds — a promise which means they can never go bust, no matter how much money they end up losing.