Fannie and Freddie - Indeed, Too Big To Fail

Robert Reich says Fannie (FNM) and Freddie (FRE) are too big to be allowed to fail:

Fannie, Freddie, and the Pending Taxpayer Bailout, by Robert Reich: Fannie Mae and Freddie Mac, the two giant quasi-public housing lenders that together own or guarantee about half the $12 trillion in home loans outstanding, are heading into insolvency. No surprise. As housing prices continue to drop, more and more middle-class homeowners who got their loans from Fannie or Freddie are under water... And as the economy continues to go south, more and more of them can't meet their loan payments.

While it's true that most of their home loans were made before 2006 when lending standards were tighter, that doesn't really matter because the rip-tide of this sinking economy is now hitting a much broader group of home owners.

Fannie and Freddie may not be technically insolvent yet, but I'm betting that if their lending portfolios reflected the true market prices of their loans they would be. That's why their own investors are bailing out.

So who gets stuck with the tab? Investors in Fannie and Freddie have always believed that the loans issued by the two giants were guaranteed by the federal government but technically they aren't. The guarantee has always been assumed but has never been put into law explicitly... Yes, the companies' charters give the Treasury the authority to buy as much as $2.25 billion in each of their securities in the event of possible default, and the two companies have access to the Fed's so-called Fedwire payments system allowing them to access funding if needed. But these won't keep the two afloat for long.

As a practical matter, we're facing a Bear Stearns squared. Fannie and Freddie are way too big to fail -- especially now. There's no question the government will have to take over the companies, which means taxpayers will get stuck with the tab yet again.

Here we have another example of socialized capitalism. The executives of Fannie and Freddie have been among the best paid in all of corporate America. We're talking tens of millions a year in CEO pay alone. Fannie and Freddie are treated like giant investor-driven entities as long as they're healthy and their investors and executives are doing well. But when they start to go down the tubes they become public entities with public responsibilities, and the rest of us have to bail them out.

On the too big to fail issue, my view hasn't changed. If failure of these firms endangers the broader economy, and hence threatens to impose large costs on people who had nothing to do with creating the problems, then policymakers need to step in and do what they can to prevent a downward economic economic spiral.

In addition, they need to change the rules and regulations that allowed the problem to emerge in the first place, and add new rules and regulations as needed to lower the moral hazard worries going forward.

What would you do?

Comments

[mkreisel:]

If the US lets GSEs fail, then the country deserves no more than a CCC credit rating.

2008 Jul 11 03:45 AM

[User 61942:]

Mark Thoma You are a Moron. I have sold real estate since 1976. The good times do not last forever and neither do the bad. Just another idiot jumping on the "end of the world" cnbc bandwagon. I have had as many as 100 homes listed in the 80's for Great American and San Diego Federal when there was another "foreclosure crisis". We sold ALL of them eventually,the market does and will absorb these losses at the point when the ROI provides a breakeven or positive cash flow on these distressed properties. Even now the savier lenders are holding the REO's and renting them out rather than take an excessive loss on the properties. The market will turn as it always has,and FNMA and Freddie will be there to package up the loans and sell them to investors seeking a fair ROI and replenishing the capital necssaary to keep the American Dream of Home ownership alive and well. This is the third Market Crash I have lived thru and have no doubt I will live long enough to see this one rebound,and perhaps see another "end of the world".

2008 Jul 11 04:05 AM

[Jason Rines...:]

Hey user, did you live through the Great Depression? Ever hear the saying 'Never trust a banker, they love foreclosures?'. The writer is correct, socialism is socialism. These policies always lead up to market crashes. If you lived through three of them, can you tell me what happened 3 years out from the crash? I can tell you, much deeper fiscal pain. The scale of these numbers and irresponsibility dwarf the Great Depression. But keep calling common sense guys idiots.

There are so many differences that make this worse I would have to write a book but some are: No energy policy, no job growth-skilled job/brain drain out of the U.S., biggest bubble EVER, investment from foreigners out and our domestic investors heading overseas (gee, even they see the writing on the wall, but stay deluded). Foreclosures and wealth destruction already beginning to break Great Depression records in scale with no one to one commercial lending practice for lenders to obtain forebearance. NO LEADERSHIP in Washinton, instead socialist agenda to create gods and clod society, shall I go on?!?!

Responsibility is needed and sometimes, you let the forest burn down to reseed. The pain to 97% can no longer be avoided, better fast then Chinese water torture. The leadership in Washington is the key source along with it's twin city sister ruining the empire there in NYC. Alexander Hamilton said in 1790 that when banks and government collude, Americans will wake up homeless and penniless. We have been here before, it's called the Great Depression.

The end of the world? Nah, a depression would be recovered from relatively quickly and leadership impeached and expunged in government and banking. But the shock of the 97% of the citizens going from riches (whether real or perceived) to rags in less then 5 years tends to cause some pretty big civil unrest.

First stage, stagflation. But what we really have here is an entire failed economic theory deployed over 15 years ago and deflation.

The system cannot sustain itself for long with socialism. At least you showed your bias because you are in real-estate. That is noted. A floor on real-estate created by the bubble excess (which was also great for you no doubt) is a good thing for you, even if we become the next Cuba to do it. The imbecile is you buddy.

2008 Jul 11 03:04 PM

[ggbbppl:]

let look at ENRON,BEAR STEARN and MCI these companies was too big to fail. The CEO lie to the investors. let look at the saving and loan failure and depression which JP Morgan billout ,just researchand think before it is too late .it already late. HISTORY CANNOT LIE. I THINK WE ARE IN A MODERN DAY DEPRESSION.

2008 Jul 13 08:01 AM