The chance that American taxpayers will actually lose any money if Ben Bernanke and Henry Paulson decide that Fannie (FNM) and Freddie (FRE) need government support is very low:
- The interest payments they have coming in are greater than the interest payments they have going out.
- Their government guarantee is itself a very valuable asset that they have made a lot of money off of in the past and will make more off of in the future.
- They are not even in liquidity trouble--unless they begin to have problems rolling over their discount notes...
- As long as it is generally understood that they are too big to fail, they should not even have liquidity problems--absent a depression that bankrupts many currently-solvent homeowners, that is.
Nevertheless, there is now a risk that Fannie and Freddie will need some form of government support in the next month:
- The situation could require a lot of government-provided liquidity at any moment
- It might even require more liquidity than the Federal Reserve can provide with its current balance sheet. Either the Fed needs to be given the power to pay interest on reserves immediately--so that it can swap interest-paying reserve deposits for mortgages next week--or this has to become not Fed but Treasury business.
The game the Fed and the Treasury are playing right now is as follows:
- Keep risky asset prices from collapsing...
- So that the flow of savings to finance construction and manufacturing expansion continues...
- So that employment declines in construction and supporting occupations are roughly balanced by employment expansions in export and import-competing manufacturing and supporting occupations...
- So that the economy does not fall into a depression deeper than that of 1982...
- In which case all bets are off.
Supporting Fannie and Freddie may be something Ben Bernanke and Henry Paulson decide we need to do in order to win this keep-the-economy-near full employment game:
- They are not in the business of rescuing feckless financiers from bankruptcy.
- If their actions do have the consequence of rescuing some feckless financiers from bankruptcy, that is a side effect of their keeping the financial crisis from spilling over and destroying the jobs of millions of Americans.
- To have the government step back in order to teach feckless financiers a lesson is simply not worth destroying the jobs of millions of Americans.
- They are grownups with good judgment and as much experience in this business as anybody.
- They are backstopped by committee chairs--Chris Dodd and Barney Frank--of equally good judgment.
Bernanke and Paulson have asked for additional regulatory authority:
- They should get it.
- Fannie's and Freddie's troubles make it more and more clear that the financial-market deregulation agenda of the late 1990s that Phil Gramm spearheaded was a more serious mistake than almost of any of us realized back at the time...
- There are a bunch of options if push comes to shove:
- Having the government formally guarantee GSE debt.
- Having the government provide capital to the GSEs.
- Having the government guarantee GSE preferred.
- Putting the GSEs into "conservatorship."
- The moral-hazard worriers in the Treasury will probably favor the last--that option penalizes GSE shareholders in the same way that Bear Stearns and LTCM shareholders and principals were penalized. The cautious will favor the first option, as running the least risk of aggravating uncertainty.