Much to Like About the GSE Rescue

I see much to like about this.

From the New York Times:

... the Bush administration will ask Congress to approve a rescue package that would give the government the authority to buy billions of dollars in stock in Fannie Mae and Freddie Mac and also lend to the companies to meet their short-term funding needs...

Separately, the Federal Reserve voted on Sunday to also open a lending facility for Fannie Mae and Freddie Mac, if they need emergency capital. The two companies would be able to post their own securities as collateral.

The plan calls on Congress to give the government the authority over the next two years to buy an unspecified amount of stock in the two companies. Over the same period of time, it would permit the companies to have greater access to the Treasury, by expanding the credit line that each company has from the Treasury. Each company now has a $2.25 billion credit line, set nearly 40 years ago by Congress. At the time, Fannie had only about $15 billion in outstanding debt. It now has total debt of about $800 billion, while Freddie has about $740 billion... 

As part of the plan, the administration will also call on Congress to raise the national debt limit, people briefed on the plan said. And it will ask Congress to give the Federal Reserve a role in setting the rules for how big a capital cushion each company must hold.

The first thing I like about this plan is the fact that the ultimate determination of the level of risks to be absorbed by the federal government is being left to Congress. How much risk there is to the taxpayers in the various new lending facilities introduced by the Fed is subject to some debate, but that there is some risk, and that new loans from the Fed to the GSEs would increase this risk, is indisputable. One of the clearest lessons from history is that the fiscal and monetary functions of the government must remain separate. Pretending that we can deal with these problems with money creation rather than tax increases is too tempting to allow that door to be opened any further.

The second thing I like about the plan is that such action by Congress would take the form of a dollar limit-- here's how much we're willing to stake, and no more-- with residual losses presumably laid on the GSE creditors. I've argued that's exactly the way the debate needs to be framed. Parenthetically, I can't resist repeating here my suggestion that this is also exactly the approach we should be adopting for ever-growing federal health-care expenditures-- let Congress decide how much it's willing to spend rather than generate a wish list of all the things it would like to accomplish.

Granted, action by Congress can be a cumbersome process, often painful to watch. This I presume is why the plan includes a promise by the Fed to provide immediate lending, if needed, which I'm seeing as a kind of bridge loan. I would assume that may be quite a necessary and appropriate element of the plan.

I've railed before at the way politicians sometimes treat the debt limit as a political football, and I suppose there's a danger of that here. This is a subtle issue, to be sure, requiring balancing an unknown risk of large fiscal loss against an unknown risk of spectacular financial catastrophe. Congress may get it wrong. But ultimately this is a decision to be made by elected representatives who can be held accountable for the outcome, one way or the other.

For my part, I urge Congress to say yes.

Comments

[Trailside:]

This scenario reminds me too much of Ayn Rand's Atlas Shrugged, in which the government finds it morally expedient to help the so-called needy. Ultimately, bailing out Fannie and Freddie--excusing them for their irresponsible excesses, injecting them with funds like heroine to a junky just to maintain their appearance of sanity and tranquility--is tantamount to stifling the strong and propping up the weak. Hardworking Americans will be taxed big time to fund this toxic junk, for it will turn to junk. I always viewed Rand's novel as overtly exaggerated and totally unrealistic. She has now become a total prophet in my eyes. Our leaders, Democrats and Republicans alike, find it necessary to feed two fat junkies so that they can continue to feed the biggest junky on the planet: the USA. This is great. The needy win--Fannie, Freddie, the USA, and the subprime, uncreditworthy borrowers who, even though they can't pay up in full, won't have to lose their homes. Great country. Porter Stansberry made one great suggestion, and I'm sure Mr. Paulson would puke if he read it: "The U.S. government recognizes its severe financial mismanagement. It allows Fannie and Freddie to collapse completely and does not assume their liabilities. Mortgage investors take huge losses. Mortgage rates soar to more than 10%. Housing prices fall 75% – which makes housing affordable for millions of Americans previously priced out of the market. In the meantime, the government cuts spending by 30% and reduces taxes radically to encourage economic growth (which, ironically, increases tax receipts, leading to a balanced budget). It restructures Social Security, moving the age of retirement to 75. And most importantly, the government gets out of health care completely, renouncing all of its Medicare obligations. Hospitals and doctors immediately drop their fees to meet the affordability requirements of a free market."

2008 Jul 14 04:05 AM

[Oregonrain:]

I would like some beer with the nuts writing above thanks.

2008 Jul 14 10:14 AM

[Jason Rines...:]

That guy with nuts is Porter Stansberry. I am in with his camp, let the forest fire rage so we can reseed. Our economy passed the tipping point into non-sustainable. All American's not in the 3% of the nation's wealthiest are sufferer and will continue to suffer. Better to accept we will be feeling 3rd degree burns then to ignore the forest fire has already started to burn alive slowly because we have a squirt gun in our hand (the Fed & Treasury).

2008 Jul 14 10:59 AM

[Bellylaugh:]

The Fed operates on "Here and Now" economy, look out for a world spinning out of control.......

2008 Jul 14 11:00 AM

[icandoitdon:]

"The second thing I like about the plan is that such action by Congress would take the form of a dollar limit-- here's how much we're willing to stake, and no more"

let's see....government representatives in the form of the head of treasury and the federal reserve have just stated unequivocally that they do not want to see these institutions fail and that they will stand behind their obligations. but you say the congress will adhere to the plan of limiting it's investment, if required. in other words if they need another infusion at some point down the road we'll just let em sink.

you should find a new drug. that crack you're smoking is ruining your mind.

2008 Jul 14 06:11 PM

[Mahant:]

We are a capitalist country and have proudly followed free market theories and have shown to the world how by practising we have brought about overall economic development in countries that have joined us in this effort.

GSE's were originally created to provide mortgage finance to primary mortgage institutions by refinancing them thru consolidation of loans and securitisation. The process was simple. Original funding was done by federal Govt. at interest rates which were low to enable GSE's to rediscount at lower rates so that needy low income and middle income citizens could get mortgages at reasonable interest rates. They were allowed to issue Bonds to public and there was an implied understanding that since these institutions are created by Congress they will have full support of Uncle Sam. Their Bonds have been rated As AAA for that reason right from the beginning. Most conservative retirees have invested in their Bonds for earning fixed interest income as their rate of interest is slightly higher than GINNIE MAES whose Bonds are expressly guaranteed by Govt.

Two things are not understandable. First why these institutions would have run into losses when they were allowed substantial leverage by Federal Govt and Federal Reserve plus funding by public at rates much lower than the rates at which these institutions have been rediscounting as their spreads were always maintained and guranteed. Losses appear to be the result of mismanagement and lack of control on overheads. This seems to have happened despite close watch of Federal Reserve System and oversight of Congress. A thorough expert investigation is needed as Congressional Hearings are not enough.

Secondly on one side Mr. Paulson and Bernanke have been able to come up with a Plan which will provide emergency funding and even buying shares of both Freddy and Fannie ( commendable indeed to save the system) poor shareholders have been given clear cut message that since these two are bankrupt (per one Fedral Reserve Governor) they should not have any hope of recovering their equity. The most surprising innuendo in your artcle is that Bondholders should also be prepared to loose. In nutshell conservative retirres who are shareholders and bondholders in these GSE's ( carriers of implied Federal Govt. Guarantee) should be ready to bear this additional indirect tax as a result of mismanagement by Administration, Federal Reserve and Congress. In fact I hold Freddy and Fannie Bonds and my broker has advised by way of a footnote in my latest Statement that interest on these Bonds has not been paid and may not be paid so I should not plan things based on this estimated/accrued interest. This information has not been made public by either CNBC or other media so far and I do not know what action has been taken by Debt rating Agencies as GSE's would definitely have advised them and any action by them would create additional flutter.

2008 Jul 14 10:36 PM

[J-Texas-1:]

"Two things are not understandable. First why these institutions would have run into losses when they were allowed substantial leverage by Federal Govt and Federal Reserve plus funding by public at rates much lower than the rates at which these institutions have been rediscounting as their spreads were always maintained and guarnteed."

Hmm... where to begin? The best thing is to realize that the hallmark of the Bush Administration has been to look the other way as the bullies (big business exec's et. al.) beat up the little kids (most Americans). It's not as much deregulation as it is oversight negligence.

Let me count the ones I can think of without stopping my typing to think... credit card fees, fraudulent mortgage lending practices (squished Spitzer and 49 other state AG's from stopping it in 2003), oil futures trading in U.S., CDO's traded to get around trading laws, rampant drug advertising, electricity trading...

In every case, the law IS ALREADY ON THE BOOKS. The response? Okay, we'll start watching this now. Where the ____ where you the five years when it could have been prevented?

Just a hunch, but I believe Spitzer got exposed (pun intended) because he called out the brotherhood for its blindness after they stopped him from avoiding the scandal.

The legacy of America the past 20 years will be a new definition of how to succeed: forgo ethics and morals and embrace greed and corruption.

God forbid if you don't make the fabulous five (percent of wealthiest Americans) before the jig is up on your lies.

2008 Jul 15 12:26 AM

[johngonole:]

These GSE's have essentially acted as another source of liquidity that the govt and federal reserve have used to prop up the economy and particularly the mortgage market. Increase home prices and homebuilding are what staved off the last recession remember. I'm pretty sure loose lending standards by these GSE's helped this. Its not a failure of free markets but of centralized planning. Bush/Clinton/Bush era are ultimately to blame as they all tried to promote economic growth through the expansion of debt. Debt expansion always promotes growth at first but then it taxes through interest.

2008 Jul 18 01:11 AM