Applauding the Fed's GSE Action

It’s certainly been a tough week for mortgage behemoths Fannie Mae (FNM) and Freddie Mac (FRE). The share prices of these Government Sponsored Enterprises (GSEs) were halved last week in the wake of comments by former St. Louis Federal Reserve President, William Poole, who suggested that the two GSEs were “technically insolvent.” Market punters have jumped on the bandwagon and are now shorting every last share they can get their hands on.

In a free market, Fannie and Freddie would stand little chance, but it seems as though the Fed is willing to come to the rescue…for a second time this year. If the orchestrated bailout of Bear Stearns wasn’t exciting enough, the dynamic duo (Bernanke and Paulson) appear prepared to entertain yet again. It seems as though a fully-fledged bailout of Fannie and Freddie could be in the works.

In an attempt to restore confidence, the Fed and the US Treasury announced steps on Sunday to shore up Fannie and Freddie. The Fed said that it granted the Federal Reserve Bank of New York authority to lend to the two companies "should such lending prove necessary." Secretary Henry Paulson further readied the parachute by requesting that Congress allow the US Treasury to buy unlimited stakes in Fannie and Freddie.

In an interview with Bloomberg, Jim Rogers, past partner of George Soros’ hedge fund, sided with William Poole. Jim stated that the US mortgage lenders are “basically insolvent” and that “These companies were going to go bankrupt if [the Fed] hadn't stepped in to do something, and they should've gone bankrupt with all of the mistakes they've made.” Jim said that he would remain short FNM.

I’m torn. It’s “unfair” for investors to enjoy privatized profits and, in the event of a catastrophe, socialized losses. But, at the same time, a collapse of Fannie and Freddie just cannot be allowed. I’m a firm believer in a free-market economy, but I find myself applauding the Fed for working overtime this past weekend. Part of me wants to mimic Jim Rogers and say “why should US taxpayers have to pay for this? Let them burn!”

But the pain and suffering that US homeowners would be dealt is not worth the satisfaction of Fannie and Freddie having a dose of their own medicine. The death of these GSEs (who collectively guarantee ½ of our nation’s mortgage debt) would send the US housing market into a depression. With the US economy teetering, that is simply not an option.

Disclosure: none

Comments

[Dan Walker:]

I share your dismay at seeing these two bailed out. However, I agree that allowing them to slide into the abyss is probably not an option and would more than likely append at least 3 years onto the current mortgage panic.

2008 Jul 16 05:40 AM

[fxtrader07:]

all this sudden care for the 'public well-being' displayed by hedgefund managers like rogers and ackman is pretty odd given their high personal interest in a failure and collapse of these companies. they are talking their books , plain and simple and listening to their suggestions and bailouts is a waste of time. acting on it means to hand them profits on a silver platter. jim rogers should simply enjoy his fat profits and otherwise shut up. he has moved to singapore, so what the heck has he to lose when fannie and freddie were to collapse? he couldn't care less. oh, the 'morak hazard' argument. sure, this is involved, but the average american citizen will gladly and rightly accept a moral hazard problem here as opposed to the alternative of a total crashing and collapse of the financial system and the u.s. economy.

2008 Jul 16 07:36 AM

[Macro Monitor:]

It amazes me to think about the logic of a GSE bail-out. Here’s the genius: if the economy (for lack of a better word) sucks and American's are loosing money on their houses, let's have the American taxpayers pay for it!!

2008 Jul 18 11:38 AM