Ok. We read it 100 times in the past week. The message is clear on the part of U.S. Secretary Treasury Henry Paulson: Fannie Mae and Freddie Mac are too big to fail. As a result, the U.S. taxpayer will be required to lend them money. Watch out. Itâ€™s a round number: $25 billion for the taxpayers due in fiscal 2009-2010 according to Congress. Thatâ€™s how the â€śimplicit guaranteeâ€ť of the government becomes honestly very explicit. I just wrote a series of three articles on our site, summarizing the Fannie and Freddie mess that has unfolded over the past 10 days or so.
Clearly, the story of Fannie and Freddie is simple to summarize: an implicit government guarantee and an explicit double standard. For years, those two monsters made money for their shareholders because the government gave them a series of privileges no other financial company could ever dream of. I donâ€™t have a problem with making money, for instance, the way a hedge fund guy makes money. But with Fannie and Freddie, the art of making money is a bit more esoteric. It’s more like the art of having-your-cake-and-eating-it-too, so to speak. Let’s look at what Paulson himself nicely calls â€śthe dual mandateâ€ť of the two government sponsored entities. Here’s a summary: They donâ€™t pay state and local taxes. Instead, the taxpayer pays their bill when times are tough, like today. Their minimum capital requirement is ridiculously low, in fact, three times lower than what banks are subject to. The result: Those companies are almost insolvent. They just don’t have enough capital. They run their portfolio like there is no tomorrow, leveraging thirty to one times. You want to blame hedge funds. Look no further. Here is a pair of wild hedge fund cowboys. And the beauty of this is that they can buy assets very cheaply because it is assumedâ€”for good reasonâ€”that theyâ€™re too big to fail and that the government will bail them out.
Of course it will. We will. We, the taxpayers, are the last line of defense for a type of dizzy capitalism on the ropes, knocked out by the financial crisis. Itâ€™s a very creative form of capitalism, one that can easily flirt with socialism because if one follows Mr. Paulson logic, there will always be something too big for the government not to be the boss.
The string of recent bailouts proposed by the government suggests that free markets and wild capitalism are no longer fashionable words: mortgage bailout, student loan bailout, bank bailout/merger, Fannie and Freddie bailout.
This credit crisis in my view is a crisis of capitalism. The U.S. will either return to a free market–and that would imply, getting rid of anomalies such as Fannie and Freddie that date back from the New Deal. Or as many of us expect and fear, American financial institutions will face a much tougher regulatory oversight.
I am not so sure that the pendulum will swing toward regulation overkill. Rather, we may just cure our sick capitalism and hope for the end of those forced and dysfunctional unions between private enterprises and public interest. Translate: Kill Fannie and Freddie. They’re from another age.
But it does not look like anything very new is going to happen soon. We have too many monsters “too big to fail.” And right now, the regulators are focused on limiting freedom, such as the freedom to sell certain stocks in bad times. The idea is not really to empower the markets.
To be fair, the government has a tough job to do. They want to stop a potential disaster. We know and we understand the risk of not doing anything.
Fan and Fred have issued and guaranteed $5 trillion in debt and mortgage backed securities guarantees, out of which $3 trillion is held by U.S. banks and over $1.5 trillion by central banks all over the world. â€śBecause of their size and scope, Fannie and Freddie’s stability is critical to financial market stability,” said Mr. Paulson. You bet.
This government has been very good at explaining and addressing systemic risk. It came to the rescue of Bear Stearns & Co, Inc in March. As a result, the Federal Reserve Bank lent $29 billion to JP Morgan, Bearâ€™s acquirer. Now the Treasury wants to give unlimited credit to its darlings Fannie and Freddie. We understand the stakes. No one wants a Great Depression-like meltdown. But soon, we’ll understand the cost of those bailouts very well too.
How did we get there? How did the U.S., the heartland of capitalism, get to be such a financial mess, with the government feeding the growth of semi-public semi-private ogres? My question is: Why donâ€™t we have a competitive environment in place, one that would just as well fuel our mortgage market? It’s not forbidden to imagine a mortgage financing system made of several smaller institutions competing with one another, with no one too big to fail, in fact with the bad ones more likely to fail than the good ones. Anything wrong with that?
Of course itâ€™s time for a reform of Fannie and Freddie. If a system relies on private profits-slash-public liabilities, it screams for reform. Either privatize it altogetherâ€”why not? Or nationalize it. But itâ€™s unlikely that things will change in a deeper way anytime soon, so long as Fannie and Freddie remain what they are: lobbying bullies with a big heart when it comes to financing political campaign contributions in a positive, bipartisan spirit.
Whoever is willing in Washington to take on this challenge will have to bite the hand that feeds Capitol Hill. It’s hard to imagine it will ever happen. And yet, just like Wall Street engineered a toxic form of debt it now has to rid itself of, Washington at some point may be well-advised to do without its toxic politicized mortgage machine.Â