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The Fed Buys What No One Else Wants

The proposed rescue of Fannie Mae and Freddie Mac makes no sense.

Both companies are mortgage bundlers and investors.

They buy mortgages from other lenders and securitize them. They hold some for investment and sell some to others. They guarantee payments on the mortgage-backed securities they sell to others. And they buy for investment mortgage-backed securities from other bundlers.

Recently, the stock prices for Fannie and Freddie fell precipitously, to roughly a quarter of their previous peak. That represents a sharply revised judgment by investors about the value of Fannie and Freddie's business model and activities.

That's too bad for holders of Fannie and Freddie stock. But in and of itself, it doesn't represent a systemic economic threat warranting the intervention of the federal government.

Other financial institutions do hold mortgage-backed securities guaranteed by Fannie and Freddie. If Fannie and Freddie's financial condition deteriorates to the point of raising questions about their ability to make good on their guarantees, that would reduce the value of securities they have sold to others. And that could reduce the capital of other financial institutions.

But the effect should be minor. The mortgage-backed securities guaranteed by Fannie and Freddie are the good stuff. The mortgagors are all credit worthy and made healthy down payments. The securities are ultimately backed by the properties mortgaged. Even without Fannie or Freddie's guarantee, losses should be minimal.

After all, even including the bad stuff, 92 percent of all mortgages in the United States remain current. Losses in Fannie and Freddie securities are currently running at just a fraction of a percent.

Nevertheless, the Bush administration has proposed that Fannie and Freddie be given an unlimited line of credit from the federal government and that the federal government be permitted to contribute equity if Fannie and Freddie have capital problems. Congress appears likely to go along.

In the meantime, the Fed has agreed to lend to Fannie and Freddie as well.

Instead, Congress should phase out the existing $2.25 billion line of credit each enterprise has with the federal government over a period of, say, five years, and declare that Fannie and Freddie from that point on are on their own.

When Fannie Mae was formed in 1938, there was arguably a role for government to play in creating a secondary market for mortgages. Lending capital was scarce and fewer than half of all Americans lived in their own homes.
Fannie Mae was initially a government agency. It was sold to private investors in 1968, but retained a favored relationship with the federal government. Freddie Mac was formed in 1970, with the same favored relationship, to offer competition and choice.

Such government-sponsored entities are an anachronism today. Over two-thirds of Americans live in their own homes and, in a world of international finance, there is plenty of private sector interest in providing a secondary market for mortgages.

This rescue plan isn't about mitigating today's housing difficulties.

Nothing in the plan gets a mortgage paid that wouldn't otherwise be paid.

Nor is the rescue really about today's credit crunch, except for the minor effect a doubt about the reliability of Fannie and Freddie guarantees might have on the capital of other financial institutions.

Instead, it's about enabling Fannie and Freddie to continue to do even more of the same in the future, and that's a bad idea. The rescue plan makes an implicit federal guarantee for Fannie and Freddie explicit. This would give them an even greater competitive advantage, enlarging their already dangerously overlarge presence in the secondary mortgage market.

The Bush administration and Congress are moving toward a much larger federal role in the housing market.

Congressional Democrats propose that the federal government refinance some $300 billion in mortgages, while the Bush administration wants to open the federal checking account to Fannie and Freddie and perhaps invest in them.

Meanwhile, the Fed's balance sheet is getting corrupted with junk that others won't buy or lend against.
All this is to keep the housing market propped up at a time in which the market is screaming, about as loudly as it can: THERE'S BEEN AN OVERINVESTMENT IN HOUSING.

What the politicians propose to do about our economic problems has been consistently more troubling than the problems themselves.

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Related Topics: bush | congress | economy | federal reserve | housing | treasury |

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