Opinion: Fanning the Fannie/Freddie flames

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Noting the housing bill that House and Senate negotiators were rushing to complete last week, my colleague and intellectual superior Tim Cavanaugh asked in a recent post why taxpayers should foot the bill for bailing out Fannie Mae and Freddie Mac. President Bush signed the measure this morning, so there’s no turning back now. But I thought I’d try to answer Tim by saying he asked the wrong question.

Fannie and Freddie were created by Washington to serve a mission dictated by Washington with policies largely dictated by Washington. They operated with the implicit backing of the federal government. It’s wildly unrealistic to think that either institution could run into financial trouble without the feds rushing to the rescue. So when Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke announced their proposal to extend bigger credit lines to the companies and possibly buy some of their shares, they were merely making explicit a promise long understood by investors (and policymakers).

Rather than debating the merits of propping up Fannie and Freddie, we’re better off figuring out how to get them through the downturn intact. Then we can debate what role they should play, if any, in the future. The panicky run on their shares reflect investors’ fear of dilution (as Fannie and Freddie sell huge numbers of shares to raise capital) or nationalization (in the event of a government rescue) more than any worries about insolvency. Yes, their capital reserves are low in comparison to their exposure. Yet it would take a huge wave of foreclosures to burn through those funds. By stopping the run on the companies’ stocks, the actions by Treasury, the Fed and Congress should make it easier for them to raise more capital and gird against larger losses. Oh and yes, the bill includes important and overdue improvements in the feds’ oversight of Fannie and Freddie.

So, Tim, as much as I’d like your every wish to come true, I don’t think we’re watching ‘the U.S. government commit collective suicide.’ Well, not on this issue, at least. But the housing mess hasn’t hit bottom yet, and Congress just raised the FHA’s potential exposure by hundreds of billions of dollars. So don’t give up hope.

Photo courtesy of AP/Manuel Balce Ceneta