Fannie Mae and Freddie Mac

Today the US Government took over the two credit extension companies Fannie Mae and Freddie Mac placing them into conservatorship. Which is a gentle form of bankruptcy and Chapter 11. It means that tax payers now explicitly back the credit those companies extend, including their existing liabilities, rather than implicitly and on the nod before. According to Big Picture this means that:

The conservator's goals are to (1) put the company in a sound and solvent condition, and (2) carry on the company's business and preserve and conserve the assets and property of the company.

Tax payer money is being used to buy the mortgage backed securities the two companies own. According to Jim Rogers, those that read the prospectus of the two companies knew they were over extended and were going to fail.

The subprime mortgage market was a bad idea. The US also has the process of those that give the mortgage then selling them off to another company. This divorces the lender from collection and is one reason why this has turned into such a schmozzle. It is not a big deal if you collect the mortgage fees on the package and then rid yourself of the worry of debt collection.

I am not sure if the cost to the US taxpayer is five trillion or half a trillion; there does not seem to be concrete data on this. If it is five trillion that is the current US national debt. For perspective, even half a trillion is more than the farming subsidy bill amount and more than what the US pays for its military year to year.

The US Government is a debtor nation already so to pay for this i is likely that more money will be printed which means greater inflation pressure. This has been the policy of the central bank in the US for a while now. I doubt that will change. For the taxpaying American that will be the most obvious outcome of the current policies; increased or continuing high inflation
Update - Around the Australian commentators, Gary Sauer-Thompson argues it punctures the free market illusions and aspirations of the US Republican Party:

This must sound like socialism to Wall Street and the free market Republicans whose rhetoric is that "small government" is a virtue. Didn't the Republican convention include countless attacks on big government? Yet here we have the Republican Bush administration nationalizes a major industry! The illusions need puncturing.

John Quiggin writes that this is the end of neo-liberalism. The US financial sector was allowed to innovate into the mortgage market with minimal regulation and ended up putting pressure on the stability of the financial system instead:

On the other hand, the fact that the credit crisis has reached this point marks the failure of the central claim of the neoliberal program, namely that private capital markets, free from intrusive government regulation, can enable individuals and households to handle the risks they face more flexibly and efficiently than a social-democratic welfare state.

Joshua Gans is left defending his AussieMac proposal in the light of the failure of the US institutions. He argues the difference is that the backing from the government is explicit not implicit like it was from Freddie Mac and Fannie Mae (until today). Somehow it is assumed this will stop AussieMac purchasing high risk debt?

In our mind, it is the implicit guarantee that is the issue and when you recognise the causes of imperfection in markets -- namely, information asymmetry -- you realise that being explicit is the way to go and the way to improve efficiency. So to spend time attacking Freddie and Fannie is not particularly useful for the Australian debate.

In which case it would be better not to call the proposal AussieMac and instead call it something closer to the intent such as the National Mortgage Bank of Australia. There were Australian bank exposures to the bundling, selling and repurchasing of high risk debt, but not in the manner there was in the US. Under a free market bad companies are supposed to fail and cease to be viable competitors on the market. So Fannie Mae and Freddie Mac should fail rather than be bundled out with external money - in this case US taxpayers.

JC at Thoughts on Freedom notes incredulously:

These schleps were leveraged 35:1! And the senior staff received large bonuses for writing business and expanding the balance sheet.

Internationally, the Cunning Realist laments where the burden will fall:

Who will pay for this? Nominally, every taxpayer. But in real terms and disproportionately, the prudent will pay via inflation. ... If people really understood what was going on here - essentially a system of "soft slavery" in which an ever-increasing amount of one's daily labor subsidizes Wall Street and the speculator class via inflation and the socialization of risk - they'd be in the street. Of course very few do understand it, which is what policymakers count on.

I am not so cynical yet, but it is hard not to be disheartened.
cam 2008-09-07 17:01:34.0
adam : Good riddance. I guess this makes me a neo-liberal ultra, but this was LBJ-era Enronomics. Fannie and Freddie were setup under FDR as fully government backed corporations, but then moved off the balance sheet in 1968. That moral hazard was always prone to ending in tears, and they were very much part of the problem in the latter days of the mortgage market.

I don't think debt securitisation itself was a problem, but the assumption there was no price distortion introduced with each layer was ...
cam : Judging from what Treasury said they are treating it like Chapter 11 bankrupcy where they clean up the books and then hand it back again. So the Macs may go back to being implicitly backed. I think 12 months was the timeline.

Not that you can take anything this mob says for granted. They will happily say one thing and do another.
adam : Paulson won't be there by then - but he was not keen to go back to business as usual.

Mr. Paulson signaled that he wants to remake the U.S. housing-finance system in the longer term, ditching the "flawed business model" of government-sponsored enterprises like Fannie and Freddie. The Treasury plan limits the size of each company's mortgage portfolios to a maximum of $850 billion as of the end of 2009. (Fannie currently owns about $758 billion of mortgages and related securities, while Freddie's total is about $798 billion.) After that, the Treasury intends for the mortgage holdings to shrink about 10% a year until they reach about $250 billion at each company.
cam : I don't know with this lot. They say stuff without any intention of doing it. I will believe it when I see it.
cam : rofl:

Who could have forecast that it would be under the Bush administration, which talked about restraining the growth of these behemoths, that they came to totally dominate the mortgage markets? Now the administration wants to have it both ways in that area as well. Fannie and Freddie are ordered to start shrinking - in 2010, after a new president will be in office. Until then, they are supposed to grow.

I don't think the Bush Administration will do a thing other than beg for more money and more money.
cam : This post by DeLong places Paulson as more independent of the Bush Administration:

This deal seems to me to be motivated by five things:

Paulson's desire to make sure that there is no way in hell that either Fannie or Freddie can ever be adjudged insolvent according to GAAP--which would trigger all kinds of bond-market unpleasantness.

Palson's desire to make sure that there is no way in hell that either Fannie or Freddie will wind up illiquid--out of cash.

Paulson's desire to make sure that there is no way in hell that Fannie Mae's and Freddie Mac's stockholders profit substantially out of this.

Paulson's desire to make sure that there is no way in hell that the CBO can calculate that this deal is likely to cost the government money--if CBO threatens to so conclude, he can always up the commitment fee.

Paulson's desire to keep the options open for his successor to shape the long-term debate about how to restructure these GSEs.
adam : I think it's worth remembering Paulson was appointed fairly late in the administration after Bush's ratings were through the floor. He is a former CEO of Goldman, and looks like a non-controversial technocrat appointment ala John Roberts on the Supreme Court, rather than the partisan specials we have become more familiar with at the Bush court. None of this is policy he set.

And now gets to be the best paid janitor in the Whitehouse, cleaning up the credit mess. He's not doing too bad. I'm a bit more critical of Bernanke because I think loose money exacerbated this whole crisis.