No safety net for Fannie and Freddie
In the wake of scandals, Congress should follow the Bush administration to take bolder action.
It is received wisdom on Wall Street that the federal government would bail out Fannie Mae and Freddie Mac if they could not pay their debts – even though they are for-profit, privately owned mortgage finance companies. That's because they were specially created by the federal government to encourage homeownership.
This is received wisdom notwithstanding required language on Fannie and Freddie securities that they are "not guaranteed by the United States and do not constitute a debt or obligation of the United States," and it allows Fannie and Freddie to borrow money more cheaply than other private companies because they are perceived as low-risk borrowers.
Fannie and Freddie had been the darlings of Wall Street as they reported growth and profits year after year by borrowing money at low rates and using it to purchase residential mortgages that pay interest at higher rates. But the seemingly remote possibility of a bailout has become more likely as wave after wave of accounting scandals involving the misstatement of earnings sweep over the two companies.
The risk that these scandals pose has been compounded by the fact that Fannie and Freddie's hedging strategies expose them to serious risks: If the interest payments that the two companies owe to their lenders become mismatched with the interest payments they receive from homeowners whose mortgages they own, the companies can become insolvent. While only a handful of policy wonks focus on this arcane issue, the cost to taxpayers of a bailout could be hundreds of billions of dollars, easily dwarfing the cost of the Savings and Loan crisis of the 1980s. Hundreds of billions of dollars: That figure should make taxpayers sit up and take notice.