[DEBATE] : Stunning use of Federal Power - Pearlstein on fannie-freddie seizure

[Riaz K Tayob]

-------- Original Message -------- Subject:     Stunning use of Federal 
Power - Pearlstein on fannie-freddie seizure Date:     Mon, 08 Sep 2008 
18:24:09 +0200 From:     C.Raghavan <c.raghavan at bluewin.ch> To:     
undisclosed-recipients:;


In Crisis, Paulson's Stunning Use of Federal Power By Steven Pearlstein

Hurricane Hank swept through the nation's capital yesterday with 
gale-force regulatory winds and a tidal surge of federal cash, upending 
two of Washington's biggest enterprises and permanently changing the 
landscape of housing finance in America.

In wresting control of Fannie Mae and Freddie Mac, and in authorizing 
the Treasury to begin purchases of mortgage-backed securities, Secretary 
Henry M. Paulson Jr. has taken responsibility for assuring that 
low-interest loans will continue to flow into the country's hard-hit 
housing markets. Not since the early days of the Roosevelt 
administration, at the depth of the Great Depression, has the government 
taken such a direct role in the workings of the financial system.

Although the details of yesterday's takeover are complex, the rationale 
is quite simple: to restore some semblance of normalcy to the housing 
market. Paulson and other policymakers think that until that happens, 
neither financial markets nor the wider economy will be able to regain 
their footing.

Fannie and Freddie did not go gently into conservatorship. Although 
their access to badly needed equity capital had dried up and their 
borrowing costs had increased, they had hoped that they could muddle 
through by raising fees and demanding higher interest rates from 
borrowers. But that plan was cut short when Paulson, backed by Fed 
Chairman Ben Bernanke and their newly empowered regulator, James 
Lockhart, concluded that Fannie and Freddie could no longer reconcile 
their sometimes-conflicting obligations to shareholders and homeowners 
without posing additional risks to an already shaken financial system.

Fannie and Freddie could have fought the government in court, but that 
wasn't much of an option for companies whose business model was based on 
the perception that they were backed by the government. The market would 
have shut them down long before the first briefs were filed.

Under the deal they could not refuse, Fannie and Freddie directors and 
top executives will lose their jobs. Shareholders will lose their 
dividends, voting rights and most of their ownership stake, while 
agreeing to pay dearly for the government's money and backing. Left 
unharmed will be holders of trillions of dollars in Fannie and Freddie 
debt -- or securities backed by mortgages that Fannie and Freddie have 
insured against default -- who will get all their money back, with 
interest.

In figuring out where all this goes, it is useful to understand how we 
got to this point.

Until this weekend, Fannie and Freddie have been unique entities -- 
for-profit, shareholder-owned companies that were required by government 
charters to provide low-cost capital to secondary mortgage markets in 
good times and bad. And for most of the past 40 years, the companies 
have managed to balance those missions fairly successfully. Shareholders 
have earned a better-than-average return on their investment, while 
homeowners have had access to mortgages that not only have lower rates 
than in other countries, but rates that they can lock in for up to 30 
years.

But in the mid-1990s, things began to change. Rather than being 
satisfied with modest growth, Fannie and then Freddie began promising 
Wall Street double-digit earnings growth, which required them to grow 
their balance sheets well beyond what was necessary to assure liquidity 
in the mortgage market. Instead of just buying mortgages, insuring them 
and selling them in packages to investors, they bought more of them for 
their own portfolios, using ever-increasing amounts of borrowed money. 
Buying their own securities was profitable, but it left them highly 
exposed if anything went really wrong with the housing market, which is 
exactly what has happened.

By 2005, however, Fannie and Freddie found they were losing market share 
to private competitors offering new, highly profitable mortgage products 
that they had generally ignored -- variable-rate mortgages to homeowners 
with poor credit histories who offered little or no documentation and 
borrowed more than 80 percent of the estimated value of their property. 
To varying degrees, Fannie and Freddie decided to jump into these 
markets, both by insuring and packaging these mortgages and keeping some 
of them on their own books. That decision, too, has now come back to 
haunt them.

It is fair to blame Fannie and Freddie executives for these 
misjudgments, although they were no more misguided than others in the 
industry. Some of the blame also goes to Fannie and Freddie's regulators 
-- both Lockhart and his predecessor -- who failed to use their limited 
powers to rein in the companies' growth. And a good chunk of the 
responsibility should be assigned to elected politicians -- the Clinton 
and Bush administrations, which encouraged the jump into the subprime 
market by imposing more ambitious "affordable housing" goals on the 
companies, and Congress, which spent much of the past eight years locked 
in a bitter ideological battle over Fannie and Freddie rather than 
giving their regulator the stronger powers and mandate that it needed.

It will now take several years at least for Fannie and Freddie to dig 
out of their financial holes, even with the infusion of taxpayer money. 
But that will not resolve the long-standing question of whether a 
for-profit company with some sort of government backing is the best way 
to assure a steady flow of low-cost capital to the housing markets.

The crisis reminds us that, left on its own, the private sector will 
over-invest when the housing market is hot and then abandon the market 
when boom turns to bust. That's why Fannie and Freddie were invented, 
and why keeping them afloat now is crucial.

But the lesson from the recent debacle is that if we are going to rely 
on government to bail out private entities, then government ought to 
have a much stronger hand in making sure a rescue is never needed. © 
2008 The Washington Post Company

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