[DEBATE] : Stunning use of Federal Power - Pearlstein on fannie-freddie seizure
Riaz K Tayob
riaz.tayob at gmail.com
Mon Sep 8 22:19:45 BST 2008
-------- 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:
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
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
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
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
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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