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Government Had To Take Custody Of Wayward Freddie And Fannie

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The Tampa Tribune

Published: September 9, 2008

Congratulations, or perhaps condolences, fellow taxpayers. On Sunday we all became mortgage bankers.

Plunging confidence in the housing and financial markets forced the federal government to seize control of its quasi-public mortgage agencies, Freddie Mac and Fannie Mae. The takeover will keep them from going under and pulling much of the financial world down with them.

Taxpayers assume all the risks to reassure the world that the United States remains a safe place to invest. The alternative is unthinkable.

The total costs of the bailout depend on how quickly housing prices recover from their present slump that has left many new buyers with big debts, no equity, and little incentive not to walk away.

One lesson from the outrageous failure is that neither the free market nor the government can see very far ahead.

In recent years the private managers of Freddie and Fannie began trying to maximize short-term returns by dealing in high-risk, low-quality loans. They needed ever-higher returns to lure more private money.

The government allowed the excesses because the money flowing in from all over the world allowed almost anyone to buy a house and realize the American dream.

U.S. Sen. Bill Nelson is right that both organizations were "seriously mismanaged and have been backstopping bad debt from a bunch of unethical mortgage lenders for years."

A major flaw in the model was the accurate assumption that the companies that handled half the nation's mortgages were too big to be allowed to fail. The implied federal guarantee led to risky innovations. Both stockholders and taxpayers went along, not knowing that the roof was about to fall.

James B. Lockhart, director of the Federal Housing Finance Agency, now in charge of Freddie and Fannie, says the executives running the mortgage giants "did not create the inherent conflict and flawed business model embedded in the enterprises' structure."

Maybe not, but no one can say they did a good job of protecting either their stockholders or the public interest. It is infuriating that the CEOs are now getting multimillion-dollar severance packages.

Daniel Mudd, just ousted from Fannie Mae, explained in an interview last month that Fannie sold packages of mortgages worldwide to investors who didn't need to worry about the difference between Kansas and California.

"They have a security that's guaranteed by Fannie Mae," he said.

Wrong. It turns out to have been guaranteed by us taxpayers.

"One of the miracles of the U.S. housing system is that there are investors all over the world who are providing funds to invest in the U.S. mortgage market," he boasted. "That's a pretty good sign of strength."

A better sign of strength would be a CEO who recognized that his highly leveraged see-saw was about to break.

Treasury Secretary Henry Paulson promises a new philosophy. The companies "will no longer be managed with a strategy to maximize common shareholder returns."

That's no big surprise. The new shareholders are no one important, just common taxpayers.

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