Bill Steigerwald Bill Steigerwald, 7/12/2008 [Archive]

Explaining Fannie Freddie -- Interview

Fannie & Freddie Explained

Well, subprime housing fans, it looks like we better start learning about Fannie Mae and Freddie Mac. They aren't a dead vaudeville team. These so-called "government-sponsored entities" (GSEs) are massive stockholder-owned financial corporations that are authorized to make housing loans and loan guarantees.

Fannie Mae is the acronym for the New Deal-spawned Federal National Mortgage Association and Freddie Mac is short for the Federal Home Loan Mortgage Corp. Designed to inject liquidity into the housing market by buying mortgages on the secondary market, pooling them, and selling them as mortgage-backed securities, they have between them nearly $5 trillion worth of mortgage-backed securities -- nearly half of all outstanding U.S. home-mortgage debt.

Unfortunately, the stock prices of Fannie Mae and Freddie Mac each have plummeted more than 80 percent in the last year, and some money men on Wall Street and in Washington now are afraid that the companies could be insolvent or in need of a major government (taxpayer) bailout.

To help us understand this latest fiasco, on Thursday night I called Peter J. Wallison, an American Enterprise Institute fellow and former Reagan administration Treasury Department hand whose many books include "Nationalizing Mortgage Risk: The Growth of Fannie Mae and Freddie Mac":

Q: What's the difference between Fannie Mae and Freddie Mac?

A: None. No difference. They are the same.

Q: Why is the government on the hook for Fannie Mae and Freddie Mac?

A: Because government-sponsored enterprises are thought by people in the market to be backed implicitly, not explicitly, by the U.S. government. They think that if there is a problem with a corporation that the government has chartered that the government will stand behind that corporation's obligations. That's why the U.S. government is involved -- and in fact, yes, the government is going to have to stand behind their obligations.

Q: Is it you who has said these are two of the most powerful companies in the country?

A: Yes. They are.

Q: And it's because they have so much money, so much political clout, so much influence?

A: All of that. They are very powerful in Congress and they have always succeeded in evading real controls. There is now on the floor of the Senate a bill that contains a much stronger regulatory authority for Fannie Mae and Freddie Mac. It creates a new regulator for them and gives that regulator real power -- power something like a regulator of banks would have. If that could get passed, that would be a big step forward.

Q: What is it that Fannie Mae and Freddie Mac have been doing wrong that has led to their stock price falling 80 percent or 90 percent in the last year?

A: (Laughs) Oh, wow. What a question. They are invested almost entirely in mortgages. They never had very much capital because, as I said, they have been very powerful and they are able to influence Congress. So that what little regulation they had did not require them to hold much in the way of capital. So, if you have a very small amount of capital, and you suffer some major losses, which is happening because, as you know, the housing market is not doing particularly well and people are defaulting on their mortgages, Fannie Mae and Freddie Mac are suffering losses. It's possible, though not likely, that they will become insolvent. That's the thing that everyone is worried about.

Q: Do you think they are insolvent?

A: I have no idea. Their regulator says they are not insolvent. I'm certainly not one who would be able to say -- I don't think anyone is able to say -- whether they are in fact insolvent. It all depends on how you value their mortgages.

Q: If they were to become insolvent, what would that portend for the housing market or the economy at large?

A: Well, it'd be an absolutely gigantic problem if they became insolvent. If they became insolvent, someone has to begin to pay off their debt. That means the U.S. government, so it would be a huge amount of money the U.S. government would have to put out over time to meet their obligations. There isn't in my view -- and I say this, it's my view -- any possibility that they can be allowed to default on any of their obligations.

Q: So they're "too big to fail," as they say?

A: It's not a question of being big. It's a question of who is holding their obligations and their importance to the housing market. Their obligations are held by banks all over the country and are held by central banks in other countries. Right now they are the only buyers in the housing market, so if they were not functioning, the mortgage market would come to an end. It would stop. And that would mean that people wouldn't be able to buy or sell houses. So it's essential that they be kept operating and the government will have to step in and do that -- if they become insolvent. I have no way of knowing if that will happen, but because they have so little capital, it's a possibility if there continue to be losses in mortgages which they hold.

Q: Do you point a finger or fingers at who or what is to blame for this problem?

A: Yes, it's called the U.S. Congress. First of all, because they established these organizations and took responsibility for them basically by making them government-sponsored enterprises. And then even though the law says that the U.S. government is not responsible for their debts, they allowed people to assume that the government is going to be responsible for their debts. No one ever took any steps to deny that. And Congress has continuously called on Fannie Mae and Freddie Mac to make investments in housing that have not turned out to be good investments. The only reason they make those investments is that they know that Congress will ultimately back them up. Congress is responsible. Administrations are responsible over 20 or 30 years and now we are in a bit of a pickle.

Q: What should be done immediately and what should be done in the longer run?

A: Immediately the Senate ought to pass the bill it is debating right now on GSE regulation. That should be the first order of business. It is attached to a housing bill and the housing bill is very controversial and the president says he will veto it. So if it's attached to a housing bill, there will be no GSE bill. So the most important thing for the people in the Senate to do is to sever the GSE bill from the housing bill and pass the GSE bill separately. That would be a good short-term move. That would show people in the markets that the government is finally getting serious about regulating and controlling Fannie Mae and Freddie Mac and the risks that they take. Long run? I don't even want to get into that.

Q: You are a fan of privatizing them, correct?

A: I am a fan of privatizing them. I would protest against setting up any more government-sponsored enterprises. It was a stupid idea to begin with and it is now coming home to roost.

Bill Steigerwald is a columnist at the Pittsburgh Tribune-Review. E-mail Bill at© Pittsburgh Tribune-Review, All Rights Reserved.

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