The U.S. government seizes Fannie and Freddie

What happened

In a high-stakes bid to stabilize the housing market and bolster the economy, the federal government this week seized Fannie Mae and Freddie Mac, the two giant lenders that together own or guarantee nearly half of the nation’s $12 trillion in home loans. The value of those loans has deteriorated as home prices have plummeted and foreclosures have skyrocketed, jeopardizing the two companies’ ability to repay their debts. U.S. financial institutions and foreign central banks hold billions of dollars worth of securities issued by Fannie Mae and Freddie Mac, and the failure of the two big lenders could have unleashed a global financial meltdown.

Under the terms of the deal, engineered by Treasury Secretary Henry Paulson, the U.S. Treasury will buy up to 80 percent of the two companies’ stock and take over their debts. To keep money flowing into the housing market, Fannie and Freddie will continue until 2010 to buy mortgages issued by other lenders, which recycle the proceeds into new loans. But to curb the companies’ influence over the mortgage market, the government will reduce their mortgage portfolios by 10 percent a year beginning in 2011, until their holdings total $250 billion each. Many economists said that the takeover was “necessary” but risky. “The bottom line,” said Richard Yamarone of Argus Research, “is that the American taxpayer is left footing the bill.”

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What the editorials said

One of the most “welcome” features of the rescue is that Fannie and Freddie are now barred from lobbying Congress, said The Christian Science Monitor. Fannie and Freddie doled out millions to members of Congress to ensure that they operated with little federal oversight or regulation. Free to do what they wanted, the companies’ executives recklessly supported bad loans to people with weak credit, creating the housing bubble that has now burst.

The bailout has calmed financial markets, said The Wall Street Journal, but “is one of the great political scandals of our age.” It was clear for years that Fannie and Freddie’s “perverse” business model, in which private stockholders got the profits while taxpayers assumed the risk, would lead to the very disaster that has now occurred. As soon as possible, the two companies should be liquidated, once and for all.

What the columnists said

Getting rid of Freddie and Fannie would be a serious mistake, said Steven Rattner in The Washington Post. True, Congress encouraged the companies to get too big and make imprudent loans. But advocates of shutting them down are forgetting the “compelling” reason they were created in the first place: to ensure a steady flow of mortgage money in “difficult times” like the present. Fannie and Freddie should be reconstituted as federally owned entities with the “limited” role of “underpinning the private providers of mortgage credit rather than competing with them.”

Even this bailout won’t stop the slide in home prices, said Irwin Kellner in Marketwatch.com. Housing prices are falling because there are “too many houses for sale at prices well above” what buyers will pay. To stop the slide, we need a federal agency that will “put a floor under housing prices” by offering to buy all the homes in a given area at a fixed price. Until that happens, we can’t be sure the rescue has done anything but buy the feds a little more time.

Taking over Fannie and Freddie was “the right thing to do,” but it won’t turn the economy around, said Paul Krugman in The New York Times. All the major banks and financial institutions are now highly leveraged, and as the value of their assets declines, they’re selling them off at the same time—further reducing the assets’ value. It’s a vicious cycle, and as losses mount and unemployment hits a five-year high, our imploding economy now “bears a strong resemblance to the crisis that hit Japan at the end of the 1980s.” That crisis lasted for a decade.

What next?

Connecticut Democrat Christopher Dodd, chairman of the Senate Banking Committee, this week announced hearings on the takeover. The panel is likely to question the multimillion-dollar severance packages granted to Fannie Mae CEO Daniel Mudd and Freddie Mac CEO Richard Syron. “It’s just another example of pay for failure,” said Amy Borrus of the Council of Institutional Investors.