EDITORIAL: Bailing out Freddie and Fannie

By | Monday, July 21, 2008

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President Bush could not have been more wrong in dismissing the term "bailout" being ascribed to his policy opening the door for mortgage monoliths Freddie Mac and Fannie Mae to borrow from the Federal Treasury to cover their losses during the mortgage-foreclosure crisis. Despite Mr. Bush's contention, it is a bailout. In fact, the bailout provision is written into the charter of the two hybrid-public-private companies.

At the very least, announcing the potential for the bailout sent shock waves. In offering the two companies the ability to borrow from the Treasury at rates as low as 2.5 percent, Fannie and Freddie will have the ability to increase their liquid capital, as the Wall Street Journal noted.

That cash infusion may just buy the two companies enough time to weather the growing storm of foreclosures, which jumped another 53 percent in June. And it will give investors a reason to hang in there, leaving their money with the company instead of calling in their loans. This is often referred to as "raiding the bank," as those who act first get paid and those who don't lose their shirts. That is what happened to Bear Stearns and IndyMac this year already. While IndyMac was small enough to let die, Bear Stearns was deemed simply too big to be allowed to collapse, and Fannie and Freddie are much bigger, with a potential debt liability of more than $5 trillion, owning about half of the $12 trillion U.S. mortgage market.

Economists have been warning Americans that this was possible since 2002, when it became clear that the "housing boom," accelerated by the use of risky loans to help consumers pay inflated prices, was fattening up Fannie and Freddie to the point off bursting. "Lenders should recognize that there are repercussions for risky loans, and borrowers should realize that there are consequences for taking loans they can't repay. If it's financial collapse, or having your house foreclosed - so be it," said the Libertarian Party this week. And in an altruistic environment they are right. When a company gets overextended, owing more than it has in the bank and subsequently yielding low investment returns or losing them outright, it dies. But that can't happen here.

Fannie and Freddie are responsible for millions of mortgages bought by responsible homeowners who couldn't get a home mortgage in the marketplace. And if they were allowed to fail. who would buy up and guarantee the trillions of dollars in mortgages they own? The American taxpayer. Knowing that the government would be on the hook if there were a collapse is what got us here, whether is was implied, expressed or hinted. If the two companies manage to survive this without doubling the national debt, serious regulation and massive downsizing must be on the front burner.

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