July 13, 2008
The Fannie and Freddie assistance plan
I see much to like about this.
From the New York Times:
the Bush administration will ask Congress to approve a rescue package that would give the government the authority to buy billions of dollars in stock in Fannie Mae and Freddie Mac and also lend to the companies to meet their short-term funding needs....
Separately, the Federal Reserve voted on Sunday to also open a lending facility for Fannie Mae and Freddie Mac, if they need emergency capital. The two companies would be able to post their own securities as collateral.
The plan calls on Congress to give the government the authority over the next two years to buy an unspecified amount of stock in the two companies. Over the same period of time, it would permit the companies to have greater access to the Treasury, by expanding the credit line that each company has from the Treasury. Each company now has a $2.25 billion credit line, set nearly 40 years ago by Congress. At the time, Fannie had only about $15 billion in outstanding debt. It now has total debt of about $800 billion, while Freddie has about $740 billion....
As part of the plan, the administration will also call on Congress to raise the national debt limit, people briefed on the plan said. And it will ask Congress to give the Federal Reserve a role in setting the rules for how big a capital cushion each company must hold.
The first thing I like about this plan is the fact that the ultimate determination of the level of risks to be absorbed by the federal government is being left to Congress. How much risk there is to the taxpayers in the various new lending facilities introduced by the Fed is subject to some debate, but that there is some risk, and that new loans from the Fed to the GSEs would increase this risk, is indisputable. One of the clearest lessons from history is that the fiscal and monetary functions of the government must remain separate. Pretending that we can deal with these problems with money creation rather than tax increases is too tempting to allow that door to be opened any further.
The second thing I like about the plan is that such action by Congress would take the form of a dollar limit-- here's how much we're willing to stake, and no more-- with residual losses presumably laid on the GSE creditors. I've argued that's exactly the way the debate needs to be framed. Parenthetically, I can't resist repeating here my suggestion that this is also exactly the approach we should be adopting for ever-growing federal health-care expenditures-- let Congress decide how much it's willing to spend rather than generate a wish list of all the things it would like to accomplish.
Granted, action by Congress can be a cumbersome process, often painful to watch. This I presume is why the plan includes a promise by the Fed to provide immediate lending, if needed, which I'm seeing as a kind of bridge loan. I would assume that may be quite a necessary and appropriate element of the plan.
I've railed before at the way politicians sometimes treat the debt limit as a political football, and I suppose there's a danger of that here. This is a subtle issue, to be sure, requiring balancing an unknown risk of large fiscal loss against an unknown risk of spectacular financial catastrophe. Congress may get it wrong. But ultimately this is a decision to be made by elected representatives who can be held accountable for the outcome, one way or the other.
For my part, I urge Congress to say yes.
Posted by James Hamilton at July 13, 2008 07:53 PMdigg this | reddit
Listed below are links to weblogs that reference The Fannie and Freddie assistance plan:
Tracked on July 16, 2008 11:33 AM
While I appreciate your position, Jim, from a practical standpoint, this is a disaster.
It's an election year. Congress will vote to avoid having a catastrophe, which means that they will vote to fully support Fannie and Freddie. The problem is that moral hazard is high and rising.
* The Fed decision to take dodgy paper as collateral was the first step down a slippery slope.
* The Bear bailout/wipeout was a second step down that slope, being plainly outside the Fed mandate.
* During this year, bad debt was piled onto Agency books-- socialism at its very worst-- as what looks like a corrupt scheme orchestrated at very high levels.
With Fannie and Freddie, we are seeing how completely socialistic the corporate right is. Not only did they dump bad debt onto their books, now they want us to make whole the bondholders and the shareholders of Fannie and Freddie and turn them into state enterprises.
On the one had, we have people who were defrauded in their mortgages being dumped into the street. On the other, we have corporations who did the defrauding backing their trucks up to the Treasury to make a withdrawal of taxpayer money.
We all want a solution that does not crash the banking or mortgage systems. But this deal increasingly looks like a huge payoff to wealthy crooks.
Posted by: Charles at July 13, 2008 11:06 PM
Time was, if you wanted a Charter from the State to sell tea or do other business, you paid for the privelege, rather than got a subsidy. Here we subsidized the GSEs to become Too Big to Fail.
Negative license fee.
What would happen if we chopped Fannie and Freddie into 20 pieces each -- arbitrarily, perhaps, by the last digit of their securities' CUSIPs -- and totally cut them loose? Investors could expect that SOME of their loans would be subject to SOME losses, but the magnitude and timing of them would be diffuse, minor and gradual -- enough for the Feds to dodge responsibility without throwing banks and other central banks into the crisis.
Various posts have railed against the failure of risk management -- chiefly, too little equity -- but it seems that the only certain risk management is holding 100% of loans in T-bonds in case of total losses on loans. This is of course ridiculous, but any lower number is just a claim that 20% of loans, or 50% of loans would always be enough, whereas others thought 5% was fine, tho it wasn't. In truth, one can never be 100% certain of the total losses and lenders and shareholders normally face up to that reality in exchange for the profits or yields that they make in absence of default.
Finally, I find it interesting/noteworthy that these problems arise from contagion from the sub-Fannie/Freddie-quality loans. How is it that they have not been written down to zero and yet the higher quality institutions are in deep trouble? If the GSEs are in trouble, I'd think we'll see many quarters of losses at institutions that hold any flavor of mortgage.
Posted by: Walt French at July 14, 2008 12:05 AM
"The second thing I like about the plan is that such action by Congress would take the form of a dollar limit-- here's how much we're willing to stake, and no more-- with residual losses presumably laid on the GSE creditors. "
I certainly like that part in theory, but what will the dollar limit be? 100 billion? 500 billion?
Posted by: a at July 14, 2008 01:25 AM
What role, if any, do you feel that programs like the 'Community Reinvestment Act' play in this sub-prime mess?
Do you feel that quasi-governmental agencies like Fannie Mae and Freddie Mac contribute to this problem just because they are a chimera whose existence creates a moral hazard?
Posted by: Babinich at July 14, 2008 02:56 AM
This is an awful solution - actually no solution at all. What it amounts to is there will be no change in Fannie Mae but we will return the federal government into owners of Fannie Mae like it was before 1968. Of course in 1968 when Fannie was made a "private" company the reason was to get it out of the budget of the government and now that the government will make itself the major stock holder in the company they will still leave it off out of the budget. Now they can claim this failed adventure as an asset because they (we) will own its worthless stock. What will prevent the stock from falling another 80%?
This plan solves nothing. It is like taking a broken leg by covering all the bruising and discoloration with makeup and calling it fixed.
Just like Social Security and so many of the other New Deal Ponzi schemes thta still hang around out necks, they/we are in trouble but just can't admit it. It is looking more and more like we are the generation that must pay the piper.
Posted by: DickF at July 14, 2008 05:51 AM
Here is my worry about this whole mess. We bail out BIG companies while we let little ones like IndyMAC fail. If we are going to be bailing out banks shouldn't we do it in a fair an uniform way? I am sure this morning the people who bank and do business with IndyMac feel slighted. I am sure they would have liked to have been spared the hassle of their bank going under.
Sure Fannie Mae and Freddie Mac don't have branches and interact with customers directly, however the signal this sends to the American public is if a company is big enough you can run it as poorly as you like. I thought the whole point of having a market was for competition and that competition would ensure that companies would be as efficient as possible. Here both FM's have been run poorly by taking on too much risk and getting into trouble. Small business owners don't have that luxury of a bail out.
So I am against the bail out and agree with Walt that chopping them into pieces would be a much better solution. Because it send the message that if you get too big and take on too much risk, then you won't be here tomorrow.
Another point. Quasi-governmental agencies seem to me as a perilous venture for the American people. If we want it privatized, then treat it like a private entity. If we want it to be a governmental agency, then do that.
Posted by: Ed at July 14, 2008 05:55 AM
IndyMac is (was) very large. The difference is that its deposits were explicitly insured up to $100k, and refusal to meet that insurance obligation would cause a horrible stir in the banking sector. The GSEs got big in part because of their relationship to the Federal government. For the government to walk away from the monsters it created would be irresponsible, but they are not insured by the federal government.
The moral hazard thingie already existed, and was part of the landscape. Efforts to reel the GSEs in began under Clinton, continued under Bush, and never got done. Now, calls to immediately impose a new regulatory regime on the GSEs looks like policy opportunism. New regulations are a great idea, but won't solve the current mess.
Posted by: Anonymous at July 14, 2008 06:16 AM
Calculated Risk has a very important perspective on the practical side of this. In his view, the real problem is that genuine government agencies were allowed to become private companies with federal guarantees. So, they facilitated (but did not initiate) bad loan practices. The money quote (so to speak):
Any "rescue" that doesn't wipe out the shareholders is simply making a bad thing worse.
The irony of the "subprime" situation, it seems to me, is that we probably all would have been better off if the GSEs had gotten into it in a big way. If the GSEs had been able to create a market in "vanilla" subprime--fixed rates, no prepayment penalties, careful documentation requirements, competitive pricing--and forced their seller/servicers into a "subprime box," the subprime loan market would have been a lot better off.
Posted by: Charles at July 14, 2008 07:25 AM
Apologies. The above quote is Tanta writing at the blog Calculated Risk.
Posted by: Charles at July 14, 2008 07:27 AM
i highly boubt that there will be any dollar limit.
such a move would spook creditors, send rates for GSE bonds skyrocketing and would upset creditors (chinese...) which could lead to less buying of us debt in the future.
Posted by: GreenAB at July 14, 2008 07:47 AM
This bailout of Freddie and Fannie counterproductive. Another congressional initiative, the Mortgage Bailout, will tax Freddie and Fannie to the tune of $530 million/ YEAR. So Congress wants to bail out an institution and tax it as well? What's going on? Call your senators/representatives and tell them: Back off the Mortgage Bailout Bill and Back off Bailing out Fannie and Freddie Mac!
Posted by: Michael at July 14, 2008 08:20 AM
Fannie and Freddie are both widely viewed as having been under capitalized (too high leverage) for years. Their managements have apparently resisted Congressional efforts to raise their capital requirements. If the Treasury is allowed to buy equity (provide the capital that they formerly resisted raising), this becomes poor economic management on an immense and uncontrolled scale. Where does it stop? If they can get capital, can large banks with problem loans get the Treasury to buy their equity? Who is next at the trough of our taxpayer money?
Fannie and Freddie have to be stabilized. They should get Fed loans for a while. But they should be split up into 6, 10, 15 competing mortgage banks, as several in this discussion have suggested. Competition is good for consumers and for the newly strengthened, split-up companies. The US has a great history of success with deregulation and creating competition out of former regulated industries.
If you agree with this notion, write your Senators, Congressman, and favorite Presidential candidate. Lets make something good happen out of this mess.
Posted by: Mike Laird at July 14, 2008 02:19 PM
While one doesn't want to reward risk taking, one also doesn't want to punish them for a problem the private market caused. Their problems are largely the result of easy private lending inflating real estate values that they had to lend on. Restricting such lending, while overdue, will do more to prevent a recurrence than changes in their structure.
Posted by: Lord at July 14, 2008 05:12 PM
What Congress needs to do is fire the privately owned and operated Federal Reserve and install a Public Central Bank that creates our money without debt.
There will be no way to keep the economy afloat without the government intervention of debt free money. Without debt free money deflation will ravage the country and the world.
Posted by: Michael McKinlay at July 14, 2008 05:45 PM
The private market didn't cause the problem with Fannie and Freddie. Every loan could be 100% and they would still have problems. This is a structural problem with Fannie and Freddie. They borrow long, tie up money for 30 years but are constantly hungry for more money to lend. Fannie on paper has 50% of all mortgages in the country and some estimate that with the current credit crunch this is up as high as 70%.
But what is congress doing? Last night I heard Barnie Frank suggest that we use Fannie to finance low income housing!!! What a foolish statement. Here you have an institution that is failing because it is over extended and he wants to expand its exposure. And to think his is the chairman who is running the committee responsible for this mess.
Posted by: DickF at July 15, 2008 04:52 AM
I read that China owns a large part of Fannie Mae and Freddie Mac. Is that why Bush wants to bail them out but said he will veto a bill to help out homeowners?
Posted by: Reta Pitcock at July 18, 2008 12:19 PM
"If we are going to be bailing out banks shouldn't we do it in a fair an uniform way?"
Fairness has no place in risk management, or a rescue mission. Firemen don't survey the whole site before decide which building to save, on a fairness basis. They save the buildings that will help save as many other buildings as possible. If you are a building sitting out at the fringe and won't cause any other building to burn, you are out of luck. Fairness just won't work.
By letting down IndyMac, some other companies will be affected, but not as many as the biggies. It is using the least amount of money to save the greatest amount of assets.
Posted by: Bill at July 20, 2008 12:41 PM