- The Washington Times - Wednesday, August 10, 2005

In a recent article in this newspaper(“Fannie Today, Citigroup Tomorrow?”), James Miller III issued a strong warning to conservatives. Watch out!

Congress is about to do to Fannie Mae and Freddie Mac, the two mortgage giants, what the Supreme Court did when it approved in June the right of a city to use its eminent domain authority to arrange for the transference of property from one private party to another (Kelo v. City of New London). In seeking to “downsize” Fannie and Freddie, Mr. Miller contends that Congress, in effect, will be acting similarly to the Supreme Court by approving governmental action that sanctions the transfer of shareholder value from one private party to another.

For Mr. Miller, the legal status issues for Fannie and Freddie are simple. They are private and similar to Citigroup and Bank of America. Thus the warning in the title, first Fannie, then Citigroup. To Mr. Miller, conservatives should view the efforts by Congress to place limitations on Fannie as a direct assault on the property rights of the private sector. In this attempt to stir up the fears of conservatives, Mr. Miller, self-identified as a consultant for Freddie Mac, is dead wrong.

Fannie and Freddie are not purely private corporations and the citizen/taxpayers of the United States have a direct fiduciary interest in their policies and practices. Fannie and Freddie are government-sponsored enterprises (GSE). A GSE is a congressionally chartered,shareholder owned financial institution with nationwide scope and specialized lending powers that benefits from an implicit federal guarantee to enhance its ability to borrow money.

Citigroup and Bank of America, on the other hand, are not congressionally chartered; their debt does not enjoy the implicit protection of the full faith and credit of the U.S. Treasury, nor can they borrow from the Treasury. And they are not exempt from state taxes, as are Fannie and Freddie.

Congress assigns benefits and privileges to GSEs in their charters (public laws) and in return limits the activities that GSEs can perform. GSEs are highly controversial and for good reason. They violate a basic principle that is implied throughout the Constitution although not expressed explicitly. The Founders gave us two jurisprudential systems; one based on public law and the other on private law. Through most of our history these two jurisprudential systems have been kept separate and distinct. Indeed, this distinctive sectors doctrine is a fundamental conservative value.

Although the government does not own any shares in Fannie or Freddie, the corporations’ shareholders are nonetheless beneficiaries of the limited agency status afforded these mortgage GSEs. Fannie and Freddie are treated by the market as if they have the federal government guaranteeing their debt instruments. Thus they are able to borrow money at a rate lower than private corporation competitors, such as Bank of America and Citigroup, which are subject to normal credit ratings. This implicit guarantee of its debt constitutes a subsidy to shareholders by the taxpayers, a sum estimated by the Congressional Budget Office to have been worth almost $20 billion in 2003 alone. Their multibillion dollar federal subsidies and exclusive charters permit Fannie and Freddie to act as an oligopoly, shunting aside would-be competition.

With GSEs, a fundamental conservative value is breached. In a properly functioning market system, those who stand to gain from an investment should also be those who are at risk if the investment fails. Fannie and Freddie violate this principle. Those who stand to gain from Fannie and Freddie’s investments are the shareholders and managers. Those who are at risk if the management mismanages these immense investments are not only the shareholders and managers, but also the taxpayers, who stand to lose much more. Chairman Alan Greenspan of the Federal Reserve Board has warned of risk to the entire financial system from a possible failure of a GSE. The absence of effective accountability, either from the market or from the political system, also accounts for the extraordinary financial mismanagement of these firms in recent years.

There is no explicit guarantee in law for GSEs and their $3 trillion unfunded contingent liabilities. Whether correct or not, the specific liabilities incurred by GSEs are considered by the market as contingent and political liabilities of the federal government because of their unique federal charters.

There is a general presumption that the federal government would not let the GSEs fail, and even the pending legislation lacks authority to terminate a failed GSE and its charter. This “implied” guarantee is similar to free insurance; it is also the critical elementdeterminingthe behavior of GSE management and of the market’s attitude toward GSEs.

The problem of what to do with Fannie and Freddie is generally debated by economists as to how much regulation is necessary to ensure the safety and soundness of these corporations. Needless to say, Fannie and Freddie and Mr. Miller come down on the side of less regulation. Many policy-makers now seek more effective regulation. Mr. Greenspan points out, however, the paradox in this debate: “World-class regulation, by itself, may even worsen the situation if market participants infer from such regulation that the government is all the more likely to back GSE debt.” In short, regulation is not the long-term solution to the GSE problem; full privatization is.

There is nothing inherently difficult about the privatization process. We have just completed a multi-year transition of Sallie Mae, a former GSE, to full private status. Its debt is no longer the responsibility of the U.S. taxpayer. We have privatized ConRail, ComSat and the U.S. Enrichment Corp. In each case, it required an act of Congress. In each case, the corporation was shifted from public law jurisprudence to private law jurisprudence. These corporations now have the private right to merge with other corporations, enter new markets and go bankrupt without having to come to Congress. Fannie and Freddie deserve these rights and responsibilities.

The GSEs were originally created to rectify market imperfections related to the absence of national liquidity in the mortgage market. This purpose was achieved long ago and GSEs are not longer necessary or desirable. If ever the conservative philosophy of free markets has been violated, it is in the instance of GSEs.

Mr. Miller should be warning conservatives not to support GSEs but instead to work toward their full privatization.

Ronald C. Moe is a fellow of the National Academy of Public Administration.



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