In mid-July, Treasury Secretary Henry Paulson told Congress that there would be no need for the federal government to take over Fannie Mae and Freddie Mac, saying they had adequate capital to weather the storm. Yet less than two months later, that is exactly what happened.
Treasury is going to infuse the two government-sponsored entities with about $200 billion, spend $1 billion acquiring preferred stocks in each company and another $5 billion buying new mortgage-backed securities issued by Fannie and Freddie on the open market. All of this is to shore up confidence among investors and the two companies’ debt holders - largely Asian banks - that their money will not be lost. But for the average investor, there will be no federal security blanket. In the end, Mr. Paulson chose to put the companies into conservatorship, a slightly less intrusive takeover whereby the Federal Housing Finance Agency will run the company. Or to put it bluntly, guard the money while the next Congress and president figure out what to do with them.
Mr. Paulson should be congratulated for trying to somewhat protect taxpayers, but it still is a band-aid approach. Fannie Mae and Freddie Mac are failing, and are likely to cost more money than projected because the housing downturn is expected to continue well into next year.
Mr. Paulson and others actually made the claim that the federal government could end up making a profitable investment if the mortgage companies make a significant turnaround. The real problem that comes to bear is trust.
Treasury took this action despite the fact that they had already told Congress they would not. Now, the sum of Treasury’s solution is to effectively pass the buck, leaving open the possibility that as the two companies gradually climb out of the pit, members of Congress may decide to continue their private entity backed by government dollars business model without any meaningful reform. That is the great tragedy. As long as Freddie and Fannie are in business this way, expecting a government bailout whenever they get in over their heads, it is the taxpayer who pays the price. That has to end.