I am a minority of one, or a very small number, in thinking that the failures of Fannie Mae and Freddie Mac are good news.
These two companies should not exist. No private companies should have lines of credit to the U.S. Treasury, that is, U.S. taxpayers. No private companies should be linked to a government mandate that they facilitate affordable housing by buying up mortgages. No private companies should issue debts that investors believe may have an implicit guarantee provided by taxpayers.
The only bad thing about these failures is what the Federal government may do next to keep them alive. The only bad thing is that the Federal government will probably make matters worse.
This is a golden opportunity to end these enterprises once and for all. And doing that is incredibly simple! Any Wall Street investment bank can, in short order, produce a plan to restructure these companies and charge the appropriate (high) fees for carrying out that plan. The possible ways to restructure include sales of the assets, creating subsidiaries and selling them, spinning off subsidiary companies, and breaking up the company into several companies. Fannie Mae and Freddie Mac could also put their entire companies up for sale.
Such restructurings are Wall Street’s bread and butter. The equity values of these companies have already fallen considerably. Their value in a restructuring may be quite small, but control does have a non-negligible value. The markets are already pricing the debts of these two giants at less than face value, despite the chance of an implicit guarantee or a taxpayer bailout. The debt-holders took a chance buying this paper. They should bear the consequences. Restructuring will reveal the true worth of these debt securities.
Investors in these enterprises, both debt and equity holders, should not be bailed out by the taxpayers. These two companies made bad investments by buying mortgages that have gone bad. These two companies also issued too much debt to finance these investments, which gave them very shaky financial structures. The worth of their assets is less than the worth of their liabilities, which makes them insolvent. They are not yet bankrupt. They still have the cash to service their debts. These debts are by no means worthless. About 11.6 percent of money market funds are invested in agency debt. At current prices of these debts, news of money market troubles has not surfaced. If those prices fell by 10 percent, the money market losses would be a modest 1 percent.
Any restructuring presumes what is not in evidence, which is that the Federal government has to sever completely its relationships with housing markets and specifically with Fannie Mae and Freddie Mac. There’s the rub. Congress won’t do this, unless seized by some unforeseen miracle of rationality.
There are millions of Americans who may fear the dissolution of these companies. They will wonder where they will get mortgages from. There are hundreds of columnists who share this fear. Some will pretend to hold their nose while supporting a government bailout. Some will want to maintain the government’s interference in housing markets or even expand it as a matter of public policy.
There is nothing to fear. The amount of money on the sidelines that is available for funding mortgages is tremendous. It can be coaxed into mortgages if the interest rates paid are high enough. A free market in mortgages will easily provide capital to creditworthy borrowers. But that too is the rub. The government wants to keep mortgage rates low so as to keep the housing industry going and to satisfy the voters who take out mortgages. The government does not want a free market in mortgages, and that is because neither voters nor the housing industry want a free market in housing. As long as there is a government that is empowered to interfere, the pressure to interfere will overcome the free market.
Democracy just does not work, my friends! Sooner or later, in this case 70 years later, 70 years after Fannie Mae began, the system starts to break down. Call it what you will, democratic socialism or democratic fascism or both, democracy does not work. It doesn’t work in agriculture, in the military, in the space program, in the banking system, or in any other part of an economy. Sooner or later, depending on various particulars, blowups occur.
Without the government in the picture, there is no way that Fannie Mae and Freddie Mac could ever have grown so large. Their balance sheet assets (and liabilities) total about $1.6 trillion. They have off-balance liabilities of another $3.5 trillion or so. How big is $5 trillion? The national debt of the U.S. is $9.5 trillion!
It is almost unbelievable that these two companies could have run up debts that are more than half the size of the country’s national debt. But that is inherent in the chemistry of government + housing + debt guarantees. The housing market is huge, especially over time as the housing stock accumulates. By giving Fannie Mae and Freddie Mac an advantage in issuing debt, these companies came to dominate the housing finance market. There is no better time than now to end this absurdity.
Freddie Mac faces huge losses, as much as $775,000,000. Its equity can easily be wiped out. That means bankruptcy. That is nothing to fear, either. That means that restructuring will be forced upon the company. The point is to let it happen and happen quickly and get the government out of the picture altogether.
Naturally, this has not been what the government has been doing. Instead, it has done the opposite so far. Congress has passed a bill that awaits the President’s signature or veto. There will be a deal. The bill increases mortgage loan limits drastically. Smart move, guys. Pelosi wants them even higher, $730,000 instead of $625,000.
Mr. Corruption himself, Chris Dodd, is the lead sponsor of the bill. Even as the stocks of these two companies approach $0, he reassures the public that the CEOs of Fannie Mae and Freddie Mac and Ben Bernanke tell him that they are not at risk of default. This is a bald-faced lie. Failure to face and state truths is a national addiction. The predilection to lie in the face of bad news is so ingrained that our leaders no longer can even detect the difference between what is true and what is false. They lie and they know they lie. But they also believe their lies because they believe their lies to be political necessities.
Can liars even begin to think straight about what should be done that is in the long-run interest of the American public? If they could think straight, could they summon the courage to act? Democracy encourages lies, liars, and cowardice in the face of voters and payoffs. Democracy just does not work, my friends.
Terminate Fannie Mae and Freddie Mac. Sever the relations with the government and let Wall Street, or investment bankers in San Francisco or Austin or Boston or Tallahassee do what they know best, which is restructure these companies. All the mortgages held or guaranteed by them will still be held and serviced, but by new companies and new investors. Problem solved.
Michael S. Rozeff [send him mail] is a retired Professor of Finance living in East Amherst, New York.