Something interesting happened yesterday in the business world. The federal government took over Fannie Mae and Freddie Mac.
The government established Fannie Mae during the Great Depression to facilitate home loans. In 1968, it was converted into a government-sponsored enterprise — a private, for-profit company that has the public mission of supporting affordable homeownership.
Freddie Mac also has this unique designation, and both companies have spent countless amounts of money on lobbyists to protect their status.
On Sunday, U.S. Treasury Secretary Henry Paulson placed the companies under “conservatorship”—
basically a type of bankruptcy—and fired their boards and chief executives.
This massive government intervention calls into question the future of the companies as government-sponsored enterprises.
As the subprime mortgage meltdown continues to affect the markets, could Fannie and Freddie be nationalized?
The two mortgage institutions have paid for 70 percent of home loans in recent months, according to a Sunday Washington Post article.
The companies were becoming bloated from trying to buffer the market from foreclosures, so it’s easy to understand why their dealings became unsustainable. But should American taxpayers be responsible for bailing the government-sponsored enterprises out?
The consensus is that we should. Banks hold vast reserves of bonds and preferred shares issued by the two firms.
If Fannie and Freddie were to fail, the effects would ripple into a new wave of bank failures, which wouldn’t exactly help the tense credit market.
The Treasury Department concluded that neither company has enough capital to weather the continuing crisis, and thus will likely require cash infusions over the next few quarters, according the Post article.
Much of the assets on Freddie Mac’s books are “deferred tax credits”, and any student who has taken Intermediate II Accounting can tell you that they are worthless unless Freddie makes a profit in the next few years.
This situation is just another in a string of government interventions over the past year.
Although Americans can certainly understand why actions need to be taken now, long-term responses need to also be taken. Regulation and oversight do have roles in preventing bubbles and crises.
Lax regulation can encourage growth to a point, but historically, it isn’t sustainable and losses ensue afterward.
As companies grow and merge, it often times becomes more difficult for them to earn a return beyond their cost of capital. Chasing returns pressures management to invest in riskier positions and projects; this combined with faulty analysis can engender a crisis like the subprime mortgage meltdown.
Somewhere, whether by increasing regulation and oversight on the banks, the mortgage brokers, et al., this could have been stopped without the estimated one trillion dollars in eventual losses.
However, companies chide regulation as stifling, and they argue the government shouldn’t intervene in the free market—at least during economic expansion.
It’s interesting how the tune changes during recessions.
Bail-outs are the very antithesis of free market beliefs. After all, the free market mechanism for dealing with companies that overstep their bounds is to let them fail.
I suppose the concept of cognitive dissonance is lost on them.
Just as there are no atheists in foxholes, it seems there are no free market activists in banking crises.
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