A new life for Fannie and Freddie

By "federalising" Fannie Mae and Freddie Mac, Treasury Secretary Henry Paulson wants to prop up the two mortgage giants – albeit at great expense to taxpayers – so the world keeps buying their mortgaged-backed securities (MBSs). The tragedy is that Paulson didn't do something 18 months earlier when the cost would have been much less, says the Wall Street Journal.

Still, the Treasury's plan does put some useful limits on Fannie and Freddie risk-taking, albeit starting only in 2010, says the Journal:

Until the housing market bottoms out, presumably in 2009, the feds want the two companies to keep securitising and guaranteeing mortgages as they do now.

But in January 2010, the companies will have to start reducing their portfolios of MBSs by 10 per cent a year, to a total of $250 billion.

Also in 2010, the companies will have to start paying a fee – which could be paid in cash, or in preferred stock adding to the government's controlling stake – to the federal government in return for their taxpayer guarantee.

Moreover:

The federal government has fired the company boards and CEOs.

The taxpayer purchase of preferred stock means that the federal government will own about 80 per cent of the companies if all the warrants are ultimately exercised.

The government also stopped dividend payments, saving about $2 billion a year.

The Treasury chief also gave a free pass to the holders of some $18 billion in Fan and Fred subordinated debt.

However, the biggest risk is that the companies could still emerge with their business model intact. That model is the perverse mix of private profit and public risk, which gave them an incentive to make irresponsible mortgage bets with a taxpayer guarantee, says the Journal.

Source: Editorial, Weekend at Henry's, Wall Street Journal, September 8, 2008.

For text: http://online.wsj.com/article/SB122083012951708369.html

For more on Economic Issues: http://www.ncpa.org/sub/dpd/index.php?Article_Category=17

FMF Policy Bulletin/ 16 September 2008