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Fannie and Freddie follies

November 19, 2008

Fannie Mae and Freddie Mac thrived for nearly four decades as companies that were private in name only. The bonds and mortgage-backed securities they sold to Wall Street had a unique advantage over their competitors': an unstated guarantee that the federal government would prevent defaults. And sure enough, when the housing bubble burst and the companies' bets went bad, regulators promised to supply up to $200 billion to cover any losses. The two companies are due to remain in a federal conservatorship until the end of 2009.

The obvious problem with the arrangement is that the companies' executives and shareholders collected all the gains during the go-go years, but the taxpayers got stuck with the losses when the market crashed. This month, the Treasury Department is expected to pump $13.8 billion into Freddie Mac to cover shortfalls. And Fannie Mae $13.8 billion into Freddie Mac recently warned that it may be pushed into insolvency too.

Nevertheless, Congress hasn't changed Fannie's and Freddie's status. They remain privately held companies, albeit with stocks that sell for less than $1 a share, and are barred from paying dividends while federal regulators are in charge. When the conservatorship ends, Fannie and Freddie will be under private control once more, and their operations will be aided again by the expectation of a federal rescue. After all, if the feds bailed them out once, won't they do it again? The main difference is that the two companies' mortgage-related holdings will be significantly larger -- as much as $1.7 trillion more than when the feds stepped in. That's because the Treasury has pushed Fannie and Freddie to increase their shares of the housing finance market to offset cutbacks by private sources.

The credit crisis makes it difficult today, yet lawmakers and the incoming administration need to start working soon on a whole new approach to Fannie and Freddie. In particular, they should explore ways to phase out both companies, allowing truly private firms to take over the secondary market for mortgages that Fannie helped create decades ago. As for Fannie's and Freddie's mission to promote affordable housing, there are much more efficient and transparent ways for the government to achieve such goals -- for example, by providing subsidies directly through federal agencies instead of siphoning dollars from Fannie and Freddie. The collapse of Fannie and Freddie calls into question the government's role in the American dream of home ownership. Washington needs to start looking for answers now, before taxpayers relive the Fannie-Freddie nightmare.

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