How to fix Fannie Mae and Freddie Mac: Nationalize 'em

William Poole has long warned that mortgage titans Fannie Mae and Freddie Mac had grown so large that they posed a serious threat to the U.S. financial system.

It looks like the former Federal Reserve policymaker had it right. Stocks of both companies are in meltdown mode this week, sending ripples through U.S. markets, on fears that they don’t have the capital they’ll need to survive rising mortgage defaults.

So let’s admit the obvious, Poole suggests: Fannie and Freddie should be nationalized.

In America, nationalization is among the dirtiest of words. It conjures the image of the government grabbing control of private-sector assets.

But Fannie and Freddie, which buy or guarantee mortgages to support the housing market, are strange animals. They are owned by shareholders, but they were chartered by the government, and they’ve grown to their gargantuan sizes ($843 billion in assets at Fannie, $803 billion at Freddie) because investors worldwide believe their debts have the implicit backing of the U.S. Treasury.

If Fannie and Freddie face a wipeout of their capital because of loan losses, then, Uncle Sam couldn’t possibly allow the companies to collapse. So why not just nationalize them now, turning them into full-fledged government agencies and thereby taking away the uncertainty on Wall Street about their ability to continue buying home loans?

Poole, who was president of the Fed’s St. Louis branch until he retired in March, said in an interview with Bloomberg News this week that nationalization was "the only practical course" for Fannie and Freddie.

Though he’s often labeled a curmudgeon, the 71-year-old Poole isn’t alone in his view of what to do with Fannie and Freddie, which combined either own or guarantee a total of $5 trillion of U.S. home loans, nearly half the entire market.

"We have to stop pretending these are private companies," said Christopher Whalen, a managing director at research firm Institutional Risk Analytics.

There has always been an inherent conflict in the structure of Fannie and Freddie, Whalen notes: Their shareholders would reap the benefits if the companies took big risks and won, while it was presumed Uncle Sam would have to pick up the pieces if the companies blundered.

In Washington, Treasury Secretary Henry M. Paulson Jr. and others want Fannie and Freddie to get back on their feet on their own. But if the companies try to raise massive sums of new capital by issuing stock, they will severely dilute the ownership of their current shareholders (that’s a big reason the stocks have nosedived).

And what if, six months from now, the loan losses turn out to be so massive that any additional capital the companies raised in the interim is burned up?

Politically difficult as it may be, Whalen says, if you make Fannie and Freddie government agencies now, "you take a major source of instability out of the market. You don’t have to worry about it anymore." That would be one less issue for the housing market, which obviously has plenty.

Given the dilution risks they already face, shareholders of Fannie and Freddie ought to welcome a buyout even at these depressed prices, Whalen says.

In terms of stock market value, all that’s left of Fannie and Freddie now is about $18.2 billion, combined. Wall Street wouldn’t even notice that amount disappearing from the public market.

Comments

[Steve Matulis]

"...Their shareholders would reap the benefits if the companies took big risks and won, while it was presumed Uncle Sam would have to pick up the pieces if the companies blundered."

Why not call it what it is? Privatized gains,socialized losses. "Uncle Sam" picking up the pieces really means "all of us taxpayers", since this is where Uncle Sam's money comes from -- taxes.

"nationalize them now, turning them into full-fledged government agencies and thereby taking away the uncertainty on Wall Street about their ability to continue buying home loans"

This means common shareholders get zero. While this takes the uncertainty out of Freddie and Fannie's share prices, it will cause financial institutions to collapse further as investors pull out and put their money into energy / commodities / etc.

To make a long story short, confidence is shot because all of these organizations, from Fannie and Freddie to all but a few banks in our land, are ALL insolvent and being propped up with smoke and mirrors right now.

[rc whalen]

The Ugly Girls, Fannie Mae and Freddie Mac, have failed, it is only now a question of the reckoning. The sane policy is to nationalize and then merge FRE and FNM. Once this is done, Treasury should run the newco under the Greenspan/Shelby Rule, where anything that can be sold should be sold. That means total assets drop to $200-300bn for conduit only and interest rate/systemic risk goes away. We never hear of the GSE called ever again. That is the good news. If Treasury moves swiftly to resolve this situation, we can end up better off on the other side.

[plankbob]

Health care also needs a fix that could include some form of nationalization.
Socialized medicine is NOT to be feared.
Do you hear of any citizens of countries that have national health systems clamoring for one like America has? No.

[tornadoes28]

Nationalize them? What is this, Venezuela? That is the dumbest idea I've heard. My God , this is the United States, not China.

[robert NO longer in LA]

Well, bush has Fema'd us again! What a man! What a war president! bush has FINALLY achieved something....something that Marx and Lenin, Mao and Bin Laden have failed to do....DESTROY AMERICA FROM WITHIN. Be sure to re-elect all those party stooges in Washington DC, and remember to stay faithful to the Dem Party in Sacramento, LA and SF. Just keep rewarding the two parties' stooges when you vote in November...you're getting a Bill, and a danged BIG one!!! Great job bush, cheney, feinstein, boxer, pelosi!!!!

[HighwayMan]

Let them fail! The market will correct itself. It may take years, but in the long run we'll all be better off.

[Jack]

All we need now is George W. Doofus to stand before microphones and assure us everything is okay. When he did that the last time, the Dow dropped like a rock.

[356man]

Hey, if we are going to go on a nationalization kick, why not start with the oil companies, then use their obscene profits to prop up the real estate ripoffs. Throw health care in there, too--then our whole lives can be run by one giant Post Office/DMV/Your Government Agency Name Here group of folks. I can hardly wait...

[Drew]

I really cannot believe that we have Americans on this board saying to Nationalize? This is against American values, we are a free market and just because the interests of a few affected the whole economy and I am not talking about the mortgage bubble. Did we not all hate the Russians not too long ago? What happened to the American spirit, the problems of the economy can be traced back, maybe it is time we punish those responsible. It is simple, we cannot have a Federal Government this big, there is not enough revenue coming in. America was never meant to be a nationalized state or have fiat money and we as the people have let the reins go and it is time to get them back for our children’s future. the problem is the Government people, where do you think the money to "Nationalize" this is going to come from?

[anonymous]

This makes total sense. Let's shove this problem down 100% of the taxpayers throats. Afterall, the problem is about 10% of taxpayers. Looks like Bush logic to me.

[Vette]

This is so wrong how can we have such a dump in the market I feel someone need to fix this and soon

[LS]

Here's a simple fix: Outlaw shorting of stocks. Shorters exploit and accelerate these situations by drastically increasing the trade volume of a stock. If Bush had any brains or guts he would issue an Executive Order temporarilly stopping the shorting of Fannie Mae and Freddie Mac stocks.

[London Limey]

to the person who made the comment about it being a dumb idea and the US is not china, he is right about the second part. china has a trade and budget surplus, massive amounts of liquidity (possibly too much), and unlike the US, its not financed on the back of treasuries sold in the open market. after all, why would they borrow money when they have lots already. there is no chance of a china defaulting on any debt. if fannie and freddie were allowed to collapse it was would have a knock on effect on all those treasuries issued and sold by the US government, and would cost the US taxpayer trillions of dollars. thats a lot of money even for the richest nation on earth and america would have a sudden economic depression that would make the 1930's look like a picnic.

at the moment the fed just needs to keep a close watch but be ready to jump in at a moments notice. they need the plan in place now and hope they dont have to act on it.

one final note: the fed is doing as much as it can and is very active. am not seeing much from the white house and have not through out the whole course of this administration. tax cuts are not the only instrument available to Bush. he should never have run up such a large national debt and budget deficit. he should have encouraged a stronger dollar than the devaluing inflation producing currency it is now. if he had shown as much determination in reforming social security and promoting financial prudence with regards to the budget, as he has over foreign policy, things might not be as bad as they are.

[freddie wac]

Look, if China hold the majority of the stock and loans then the the obvious solution is bankruptcy.

[Wouldn't You Know It]

An important reason why these two entities had private sector elements to their structure was that it prevented politicians from meddling in business decisions. Granted, free enterprise didn't do well with the mortgage meltdown and all, but the perverse political incentives (interest rate policy, tax benefits of homeownership, lack of regulatory framework for intermediaries, etc.) leading free markets into the mess were partially to blame. What will happen if these two are nationalized and effectively being "the market" for mortgages in the U.S. Would you trust the likes of Ms. Richardson or Mr. Dodd to decide how to run these nationalized companies and make the management decisions on who to lend your, the taxpayers money to? I have NO faith in the ability of politicians to run a business capitalized by taxpayers. Watch your taxdollars at work if that happens.

[Angelique]

Yes, nationalize and we don't have to worry about this instability in our market in the short term, but in the long term we have to worry about the combination of increased monetary power and socialist policy undermining the basic principals of our government.

The problem with "government backed" is that we are not eliminating risk, we are putting it squarely on the backs of taxpayers. Every mortgage has a certain risk factor, but the bank enjoys less risk when the government agrees to step in and bail them out. As a result banks give more loans to risky borrowers. Don't think they are doing these borrower's a favor: the government is encouraging home ownership among Americans who are likely to end up facing devastating bankruptcies and foreclosures. While individual banks and investors may be to blame for supporting subprime loans and being complacent about inflation, these investors would have been reigned in long ago if shareholders did not intuitively know that in the end the US Treasury (read: US Taxpayers) would protect their assets.

This economic policy all points to a commonly accepted that appears no where in the laws of economics: growth of our GDP must be protected and encouraged at all costs. Occasionally it is healthy for the economy to slow down, and even contract after periods of inflation. FDR went too far when he created Fannie Mae and Freddie Mac, and it's time to end it.

Tu ne cede malis, sed contra audentior ito.

[Derek]

The irony of government intervention.. FNMA & GNMA were created to help provide affordable financing so the middle class could afford to buy a home. But cheap financing lead to higher asset prices and not quite so affordable housing. So at the end of day what did we do other than exacerbate volatility?? Good idea, but bad execution. They will be nationalized, and anyone who pays taxes or holds US dollars will foot the bill - not pretty.

But here's an opportunity - have the U.S. purchase preferred stock in FNMA & GNMA, stabilizing the capital structure. Next, increase their capital requirement to avoid future bubbles (the exact opposite of what the dumbest man on earth, Chuck Shummer, had done). It may take a decade or more, but at the end of the day Government will get some kind of return this "investment". The Commons be damned, they placed their bets and they lost..

[bkl]

If Bank of America issues mortgages and doesn't want to hold them in its own portfolio, why is it the government's job to buy, package, and resell them for Bank of America? Let Bank of America bundle and sell its own mortgages.

Fannie and Freddie should be allowed to fail and disappear. The claim that Bank of America can't issue a mortgage without their help is fiction.

[snake eyes 4u]

just because i'm public-spirited enough to pay all of my taxes, you think i'm some kind of chump, huh? why not let those worldwide investors take a bath instead of the few remaining taxpayers in the above-ground economy who pay for your police, fire, teachers, road services, etc. let 'em die!

[TDK]

Derek said: "increase their capital requirement to avoid future bubbles". Of course that's right and of course exactly the opposite happened. As the mortgage backed security market started tanking last year OFHEO reduced the margin requirements so that Fannie and Freddie could help deleverage the banks by taking on more leverage. The gov't has been bailing out the banks and hoping that confidence in Fannie and Freddie would stem the crash, but it's looking like we've only put it off. Yet another example of what Kevin Phillips called the "socialization of risk".

[Mariano Guerrero]

By nationalizing Fannie and Freddie, the U.S.A. would be capitulating to Latin American political thought process that has proven the state owned companies DO NOT work! Although the fall of these entities would hurt all Americans, it’s the price to pay to for letting things get out of hand, lets face it… our regulating institutions and over-greedy businessmen failed! But let’s not add shame to the failure by recognizing a Chavez, Morales, Kischner and all other 3rd world minded SOBs that over that past 50 years have driven other 1st class developed American countries (i.e. Argentina, Columbia, Venezuela, and etcetera) to there current situation of under-development, instability, injustice, inhumane and so many more negative adjectives.
If Fannie and Freddie, must fall lets make sure that those responsible (within the companies and within in the government regulators) pay for their incompetence and corruption. We must also hold the politicians accountable for their part in this mess.
And let’s learn from this.

M.G.

[Surfside7]

The "implicit" guarantee that the federal government has "bestowed" or "endorsed" on these hybrids creatures (FNMA & Freddie) creates a situation where the government can't just walk away from the mess. The government needs to nationalize these entities; there is no other choice. To delay will just prolong the agony.

The government must not cut in the stockholders of these two entities with a Bear Stearns style "bailout". The stockholders and the management of the two entities must be penalized (and heavily) with the management (including past managers) having to disgorge their unlaw gains (bonuses, incredibly high pay, etc.) Racketeering statutes should be utilized to get these monies back from these transgressors.

FNMA and Freddie have been political spoils operations for many years. Franklin Raynes was never prosecuted for his operation but of course he was placed there by Democratic party operatives and the money circled around.

The government needs to rechart a course to step out of the housing industry. None of these crazy loans (no money down, no docs loans, cash flow (Alt A) loans) would have been made if institutions and individuals had thought they might lose their funds if the loan didn't perform.

The government needs to get rid of the HMDA law and the High Cost Mortgage rules. Certain perameters need to be set so that banks and companies don't victimize consumers (similar to Usury Laws). Its obvious that high cost mortgages are usually tied to risky, imprudent and unworkable loans. Further, with regard to HMDA, banks and mortgage companies don't care what color or nationality you are; they should, however, feel comfortable that the borrower has the means and propensity to pay back the obligation.

[Goldie]

If taxpayers money will be used to bail out, then the taxpayers should get benefit. Either nationalize or let them fail on their own.

[LT]

Either let them fail or nationalize them.

If the taxpayers keep bailing out these idots than they should be nationalized.
WE'RE PAYING ANYWAY !!!

[meredith]

Thanks, Hugo! (This article WAS written by Hugo Chavez, wasn't it??)