Too Big to Fail

14 July 2008



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US Government Backs Fannie Mae and Freddie Mac

The Federal National Mortgage Association (nicknamed “Fannie Mae”) and the Federal Home Loan Mortgage Corporation (called “Freddie Mac”) hold about half of the home mortgages in the US. Despite these government agency-sounding names, they are publicly traded on the New York Stock Exchange. Last week, investors got panicked and sold both aggressively. Over the week-end, the US Treasury announced that if either needed to do so, it could call on the Federal Reserve Bank of New York for funds. It’s a pre-emptive bailout.

The function of the two is to buy mortgages from the banks that originate them, pool them and sell off mortgage-backed securities – which is just a fancy way of saying selling bonds that are backed by the revenue that comes from people paying off their mortgages. The trouble is the perception that people aren’t paying off their mortgages, making the bonds less reliable, and thereby screwing up Fannie Mae and Freddie Mac’s financial picture.

Treasury Secretary Henry Paulson said, “Fannie Mae and Freddie Mac play a central role in our housing finance system and must continue to do so in their current form as shareholder-owned companies. Their support for the housing market is particularly important as we work through the current housing correction.” Read carefully, this clearly states that there will not be a government takeover (that would be socialism) but there will be government support (giving corporations money is OK).

He went a step further yesterday and said the administration would ask Congress to enact legislation that would increase both entities’ line of credit with the government on a temporary basis. The White House also wants to ask Congress to give the Treasury to buy stock in both. This latter power would ensure that the two will always have a buyer for their stock, thus preventing the kind of meltdown seen on Friday when both lost about 40% of their value.

As this is posted on the internet, Wall Street hasn’t opened for business yet so it’s hard to say if this is sufficient to calm the market after Friday’s silliness. The key indicators are the stock prices of the two and Freddie Mac’s sale of $3 billion in debt today. If the prices stabilize and the sale goes well, the fire is out. If not, it will be a very long week for people in finance and government.

© Copyright 2008 by The Kensington Review, Jeff Myhre, PhD, Editor. No part of this publication may be reproduced without written consent. Produced using Fedora Linux.

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