UNDERSTANDING THE FANNIE MAE BAILOUT

It looks like the Bush administration is pushing hard to get Congress to support Bush's bailout of Fannie Mae and Freddie Mac. He's got the Federal Reserve inspecting their books, from which they will reveal ... well, whatever the Bush administration wants them to reveal.

Seriously, there's no secret to what the Fed's inspectors are going to find. Fannie and Freddie are deep in debt. They owe $1.5 trillion. They "own or guarantee more than $5 trillion in mortgages" - which may not be saying much given the state of many of those mortgages (see previous post).

And that's that, so lend them some money.

For those of you who are unsure why any of this is important, consider this. Fannie Mae and Freddie Mac are government-chartered, but privately held, companies that purchase mortgages. Together they own half of America's mortgages. By purchasing mortgages from the mortgage industry Fanny Mae and Freddie Mac help pump money back into the industry so that mortgage companies can loan more money for housing purchases.

The arrangement is supposed to be a win-win situation for both consumers and the industry. The problem is Fannie and Freddie are so big that if they go under it is widely suspected that mortgage lending in this country will come to a virtual standstill.

And that's the rosy scenario.

Problems for the mortgage industry began when they started relaxing standards with "No Doc" loans, NINJA (no income, no job, no assets) loans, and the Pick Your Payment plans (noted in the previous post) at the same time that Alan Greenspan lowered interest rates. And, in a brilliant stroke of genius, Fannie Mae and Freddie Mac kept on purchasing these and other "innovative" loans.

But here's the funny part.

With so many potentially bad loans on the books, the Bush administration is arguing that the bailout is necessary because, well, Fannie Mae and Freddie Mac don't really need the money. Huh? Here's Treasury Secretary Paulson's rationale for the bailout:

The more flexibility we have on the credit facility, the more confidence you have in the market and the greater protection to the taxpayer because the less likely it will be used.

Seriously, Secretary Paulson is arguing that Congress should provide the administration with "open-ended authority" to make investments and loans to the two giant companies because the Bush administration wants to send a strong signal to the markets that they have plenty of financial muscle behind them.

He'd be better off telling the truth. The Bush administration doesn't want the economy collapsing on his watch.

Incredibly enough, Paulson added that the American taxpayer shouldn't be worried because both firms have "strong collateral" to back what the government makes available. And that "strong collateral"? One has to assume it's all the mortgages they own.

So this is what we have. The Bush administration wants to make about $25 billion available to two private firms, who are sitting on a pile of mortgages that may be toxic and ready tank. And it's because they want to send a strong signal to markets.

Hey, I have an idea. Why not let them go under. This will send a better signal: Don't make stupid business decisions, and expect the American Taxpayer to bail you out.

- Mark

P.S. I understand that letting Fannie and Freddie go under is not responsible, and probably even dangerous. However, if the federal government is going to provide the confidence that market players clearly cannot, we need to start looking at new regulations, including those listed in the Robert Reich post listed below.