NCPA - National Center for Policy Analysis


April 11, 2008

Decades ago, Congress created two government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac, to buy mortgages from banks with the goal of increasing the supply of mortgages to enable more Americans to become homeowners. 

It has been known for many years that both organizations were financial time bombs, says Richard W. Rahn, chairman of the Institute for Global Economic Growth.  Peter J. Wallison, former general counsel of the U.S. Treasury Department and now a senior fellow at American Enterprise Institute, wrote a book in 2001 warning of the unfolding disaster we now see, and recommended corrective action by Congress (as did other distinguished financial experts).  Nothing was done:

  • Both GSEs are now in trouble, with Fannie Mae reporting it has $74 billion of subprime and Alt-A mortgage debt but only has about $45 billion in capital.
  • If the GSEs fail, there would be a snowball effect.

In a new AEI report, Wallison notes: "Thousands of financial institutions hold GSE debt -- in amounts that exceed their capital in many cases -- and a requirement to write down the value of this debt would weaken the entire financial system as a whole and surely worsen the economic outlook."

  • If this occurs, Congress would most likely panic and declare the GSEs' mortgage-backed securities are now credit obligations of the U.S. government.
  • The GSEs' combined debt of $4 trillion would suddenly be added to the debt of the United States, which would substantially injure the credit position of the United States and hurt every American taxpayer, who would ultimately be responsible for its payment.

Unfortunately, there is no present alternative to this doomsday scenario because the GSEs are not covered by the normal bankruptcy laws and Congress has not passed measures for an orderly windup of their businesses -- clearly, willful misconduct, says Rahn.

Source: Richard W. Rahn, "Willful Misconduct," The Washington Times, April 9, 2008.


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