TOO BIG TO FAIL, OR TO SURVIVE
July 29, 2008
To permit Fannie Mae and Freddie Mack -- which enjoy a peculiar and highly advantageous status as quasi-public agencies and quasi-private companies -- to default would set off a worldwide crisis. But we can decide what should become of Freddie and Fannie after this crisis. The best option is one getting little mention in Washington: get rid of them, says William Poole, a senior fellow with the Cato Institute.
Because the government cannot permit Fannie and Freddie to default, their obligations are part and parcel of the full-faith-and-credit obligations of the United States, explains Poole:
- Thus, the national debt, usually viewed as the $5 trillion held by the public, is really $10 trillion once we add the Fannie and Freddie obligations and the mortgage-backed securities they guarantee.
- For now, the Congressional Budget Office has entered a "place holder" of $25 billion to cover the bailout costs over the next two years but recognizes that this is a guess.
The important issue is not the 2009 outlay, but the total that will be required eventually. Even if the two firms are technically insolvent, the market will continue to buy their obligations readily, for it understands that they are fully backed by the government, says Poole.
In fact, there has already been a test case for how the mortgage market would function without Fannie and Freddie, says Poole. After an accounting scandal in 2005, regulators severely constrained their activities:
- The nation's total residential mortgage debt outstanding rose by $1.176 trillion in that year, even though Fannie's and Freddie's stakes rose by only $169 billion, just 14.4 percent of the total.
- In essence, the market barely noticed that the two agencies' private competitors were providing 85 percent of the increase in mortgage debt in 2005.
Source: William Poole, "Too Big to Fail, or to Survive," New York Times, July 28, 2008.
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