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Paul Kiesel
Paul Kiesel
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Taxpayers on the Hook for Fed's Recent Fannie Mae and Freddie Mac Intervention

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Fannie Mae and Freddie Mac own over half of the $10 trillion in home mortgages in the U.S. combined. These two government sponsored entities are seen as the wheels that make the mortgage industry move. Therefore, the government, in order to ease investor concern that the two mortgage giants were having “liquidity” problems and/or their ability to originate new mortgages, decided to swoop in and help boost “investor confidence” on Sunday with government backed money: Fannie and Freddie were able to access ultra-low interest loans from the Treasury Reserve (i.e. taxpayers are now on the hook for potential losses and will continue to be as Fannie and Freddie struggle over the coming months).

Since IndyMac failed and was taken over by the FDIC on Friday, all scrutinizing eyes turned to Fannie and Freddie, and the move by the Fed on Sunday was not seen as a surprise, but more as a “why did it take this long for the current administration — which promoted the lending practices that they’re now condemning — to step in?” Most analysts have been very surprised that it’s taken the government this long to intervene. And many suggest it’s too late — the best the Fed or the Bush Administration can do is prevent another one of these mortgage/credit crises from occurring again in such a severe manner. For the meantime, we are apparently amidst the beginning of further market distress.

Here’s what the New York Times had to say on Sunday regarding the Fed and Fannie/Freddie:

“Over the course of this 18-month financial crisis, we have lurched from land mine to land mine. Last week’s was all about Fannie Mae and Freddie Mac, the giant government-sponsored enterprises set up to provide affordable housing across the nation. By issuing debt, these shareholder-owned companies guarantee or own more than $5 trillion in home mortgages. Got that? $5 trillion.

“Because the federal government established the companies, investors view them as backed, at least implicitly, by taxpayers. And that implied guarantee is what drove Fannie and Freddie’s business models.

“The advantages the companies gained from this unique arrangement were huge. They had to keep less cash on hand than traditional lenders, for example. They also made more money on their mortgages than lenders because they paid less to borrow money in the bond market. These profits enriched Fannie and Freddie shareholders over the years and bestowed significant wealth on the companies’ executives.

“Now it looks as if the bill for that largess is coming due. Of course, it will be borne by the usual bagholders: United States taxpayers. You and me [. . .]

“[. . .] Even as investors were stampeding out of these stocks, the claque in Washington rushed to reassure them. Both Ben S. Bernanke, the Federal Reserve Board chairman, and Henry M. Paulson Jr., the Treasury secretary, said the mortgage giants’ regulators confirmed that the companies were “adequately capitalized.”

“Which brings us to the main problem: credibility. Wall Street and our senior regulators seem to be running out of that precious commodity almost as quickly as cash,” (New York Times, 7/13/08)

The New York Times’ Gretchen Morgenson nails the other major problem: Americans’ are continuing to lose trust in Wall Street and regulators, as the latter has been chameleon-like in its opinion of the mortgage crisis, from optimistic to pessimistic to indifferent over the last 10 months alone. What should Americans believe?

There’s a very good chance that this mortgage crisis will continue for at least another year and will also likely get worse; and regardless of the positive words coming from the Fed, the White House and others on Wall Street, the actions of all three over the last four months are giving us a better idea of what’s to come: A potential trillion dollar bailout for Fannie and Freddie.