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Fannie-Freddie takeover: the 'bazooka' option

Treasury Secretary Henry Paulson, right, and Jim Lockhart, director of the new Federal Finance Agency, speak during a news conference Sunday.
REUTERS/Joshua Roberts
Treasury Secretary Henry Paulson, right, and Jim Lockhart, director of the new Federal Finance Agency, speak during a news conference Sunday.

The intoxicating effect of the political parties' gala national conventions gives way this week to the sobering reality of the government seizure Sunday of mortgage giants Fannie Mae and Freddie Mac.

The Fannie-Freddie disaster raises sticky questions politicians usually avoid. For one, how much regulation should be imposed on capitalist cowboys in the financial markets? This is the second time this year taxpayers have been forced to shoulder the consequences of mistakes made by people whose pay is several times the wages of the average voter and taxpayer.


The upshot is a system that is a pretense of free-market capitalism because the taxpayers, not the cowboys, bear the risks of bad judgment and crooked dealings. How much the taxpayers get soaked this time depends on how the takeover plays out, but it could be tens of billions of dollars.

The quasi-public mortgage companies own or guarantee almost half of the nation's outstanding mortgage debt.

Fortune magazine called the government's takeover the "bazooka" option. Treasury officials had hoped to avoid firing their big gun, but markets didn't respond sufficiently to less drastic steps taken earlier.

If the banks that write mortgages to regular homebuyers can't count on Fannie and Freddie to buy their loans, they have to charge higher interest rates, tighten credit standards and demand higher down payments — all of which was already happening and slowing a recovery in housing markets, Fortune said.

With Fannie and Freddie teetering on the brink of collapse, investors had lost confidence in credit markets, the stock market had a chronic case of jitters, loans were drying up even for credit worthy borrowers, and homes were impossible to sell in some areas.

No choice
Treasury Secretary Henry Paulson Jr. said in a statement Sunday that the government had no choice but to take over the mortgage companies. (Details of the takeover terms are here.)

"Fannie Mae and Freddie Mac are so large and so interwoven in our financial system that a failure of either of them would cause great turmoil in our financial markets here at home and around the globe," Paulson said. "This turmoil would directly and negatively impact household wealth: from family budgets to home values, to savings for college and retirement."

Paulson said a failure of the mortgage giants would have set back "the ability of Americans to get home loans, auto loans and other consumer credit and business finance." Further, he said, it would have been harmful to economic growth and job creation.

Paulson also made it clear the next administration faces major decisions — and major controversy, too — about the structure of the mortgage market.

"The new Congress and the next administration must decide what role government in general, and these entities in particular, should play in the housing market," he said.

Candidates weigh in
Both presidential nominees said over the weekend that the government is taking the right steps by forcing the two mortgage giants into a conservatorship and firing their top executives, Bloomberg reported. But companies can't be permitted to reap profits during boom times and then look to the federal government for help when the market goes awry, said Sen. Barack Obama, the Democratic nominee, while campaigning Saturday in Terre Haute, Ind.

"You notice a lot of these folks they don't like government when they are making money,'' Obama said. "But as soon as they start losing money they think the government is just swell. We are going to change that attitude.''

Obama set these benchmarks for evaluating the government intervention: It must protect taxpayers and stabilize the mortgage market, it shouldn't protect investors who've profited from risks taken by Fannie and Freddie, and it must "clarify'' government housing policy to make sure the crisis doesn't repeat itself.

Sen. John McCain, the Republican nominee, said on CBS' Face the Nation (PDF), "I think it has to be done. ... We've got to keep people in their homes."

But the system must be restructured in a way that the management and shareholders don't benefit from the federal intervention, McCain said.

"It's an example of cronyism, special interests, lobbyists, a quasi-governmental organization where the executives were making … some million dollars a year while things were going downhill, going to hell in a hand basket," McCain said.

'More regulation, more of everything'
Asked by host Bob Schieffer if more regulation was needed, McCain answered, "more regulation, more oversight, more transparency, more of everything."

It's tough talk all around. But how much support will McCain get from his fellow Republicans for more government oversight? Their practice is to rail against government.

Business Week said that the takeover "was a dramatic move for the Republican Administration." The two publicly traded companies "are in effect being nationalized, something that's ordinarily anathema to conservatives," it said.

Across the Atlantic, the UK's Guardian observed in a news blog, "It's a funny old business when a Republican administration espousing small government and unfettered capital markets has to nationalise the country's two biggest mortgage companies."

McCain has said he would move quickly to break up and privatize the companies. The details are yet to come.

Obama faces real-world limitations too. Should he win the election, his visions will be boxed in by the fiscal fallout from this administration, which had shattered records for deficit spending even before it added Fannie and Freddie's multibillion dollar troubles to the load. That's true not only for restructuring finance markets but also for energy investments, education and other programs Obama has promised to bolster.

Not limited to Fannie and Freddie
The backdrop for this drastic step is that the kind of executive office mistakes that helped bring down Fannie and Freddie weren't limited to those companies. Many players in the banking sector set up the mortgage crisis. And despite rhetoric honoring free-market capitalism, many executives continue to shield themselves from the consequences of their actions — no matter what the government says or does.

Two years ago, the Securities and Exchange Commission began requiring companies to explain performance targets used to calculate incentive pay for executives, hoping that the rule would discourage fat compensation awards for thin results.

How is the rule working? "In some cases, well — but in most, not at all," New York Times business columnist Gretchen Morgenson wrote on Sunday.

Not bothering to comply
"Many companies are simply not bothering to comply," Morgenson reported, citing a study by James F. Reda & Associates, a compensation consulting firm in New York that analyzed a representative sample of the medium-size companies in the Standard & Poor's MidCap 400-stock index.

Only 47 percent of the companies made the required disclosures concerning short-term incentive pay, like cash bonuses, for the reporting period that included 2007, the researchers found. On long-term incentive pay, the compliance was 62 percent. Still, that meant more than a third took advantage of loopholes to avoid the intended reform.

It wasn't executives alone, but a whole class of operatives who benefited at Fannie and Freddie, Eric Dash said in today's New York Times.

"Over the years, Fannie Mae and Freddie Mac showered riches on many winners: their executives, Wall Street bankers and Washington lobbyists," Dash said. "Now the foundering mortgage giants are leaving some losers in their wake, notably their shareholders, rank-and-file employees and, in the worst case, American taxpayers."

Meanwhile, ordinary working families greet the candidates as they campaign in states where at least one in 20 workers is jobless, tens of thousands of families have lost homes, and retirees are helpless to stop their savings from evaporating.

The candidates can promise. But with the problems so endemic and government so seemingly feckless, it will be a challenge for either of them to deliver deep and true economic reform.

Sharon Schmickle writes about national and foreign affairs and science. She can be reached at sschmickle [at] minnpost [dot] com.

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Comments (2)

Typical Republican result...protect the bond holders (China and Middle East financial interests) and the banks and stiff the common stock holders. When Bear Stearns was forced to sell the common stock holders got chopped but the preferred stock holders were treated as an "asset class". Not this time unless you are a bank and then you will be dealt with "on a case by case basis". But the senior citizen or person with a retirement account who owner Fannie Mae perferred stock gets stuck. How fair is that?

Meanwhile the CEO's walk off with millions in severance and they helped drive it int the ground. How fair is that? Watch who benefits..which mutual funds and other folks. Just another typical Republican deal of bailing out their rich friends.

Next up for a taxpayer bailout, the big three U.S. auto makers. And since it's unthinkable to raise fuel taxes to keep the highway trust fund solvent, a road building bailout from general tax revenues.