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Monday, July 14, 2008
New financial world dawns today
The Atlanta Journal-Constitution
The morning’s headline are likely to make this a rough day on Wall Street: “Feds will offer lifeline to 2 mortgage giants.” The huge Bear Stearns financial services firm essentially disappeared in a single weekend. Can Fannie Mae and Freddie Mac be next?
Yes.
Will they? Probably not. But hang on for the ride. The Federal Reserve and the U.S. Treasury will act, as the feds did with Bear Stearns, to prevent a collapse of the function Fannie Mae and Freddie Mac performed. Treasury Secretary Henry Paulson said Sunday that Congress will be asked on an expedited basis to provide additional credit to each company beyond the $2.5 billion each has now. The two hold or guarantee about half of the $12 trillion in U.S. mortgages.
“Fannie Mae and Freddie Mac play a central role in our housing finance system and must continue to do so in their current form as shareholder-owned companies,” he said.
Maybe. It certainly is desirable that both continue as shareholder-owned, but with far greater federal oversight and regulation. Ordinarily I’m not one to urge more regulation. But here it’s clearly warranted.
Both are private corporations but they operated as high-flyers because investors commonly believe that, as government-sponsored companies, the feds will step in to bail them out in the event of financial distress. Indeed that’s happened. As taxpayers we’re trapped.
Lenders poured money out the door fueling a speculative real estate market. The result was that standards tanked. People who never should have been borrowing, who could not afford the homes they bought or who just flat lied about their ability to repay got loans. No hard questions.
The media has focused attention on “subprime” loans because it’s easy to compare interest rates and argue that some poor soul is the victim of “predatory lenders.” That was, as they say, the tip of the iceberg.
The real problem was that there was no accountability anywhere at any level. The front-line brokers could cut corners because they got the commissions and vanished. Lenders weren’t all that concerned because Fannie Mae and Freddie Mac would take the loans. Fannie and Freddie packaged them up as securities and passed them on to investors who believed that the pool was large enough to cover a few bad loans and, besides, the feds would come to the rescue if need be. They all got fees and commissions and passed junk down the line.
The bet here is that the market’s about to finish off its policing responsibilities. The collapse of Fannie and Freddie is unthinkable and the feds can’t — and won’t — allow it to happen. The role the two perform is a vital one. Some private-sector entities have to perform it — with strict oversight and capital requirements, more competition and a full understanding by the companies, as they evolve in the marketplace, that there’s no promise, real or implied, that taxpayers will bail out the private sector’s financial recklessness.
We’re stuck today. The feds have no alternative but to act, as they did with Bear Stearns, to prevent panic. But tomorrow is another day.
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