Department of Treasury Seal

Department of Treasury Seal

(Updated 10PM PST)  When a friend e-mailed me and said "are you going to write about the Fannie and Freddie bailout?" I scratched my head and started to write back that I couldn't see the story:

  • The fact that Fannie and Freddie went bankrupt is no surprise. Multiple people predicted it, oh, years ago.
  • The fact that it's happening as the housing bubble collapses is, likewise, no surprise.
  • The fact that they're going to be bailed out is, oh, no surprise.

As of my writing this, Sunday night, as Calculated Risk points out, what we know from Paulson's vague statement is that:

  1. Treasury wants to be able to purchase equity (ie. stock) in Fannie and Freddie
  2. Treasury wants to be able to extend a much larger loan facility to them.

We also know that the Fed has Fannie and Freddie more access to credit as well.

So, what's this mean? Well, if this is the form of the bailout it means that owners will lose a lot of the value of Freddie and Fannie, but not all because the government will wind up owning a lot of shares, which will dilute value. But diluted value is better than a value of zero, so they have no cause to whine. In fact it's a mild bailout for them.

The folks who win bigtime are folks like Bill Gross (h/t Mish) at Pimco who piled into Fannie's and Freddie's mortgage debt making an explicit calculation that the government would rescue them, even though they damn well knew that Fannie and Freddie were going to go bankrupt and that identical mortgages and mortgage backed securites bought elsewhere would be worth a lot less. I can't see any reason why these folks should be bailed out with government money, and agree with Nouriel Roubini's suggestion that they do not get full value for the bonds (better than what you'd get on the "free" market, boys.)

As best I can tell (and I sure could be wrong) this sort of bailout is unprecedented. When Chrysler was bailed out the government loaned it money, it didn't buy an equity share. Assuming a long time horizon the equity share will probably turn a profit, mind you, but the moral hazard is extreme. Private investors should not be bailed out to this extent by public money.

The board should be sacked. Bonuses should be clawed back. The books should be given a full audit and charges should be laid against those who engaged in illegal activities including breaking their fiduciary duty to investors.

Fannie and Freddie should be explicitly taken over by regulators—they clearly aren't capable of running themselves, and I don't see why if they've bankrupted themselves it makes any sense to allow them to continue to make any of their own decisions, even if they are subject to "supervision".

Fannie and Freddie are too big to fail. But their investors and owners aren't too big to pay for their failure. Keep the issuing of mortgages and the mortgage market functions they provide going, but there's no reason to do so under current management or ownership and no reason why folks who bought their debt should be paid back more than if we allowed Fannie and Freddie to go bankrupt.

Being responsible, being a rugged investor, means taking your losses. Not coming to Uncle Sam every time you lose, whining for a handout.

(See Empty Wheel for an extensive conversation.)

Update: Also, go read Numerian's excellent post. Numerian suggests that the correct thing to do may well to be wind up the two agencies and stop guaranteeing mortgages. On thinking it over, he may well be right. Put them in receivership and wind them up. He also notes that a lot of this debt is held by China and if they don't get bailed out they may become very very unhappy.

The drive to home ownership has distorted the US's economy in a number of ways, including by encouraging the spread of suburbia and thus the increased use of oil and energy. That sort of feedback loop is something we might as well shut down now and encourage a move to high density, rapid transit, walkable environments and, yes, renting.