Fannie Mae and Freddie Mac are, at least for the time being, curious entities called Government Sponsored Enterprises, federally chartered mortgage giants run as private for-profit businesses. And for a long time its executives and shareholders did very well out of them.
The two firms had an almost bullet-proof business model. Even though there was never an explicit guarantee, buyers of Fannie Mae and Freddie Mac bonds — and the buyers included a large number of foreign governments — believed that in the crunch the federal government would step in and back the bonds. The buyers were right, to the tune of about $100 billion in taxpayer guarantees for each company.
Over the weekend, Treasury Secretary Henry Paulson basically nationalized the firms. He had no choice despite the jeers of "socialism" from economic purists. The two own or underwrite half the nation’s mortgages, a figure closer to 70 percent over the past few months. Allowing them to fail — and by week’s end efforts to round up infusions of private cash proved fruitless — would have had damaging repercussions in the mortgage markets, the financial markets and the broader economy.
The bondholders are safe — and with interest. But Fannie Mae and Freddie Mac are in something akin to bankruptcy. Their top executives are out, replaced by officials chosen by the Treasury. The stockholders, who have seen their stock sink to the single digits, will have their equity in the company diluted from 100 percent of 80 percent. The companies will pay no dividends. While the amount of mortgages they underwrite will go up in the short term to stabilize the market, by 2010 they are required to reduce their role in the mortgage markets each year for 10 years. No more "too big to fail."
The two giants were able to stave off Congress and the regulators while they pursued a path of reckless and risky growth because of their large and very skilled lobbying operation. They are now barred from lobbying and any political involvement.
Congress, which bears much of the blame for this sorry pass, must decide when it returns in January the future of Fannie Mae and Freddie Mac. They could be nationalized, privatized, folded or combined into a more modest public-private entity. It certainly will be time for the lawmakers to make good on that talk of bipartisanship.
It is irony of some kind for economic conservative and free marketer George Bush that in the prescription drug benefit he presided over the largest expansion of entitlements since the Great Society, and in the bailouts of the two lenders he oversaw the largest federal intrusion into the economy since the New Deal.