Fannie and Freddie

Robert Reich says Fannie and Freddie are too big to be allowed to fail:

Fannie, Freddie, and the Pending Taxpayer Bailout, by Robert Reich: Fannie Mae and Freddie Mac, the two giant quasi-public housing lenders that together own or guarantee about half the $12 trillion in home loans outstanding, are heading into insolvency. No surprise. As housing prices continue to drop, more and more middle-class homeowners who got their loans from Fannie or Freddie are under water... And as the economy continues to go south, more and more of them can't meet their loan payments.

While it's true that most of their home loans were made before 2006 when lending standards were tighter, that doesn't really matter because the rip-tide of this sinking economy is now hitting a much broader group of home owners.

Fannie and Freddie may not be technically insolvent yet, but I'm betting that if their lending portfolios reflected the true market prices of their loans they would be. That's why their own investors are bailing out.

So who gets stuck with the tab? Investors in Fannie and Freddie have always believed that the loans issued by the two giants were guaranteed by the federal government but technically they aren't. The guarantee has always been assumed but has never been put into law explicitly... Yes, the companies' charters give the Treasury the authority to buy as much as $2.25 billion in each of their securities in the event of possible default, and the two companies have access to the Fed's so-called Fedwire payments system allowing them to access funding if needed. But these won't keep the two afloat for long.

As a practical matter, we're facing a Bear Stearns squared. Fannie and Freddie are way too big to fail -- especially now. There's no question the government will have to take over the companies, which means taxpayers will get stuck with the tab yet again.

Here we have another example of socialized capitalism. The executives of Fannie and Freddie have been among the best paid in all of corporate America. We're talking tens of millions a year in CEO pay alone. Fannie and Freddie are treated like giant investor-driven entities as long as they're healthy and their investors and executives are doing well. But when they start to go down the tubes they become public entities with public responsibilities, and the rest of us have to bail them out.

On the too big to fail issue, my view hasn't changed. If failure of these firms endangers the broader economy, and hence threatens to impose large costs on people who had nothing to do with creating the problems, then policymakers need to step in and do what they can to prevent a downward economic economic spiral. In addition, they need to change the rules and regulations that allowed the problem to emerge in the first place, and add new rules and regulations as needed to lower the moral hazard worries going forward.

What would you do?

Update: Big Picture adds:

Uh-Oh! Bad Sign on Fannie & Freddie, The Big Picture: Marketwatch reports that the government discussed a contingency plan in case the unthinkable happens, and Fannie Mae (FNM) and Freddie Mac (FRE) were to fail. But don't worry -- the Bush administration DOES NOT expect the entities to fail. And, they note no rescue plan is imminent.

Rex Nutting says Uh-Oh! This is a major contrary indicator, and it suggests Freddie and Fannie are toast! Why?

Is there any surer sign of an impending disaster than a reassurance from the White House that it doesn't expect it to happen?

Rex adds this short list of other things that the Bush administration didn't expect:

• Terrorists to fly airplanes into buildings.
• Saddam Hussein to have been telling the truth about not having any weapons of mass destruction.
• Iraqis to object to a long-term occupation by a foreign power.
• Hurricane Katrina.
• People in New Orleans to object to the government's response to Hurricane Katrina.
• The Democrats to take control of Congress.
• The Democrats to cave in so easily on important issues after they took control of Congress.
• Scooter Libby to get caught.
• Jack Abramoff to get caught.
• Abu Ghraib to be discovered.
• Scott McClellan to smell the coffee.
• The housing bubble.
• The credit bubble.
• The housing collapse.
• The credit squeeze.
• Bear Stearns to fail.

Gee, that's a tough list to argue against . . .