May 14, 2010 | Commentary on Economy, Financial Regulation

Deal with Fannie and Freddie Now or We'll Pay Later

What's the main selling point for the financial regulation bill Congress is debating? That it would end taxpayer bailouts. The Senate even added an amendment directly noting that the bill is intended to "prohibit taxpayers from ever having to bail out the financial sector."

But don't breathe a sigh of relief too quickly. Because the bill's many problems include this frequently overlooked fact: It does nothing to fix the problems with Freddie Mac and Fannie Mae, both of which A) played a major role in the meltdown of 2008 and B) are asking for more money.

Ignoring Fannie and Freddie would be a huge mistake. More than a year after going into receivership, they still dominate the housing finance market by buying mortgages from lenders, packaging them into bond issues, and then reselling them to investors worldwide. Last year, the two financed or backed about 70% of single-family mortgage loans. They hold about $5 trillion in their investment portfolios.

Most importantly: Both are losing money fast, with those losses being covered by the U.S. taxpayer. About a week ago, Freddie announced it had lost $8 billion in the first quarter of 2010 and would be asking for another $10.6 billion in taxpayer help. Not to be outdone, Fannie announced an $11.5 billion loss and asked for another $8.4 billion from taxpayers.

Unlimited bailouts

That's atop the nearly $145 billion of your dollars that Fannie and Freddie have already received. And the total is sure to go higher: Last December, the Obama administration lifted caps on how much total bailout money the two can receive. The old limits were $200 billion each (though those estimates were widely understood as fiction). The new limits {hellip} well, there are no new limits. Moreover, requirements that the two shrink their portfolios were watered down.

There seems to be no end in sight — the two firms' own management admits that there is no prospect for ending the red ink in the foreseeable future.

The crisis should have come as no surprise. Experts have warned for decades that both entities lacked sufficient capital — made up of both investors' money and retained earnings — to protect against losses. Back when they were privately owned, Fannie and Freddie had only $1 for every $20 in assets, while most banks had $1 in capital for every $12 in assets. Congress considered higher standards in the 1990s, but many of the same congressional leaders who head their oversight committees today bowed to a high-powered lobbying campaign that derailed reform.

Enough is enough. Fannie and Freddie should be partly wound down, the rest broken up and sold off — not replaced, reformed, or rejuvenated. Such a process of course cannot be done overnight. Realistically, this will take several years. But that only makes it more important that the process begin now.

Yet, reforming these two government-sponsored enterprises isn't a priority for many policymakers. According to Sen. Mark Warner, D-Va., a plan to tame Fannie and Freddie will have to wait until at least next year. An effort by Sen. John McCain, R-Ariz., to amend the pending financial regulation bill to address the problem was defeated last week, replaced by a call for a "study" of the issue.

A rush to slow things down

The issue has also been slow-tracked by the Obama administration, which only recently opened a formal proceeding to examine options for the two firms. In fact, rather than resolving the pair, the administration is making them a key part of its economic arsenal, using them to prop up the housing markets. As support from TARP and by the Fed shrinks, Freddie and Fannie seem — at least in part — to be taking their place.

Fannie and Freddie haven't been coy about their new role. In a financial statement released last year, Fannie Mae was unusually blunt about what the administration was asking, and what the financial effects were: "Our financial results are likely to suffer, at least in the short term, as we expand our efforts to assist the mortgage market, thereby increasing the amount of funds that Treasury is required to provide to us and further limiting our ability to return to long-term profitability."

This must stop. Fannie Mae and Freddie Mac have distorted housing markets enough. Fannie Mae and Freddie Mac should be put on a path to resolution. And Congress should ensure that no successor institution be provided with the implicit guarantees that allowed these two to play havoc with financial markets.

Otherwise, we can look forward to many more bailouts in the future.

James Gattuso is Senior Research Fellow in Regulatory Policy at The Heritage Foundation. David C. John is Heritage's Senior Research Fellow in Retirement Security and Financial Markets.

About the Author

David C. John Senior Research Fellow in Retirement Security and Financial Institutions
Thomas A. Roe Institute for Economic Policy Studies

James L. Gattuso Senior Research Fellow in Regulatory Policy
Thomas A. Roe Institute for Economic Policy Studies

Related Issues: Economy, Financial Regulation

First appeared in USA Today