Is re-nationalization an option?

The speed with which public-private mortgage-debt investment companies Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) tanked caught some long-time observers by surprise yesterday. Indeed, one fellow at Seeking Alpha had just published the prior week an essay commending both companies to long-term investors. Oops.

As of this morning, the companies have lost 80% of their market capitalization since the beginning of the year, which means both companies can be had for a shade over $10 billion.


For readers who have no idea what these companies are or do, there is a great, short refresher in this morning’s Wall Street Journal. Here’s the upshot:

“Fannie and Freddie’s survival is crucial not just for the U.S. mortgage market, but the entire financial system, because of the widespread reliance on their debt not only by legions of investors but also by banks around the world.”

How reliant? The New York Times reported this morning,

“Fannie and Freddie have combined debts of $1.5 trillion. They own or guarantee $5 trillion in mortgages. They have contracts with other institutions worth $2 trillion more to hedge the risks behind those mortgages.”

If the global financial system were likened to soup, these two companies are the broth. No broth, no soup.


Some folks (it tends to be liberals more often than not) invoke the botched attempt at deregulating California’s energy market a few years ago as natural end result of Milton Friedman’s economic theory – crass, bold corruption and the crumbling of our national infrastructure.

I’m a little sick of hearing how everything during the past year is but a replay of that situation in California, but in the case of Fannie Mae and Freddie Mac, one might plausibly posit such a connection, except the inspiration for these twin public-private corporate messes is anything but Milton Friedman.

According to the aforementioned WSJ article, Fannie Mae’s privatization actually began in 1968 under the Lyndon Johnson administration (Freddie wasn’t created until 1970). Then, in 1992, Congress passed legislation creating a toothless regulator to oversee Fannie’s and Freddie’s business activities. The revolution in finance that began in the 1990s then transformed the way these companies handled debt, enabling them to maintain capital requirements not unlike today’s investment banks.

This 40-year corporate history implicates politicians and regulators from both parties and across several generations. One can see the degree to which this is true by gauging our current politicos’ reactions to the bail-out plan on the table: there was near-universal assent.

At this point, I’m not so much interested in the minutiae of how we arrived at this place; I’m more interested in what comes next…how can we fix this mess?

In answering this, two competing desires immediately come into conflict. First, there is the desire to stabilize the financial system, and this – for better or worse – requires that financial players regard Fannie and Freddie as healthy (or, at the very least, not terminally infirm). Second, there is a desire to minimize the federal taxpayer’s exposure. Bail-outs cost money, and addressing the first concern necessarily puts taxpayers on the hook.

In that regard, Treasury Secretary Henry Paulson’s plan is probably the best middle ground on offer. It does indeed inject – potentially – billions of federal dollars into the ailing companies, but if confidence is restored to the marketplace among the holders of debt, the likelihood of either company accessing federal debt facilities should be limited.

But this action also strips away any pretense that these companies are public in any meaningful sense. They are what they have always been – federally-sponsored monopolies in the mortgage investment space. Many conservatives have long felt that Fannie’s and Freddie’s presence virtually nixes any real and true marketplace in the mortgage investment industry.

Secretary Paulson’s plan is fine in terms of averting immediate financial catastrophe, but as a long-term solution, we need to either re-nationalize these businesses or truly privatize the industry, so that the business risks are borne by those who profit from them and not federal taxpayers.