Think Twice Finance

Fannie Mae and Freddie Mac: Nowhere to Run, Nowhere to Hide, Baaybee!!

I’ve been waiting for thirty years. That’s when I first heard Milton Friedman predict that the real United States Deficit problem was not the one we all talk about. It is the one that will hit the fan when the Treasury assumes the Obligations of Freddie Mac and Fanny Mae, the major quasi-private lending institutions.

Thirty years ago, that debt was a whopping amount of money. But it is dwarfed by the mortgage protection provided by these Agencies today. They protect or own over  half the US  mortgages outstanding. The amount of their exposure is in the neighborhood of $5 trillion, enough to double the existing public debt of the United States if the Treasury took the obligation onto its books. The crisis has deepened under Democratic and Republican administrations alike, and under any number of Federal Reserve Chairmen, so the politics and finger-pointing with which we will be bombarded is just so much talk.

As Paul Voelker, former Chairman of the Federal Reserve, therefore no longer prevented from telling the truth, points out that the new debt is enough added risk to threaten the country’s AAA credit rating, and that means an increase in the tax bill that I don’t even want to contemplate.

The banking system and the bank regulators, congressmen and senators alike, have been quietly letting this problem grow throughout the thirty years since Friedman made his prediction. One regulation has been piled on top of another. Loophole has followed loophole.

However, it appears that we have reached the endgame. The Crisis within a Crisis seems to have erupted when Lehman indelicately pointed out that Freddie’s assets were not of sufficient value to pay off its debt. Ordinary companies become insolvent under these circumstances of course. But investors from Joe Public to Central Banks of other countries have been treating this debt like the Rock of Gibraltar since these agencies were created and nobody seems interested in finding out what would happen if they were to become insolvent.

So what’s a regulator to do? Well, give a lot of congressional testimony for starters. And then it seems, look for a way to convince the world that the Treasury promises to see that the debt is paid without a doubt, yet without actually promising to be the one to pay it. The second part is the tricky one when the amount is $4 trillion.

The plan at the moment seems to be to put the companies into conservatorship. This is an accounting “method” (notice I didn’t use the word “gimmick.” I would never accuse our government of using accounting gimmics. No sir.) This “method” means the government doesn’t actually assume the debt of the agencies. The agencies still owe the money. But if the agencies should be unable to pay what they owe, the government would. You can see that’s not a gimmick, of course. That’s very straightforward. So different from the government accepting responsibility for paying the debt. Thank God for plain speaking bureaucrats. I bet Henry Paulson and Ben Bernancke wish they were somewhere else. Say, interred in Guantanamo Bay.