Think Twice Finance

Are Freddie and Fanny Too Big to Fail? Here’s a Better Question – Is the United States Too Big to Fail?

I am so sick of having it explained to me that Freddie Mac and Fannie Mae are too big to fail. There are two aspects of this little tale that make me nauseous.

First, the reason Fannie and Freddie got this big is itself criminal (before you sue, Federal Reserve, I using “criminal” in the figurative sense, of course. No reason to throw me in jail here.) So getting back to the fiction that Freddie and Fannie are government sponsored criminal enterprises, they got this big because the banks would never have been willing to buy all the mortgages they bought without a government promise to bail them out should the mortgages go sour. The government withdrew this promise (wink, wink) but to the surprise of zero bankers, is about to reinstate the guarantee (because it suddenly is possibly useful.)

Second, the “Are they too big to fail?” question is silly. IBM was once 10% of the S&P 500 index. Rome once ruled the known world. Everything eventually fails. The life expectancy of a corporation is about the same as that of a person.

But in my current offering I’m going to make a simple point. If we don’t squeeze the life out of the corrupt and ineffective Freddie and Fannie (and if t’were done t’would be best done swiftly) we will soon be confronted by the question raised by Peter Goodman (NY Times, July 20, 2008.) Is the United States too big to fail? And although I know there is many an American that thinks the answer to that question is yes, there are no students of history among them.

Goodman is no babe in the woods. He carefully counts the major costs of letting Freddie and Fannie fail. The US Treasury would need to assume much of the debt of Freddie and Fannie. The total is $5 trillion, which would double the size of the US debt. This would no doubt drive up the government’s borrowing costs and perhaps downgrade the rating on Treasury bonds, costing taxpayers some serious money. A downgrade would put US’ financial reputation in doubt. Since the reason that most other countries around the world hoard our debt is that very good reputation, other countries would be pressured to sell in favor of the Euro or, gadzooks!, the Chinese Yuan, both of whom have been flogging the dollar for some years now. The point is, every American, and many non-Americans, are going to suffer if we don’t bail out Freddie and Fannie. And sadly, not one single politician or official is going to lay out the following truth.

We said Continental Bank was too big to fail and we bailed it out. That set a precedent. We said the Savings and Loan industry was too big to fail. That expanded the precedent. We said Long Term Credit was too big to fail. We said little bitty Bear Sterns was too big to fail. Now we are saying that Fannie Mae and Freddie Mac are too big to fail. We had better get our minds around this fact. If we bail out Freddie and Fannie, the world is going to ask the question, “Is the United States too big to fail?” And if you want to know the answer to that question, just travel abroad. Ask anybody.