Society
Fannie and Freddie go broke
Published 17 July 2008
The truth about the duo threatening US capitalism
Fannie Mae and Freddie Mac sound like a popular singing duo or the latest craze in children's dolls. Until a few days ago, even most Americans hadn't heard of them. Now they threaten, if you believe some accounts, to bring down American capitalism. It's not quite as good (oh, all right, bad) as that, but they can certainly inflict further damage to the US economy and housing market, to say nothing of the beleaguered dollar.
Since they are government-sponsored enterprises (known as GSEs) with a mission, as Fannie's website puts it, "to help those who house America", you may be surprised to learn they exist at all. Isn't this, er, what you'd expect from socialist countries or at least from the despised European social market? And since they still provide funds for the housing market when nearly every other source of money has dried up, shouldn't Britain copy Fannie and Freddie? Alas, no. They are textbook examples of the corruption of the US public realm by the mores of the private sector.
Fannie - the Federal National Mortgage Association - was once a perfectly decent public institution, set up during Franklin Roosevelt's New Deal to provide liquidity for the housing market when millions risked losing their homes. It didn't provide mortgages directly but bought or guaranteed them, so that banks had more money to lend out. It did much to lift America out of Depression.
In 1968, it was privatised by a Democratic administration, which didn't subscribe to free-market dogma but wanted the debts off the books. Two years later, Freddie - the Federal Home Loan Mortgage Corporation - was set up to provide competition. Both are shareholder-owned companies, but their GSE status carries privileges in return for minimal regulation. They don't pay taxes; they can borrow from the US Treasury; they don't have to keep as much cash in hand as conventional banks. Though all the debt they issue comes with the disclaimer "not guaranteed by the United States", everyone assumed that, if necessary, the government would bail them out (they were right). That's why Fannie and Freddie could borrow cheaply. They now control half the US secondary mortgage market.
In recent years particularly, they have behaved as badly as any other pillar of American capitalism. Their directors pay themselves enormous salaries and bonuses, sometimes on the basis of false earnings figures. They have been investigated for dodgy accounting and for making illegal campaign contributions, mainly to members of congressional committees that are supposed to oversee them. Worst of all, they hire superannuated politicians and presidential favourites who line their pockets with stock options. Fannie's recent hirings have included Franklin Raines, Bill Clinton's former budget director, and Robert Zoellick, an official in both Bush administrations and now head of the World Bank. Fannie and Freddie are straightforward examples of crony capitalism.
They can't be blamed directly for the sub-prime crisis. One of the few laws that is rigorously applied to them requires that they buy only mortgages that involve substantial deposits and documented incomes.
Nor can they buy loans of more than $729,000 - a figure that was raised from $417,000 in this year's budget stimulus package. But they virtually invented the opaque financial instruments - mortgage-backed securities - that created the housing bubble and made sub-prime possible. Now they are hit by the bubble's deflation because even "good" loans are threatened by falling house values and rising unemployment.
During the bubble, Fannie and Freddie prospered, making fat profits for shareholders and executives. Only now things have gone wrong does socialism come into play. The US government will seek approval from Congress to lend extra funds and buy shares in the two companies. It may end up nationalising them - though it will be called "conservatorship" - increasing the US national debt by a scarcely credible 50 per cent.
Fannie and Freddie have a half-sister that nobody talks about: she's Ginnie Mae (Government National Mortgage Association). She is wholly government-owned and provides guarantees for housing loans issued by official bodies to low-income buyers. There is a case for Britain adopting that model, possibly with a wider brief to bring some stability to the perpetually volatile housing market. But there's no case for Fannie and Freddie. They are devices that allow the government to give hidden subsidies (probably over $10bn a year) to middle-class housebuyers and private shareholders. They are a warning of what happens when you develop public-private hybrids while leaving accountability and regulatory responsibility hanging in the air. Next time you hear a British politician proposing an "innovatory" solution to something, involving, as it usually does, mixing private and public, think of that.
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