A Republican administration has nationalised Fannie Mae and Freddie Mac, though it is nationalisation with US characteristics. As a result, US housing finance has been brought under direct government control and, in the process, the gross liabilities of the US government, properly measured, have increased by $5,400bn (€3,800bn, £3,000bn), a sum equal to the entire publicly held debt and 40 per cent of gross domestic product.
Yet the administration is merely recognising the reality that these “government sponsored enterprises” were undertaking a public purpose, at the public's risk, though not without dispensing vast rewards to management along the way. That is a scandal. Whether the body politic will recognise it remains unclear. Since this is a bipartisan mess, the likely answer is No.
So what has the administration done? Was there an alternative? Will it work? What lessons should be learned?
Formally, the Treasury has put the two institutions into a “conservatorship”, which means they are no longer run in the interests of the shareholders; it has established “preferred stock purchase agreements”, to ensure that each company retains a positive net worth; it has created a new secured lending credit facility for the GSEs and the Federal Home Loan Banks; and, finally, it is initiating a “temporary program to purchase GSE mortgage-backed securities (MBS)”.
The aim, in the words of Henry (Hank) Paulson, US Treasury secretary, is “to protect the stability of the financial market, and to protect the taxpayer to the maximum extent possible” (the latter being notably ominous words). More specifically, the hope is that the “GSEs will modestly increase their MBS portfolios through the end of 2009. Then, to address systemic risk, in 2010 their portfolios will begin to be gradually reduced at the rate of 10 per cent per year”.
Was there an alternative to such measures? I am talking here not of the precise details, but of the broad decision. The answer is No, for two reasons.
First, the institutions were unable to raise the capital they needed to offset the losses on their lending in the collapsing US housing market. This threatened their access to finance. That, in turn, would have drastically curtailed their lending, which accounted for more than 80 per cent of US housing finance earlier this year. The result would have been even swifter declines in house prices and a deeper decline in domestic spending. The former might be no bad thing; the latter surely would be.
Second, the liabilities of these enterprises were held widely abroad, particularly by central banks and governments. A failure to guarantee these liabilities would have shaken confidence in the US government and currency, possibly to a devastating extent.
Will the measures work? If the aim is to sustain the creditworthiness of the GSEs, the answer is Yes, unless there is a general flight from all US government liabilities. The latter is possible, but extremely unlikely.
If the aim is to sustain lending to the housing market, it will, again, work. But it will also slow the needed correction in prices, so creating new losses for those who are persuaded to buy now. Some of those losses will ultimately fall on taxpayers. As the needed correction is slowed, the assumption that the GSE portfolios can be reduced from 2010 seems a fantasy.
What, finally, are the lessons, beyond the obvious one that it is idiotic to believe that the prices of any asset class can only go up? It is that the US unwillingness to recognise that socialised risk demands public control has created not just a scandal, but a gigantic mess.
The US public has ended up with an open-ended guarantee of the liabilities created by supposedly private entities. It is a bad place to be. As Mr Paulson says: “There is a consensus today that these enterprises pose a systemic risk and they cannot continue in their current form.”
Amen to that. At some point, they will have to be broken up and sold off. Given the state of the housing market, that happy day is a long way off.
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