The Fallout From Freddie and Fannie

Nationalization may be the endgame for the mortgage companies.

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Some observations on the Paulson-Bernanke bailout of Fannie Mae and Freddie Mac:

1) This crisis will ensure quick passage and signing of the Frank-Dodd foreclosure bill. My sources tell me the Fannie-Freddie emergency package will be wrapped into that bill with full action by month's end.

2) With the government guarantee of the two companies now explicit rather than implicit, I am not sure what the rationale is for keeping up the financial fiction that they are private companies. End the masquerade. My guess is that they will be explicitly nationalized because they have already been implicitly nationalized. One possible outcome is that their portfolios will eventually be shrunk and their mandate perhaps restricted to low-income borrowers.

3) With pretty much all signs pointing to further weakness in the housing market through 2009, I think the next step may well be further government intervention in the housing market, something along the lines of a housing version of the Resolution Trust Corp. that might actually buy properties to shore up the market. To quote former Bush economist Lawrence Lindsey:

During the last real estate collapse in the early 1990s, the government was forced to acquire a large amount of property as it worked to rescue the financial system. The chances are reasonable that at some point late in 2009 a similar approach might be adopted. The last time around it was called the Resolution Trust Corporation (RTC). It was, as one would expect from government, far from surgical in its approach. A lot of investors, bankers, and property holders probably lost more than they deserved to in the process. But it got the job done. It is the ultimate last resort, using the balance sheet of Uncle Sam to save the housing market. If nothing else works, a new RTC is in the cards, and those who think Barney Frank's bill is a "bailout" will be shocked by its size.

Here is some further insight from around the Web. First up, Arnold Kling:

It seems as though nobody wants to admit that the FM's are done for. Yet the new proposal on the table to have the government back more of the firms' debt and perhaps buy equity is so radical that I have to assume that there is no returning to the status quo.... A fundamental debate in economics is between central planning and the spontaneous order of the market. The collapse of the FM's, and of the housing market in general, can be viewed as a failure of central planning. Unfortunately, the dynamics are such that when central planning fails, you typically get more central planning.

And some wise words from columnist Sebastian Mallaby:

As long as Fannie and Freddie retain their private/public form, private managers will invent reasons to grow courtesy of public assistance. The best shot at taming them is to bring them into the government. Then, once financial markets have stabilized, the government should shrink the institutions radically and spin them off in pieces, creating maximum space in the mortgage market for smaller private players.