Thursday, June 12, 2008

Odd Ducks Freddie and Fannie: Example No. 17 of Government Intervention Run Amuck

"...[T]he vast majority of mortgage securities sold in the last six months" were offered by Fannie Mae and Freddie Mac, semi-public enterprises that are neither ducks nor geese, human nor animal; i.e. neither totally public nor private corporate entities. (Source.)

hybrid
[Image thanks to Patricia Piccinini, an Australian sculptress, through About.com]

The Legislature created them in the 1930s and 1970s in order to help people of modest means acquire their own home; but--and this is typical of government well-meaning ventures of this type--the latest mortgage crisis has revealed that many of the people who obtained loans over the last four or five years should never have passed through the financial screening process from a banking point of view.

Yet still the impractical goal holds the minds and wills of our legislators today:

"'I want these companies to help with affordable housing, to help low-income families get loans and to help clean up this subprime mess,' said Representative Barney Frank, a Massachusetts Democrat and the chairman of the House Financial Services Committee. 'Otherwise, why should they exist?'" (Source.)

Excellent question, especially when one realizes that Freddie and Fannie were two of the originators of "this subprime mess" (among others).

Both organisms get most of their funding from the public sale of shares, but the line to the government purse is in place, "just in case." This dual line of financing is at once their saving grace and their Achilles Heel, because management has to please two benefactors.

Unfortunately, however, there is a golden rule that says, “No one can serve two masters, because either he will hate one and love the other, or be loyal to one and despise the other." (Luke 16:13).

In trying to please both, Freddie and Fannie have take on a precarious amount of leverage (i.e. they have borrowed way over their credit limit). The market allowed them to do this because of their seeming immunity to the effects of negative market forces, which immunity springs from their position as semi-governmental agencies. The government allowed them to do this because of their above-mentioned goal.

Both companies are about to face a crisis based upon this double role they have been trying to play. They may surmount it; but to do so they may have to dip into our tax money if their regular private sources of capital dry up.

I would hate to be in their CEOs' shoes over the next few months.

Here are two easy-to-read links that will inform you of the situation:

This Wall Street Journal article from today's paper; and

This nice graphic from an earlier New York Times piece.

There's another golden rule that we the voting public may learn in due course: When governments intervene in the marketplace, unintended forces will evolve, and they often run amuck of even the best of intentions.

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