It's Too Late To Privatize...

To change things up a bit, I'll start with the conclusion. Fannie Mae and Freddie Mac should have went the way of Sallie Mae years ago. Alas, it is too late to do that now. First and foremost, let's forget about what might have been. That's in the past and shouldn't be dwelt upon. That leaves two other options. The first is to leave them as a they are now, some kind of public-private hybrid. However, that model is what created the problem. This isn't the UK or a Commonwealth country. We don't have Crown Corporations. If it wasn't for the Treasury and Fed, FNM and FRE common equity would be worthless. They should be worthless. If the common equity went to zero, there would be very little hue or cry about stockholder bailouts or moral hazard. The government would just take over the debts and wind down the two organizations to the size they should be. Note to common stockholders: this is what is going to happen so you might as well bail out of FNM and FRE now.



It didn't have to be that way. Fannie and later Freddie were set up to make sure that there was enough liquidity in the mortgage market so that it would function smoothly. Somewhere along the way, they became more like the investment banks that were profiting so handsomely off Fannie and Freddie securities. They even became publicly traded corporations to make them look like investment banks. Congress, with one notable exception, went along with this charade, fuelled by the political contributions that these two entities pumped into the legislators. This is not to say that the functioning of Fannie and Freddie were not without critics. The commercial banks complained vehemently to anyone that would listen that Fannie and Freddie were engaged in unfair competition given their, implied or otherwise, government backing. The Wall Street Journal has written a steady stream of editorials questioning their practices and their raison d'etre.

As a bond trader for the past 20+ years, we always listened to the party line about implied government obligation, the Treasury credit line, etc. of the agencies. But, it was always assumed that when push came to shove, the government would step with explicit backing. That push came Monday. The government should just take the next step , at this point, and take Fannie and Freddie completely.

What gets lost in the hype of this situation is that, in all likelihood, the government will come out ahead on this whole deal, it probably won't cost anything, and have the ancillary benefit of stabilizing the market. The only problem is the matter of the stockholders. Get over it. Take your lump and move on.

The final point is that, no matter what happens, Fannie and Freddie can't go back to what they were doing. They need to return to their roots, become more Ginnie Mae-like (granted, Ginnie Mae's mandate is much more restrictive, but you haven't heard of any significant problems surrounding them).