What To Do With Fannie and Freddie?

Treasury Secretary Henry "Hank" Paulson is tossing out a teaser. He would replace troubled Fannie Mae and Freddie Mac with private sector mortgage guarantors that would act much like public utilities, such as a power company.

With only days before he leaves office, Paulson is stirring the pot. Fannie and Freddie have always been strange ducks. They are Government Sponsored Enterprises (GSEs) that act like private firms but have special privileges such as an unlimited line of credit with the Treasury Department.

They have become lightning rods for scorn for their roles in the subprime mortgage crisis, some of which may be inaccurate or unfair, and have been taken over by the federal government which sooner or later must decide what to do with them.

Paulson's fresh idea quickly garnered enthusiasm and criticism but it is of value because the only two courses of action so far are to completely privatize them or nationalize them. On the plus side, turning them into quasi-utilities would make them more like insurance companies, which was pretty much the original idea when they were created. Others think the utility concept is inappropriate because Fannie and Freddie play distinct roles in housing and stock markets are not the same as making sure a big, monopolistic electric company distributes power and charges equally for it.

First, however, there may be some myths to dispell. One of the best sources for this is Bethany McLean's recent takeout on the companies in Vanity Fair. Her points: contrary to popular misconception, the federal government has paid nothing to Fannie Mae (other than the bailout) and only $13.8 billion to Freddie Mac which is pin money in today's mega-bailout terms. Actually over the long term, both have been well-run and profitable. And, they have been lightning rods for criticism for decades. It isn't so much that they are incompetent, ill-run institutions. Rather they have been powerful and enjoy special privileges which makes people jealous.

It seems safe to say that they are like lots of other federal programs. They were started to do one thing and then morphed over time into something else. Recently-defunct tobacco quotas are an example. Back in the Great Depression, Congress worried that destitute tobacco farmers would swarm cities looking for welfare. So, Congress set up a structure that kept tobacco prices artificially high. The tobacco companies didn't care since they moved the prices on to smokers. But the program stayed around for decades making the value of typical tobacco sales roughly four times more than what could be gotten for other, healthier crops. That's why farmers loved to grow and sell cancer-causing leaf.

Fannie Mae was designed in 1938 to buy mortgages from lenders and thereby encourage more private home ownership. It did just that. Then in the 1960s, Lyndon B. Johnson wanted to find a way to help pay for his expensive and unpopular war in Vietnam. Hence: Freddie Mac which pretty much does what
Fanie Mae does.

Iin 1995, Freddie started getting into subprime mortgages. Both the Clinton and Bush Administrations wanted to push more home ownership, especially among lower income individuals and minorities. Oversight was complex and overlapping. By 2008, the two firms owned or guaranteed half of the $12 trillion mortgage market in the U.S. The market crashed and last Sept. 7, both were placed under federal conservatorship.

Which leads us back to what to do with them. Barack Obama hasn't stated his views. Lame duck Paulson may be providing a service by suggesting a third way out even if his idea ends up not having merit.