President Bush announced yesterday that he would not veto legislation before Congress that is aimed at calming the housing market and propping up mortgage giants Freddie Mac and Fannie Mae. That was probably good news for his Treasury Secretary, who was in New York the day before telling the financial community how important the proposed legislation is.

In my view, the legislation may prove helpful in dispelling concerns about the credit worthiness of government-sponsored enterprises and thus allow the companies to help the country through this housing crisis, but for all the posturing and chest beating, the bill leaves Fannie and Freddie in ambiguous territory.

Tony Crescenzi of Miller Tabak says the spread between the rate on 10-year Treasuries and the rate on 10-year Fannie Mae bonds narrowed yesterday to 63 basis points, down 6 basis points on the day and off from 90 basis points the day the stocks got clobbered by a Lehman report that discussed a possible capital shortfall. Since 2000, the spread has on average been 56, so today’s level is fairly benign. Mr. Crescenzi says the narrowing of spreads “means that bond investors are more optimistic about the ability of the companies to pay their debts.”

Increased confidence should lead to some easing of recently rising mortgage rates, which have discouraged homebuyers at the worst possible time. Rates on 30-year mortgages last week were at the highest level for the past year, according to the Mortgage Bankers Association, causing a 6.2% drop in mortgage applications. Concerns about the likely level of participation in the market by the GSEs apparently contributed to the high rates.

The proposed legislation serves to make explicit the heretofore implicit backing of the government for GSE debt, and at a cost that sounds reasonable. Pressed by legislators, the Congressional Budget Office has estimated the cost of the assistance to the GSEs at $25 billion. Apparently, this figure was a pleasant surprise; some had expected the price to be much higher.

The route to the estimate was a curious one. On the one hand, the CBO staff figured the odds at better than 50% that the government would never actually have to pony up money to back the GSEs; on the other, there was a 5% chance that the Treasury would have to inject $100 billion. Seriously, my teenage daughter could have come up with a more convincing probability matrix.

Congress, however, was thrilled to have a number that could be used to convince the folks back home that this was a reasonable gamble. Because, at the end of the day, there was never a chance that this legislation or something similar would not pass. Despite the alarming recent collapse of the GSE stocks, the likelihood of actual failure, or default on the companies’ debt, was simply nonexistent.

Think about it: America has long made home ownership a top priority, and reasonably so. The average citizen being able to invest in a home has arguably been the cornerstone of the country’s private enterprise system. If you doubt this, look at the countries around the world where lack of rule of law or immature capital markets prohibit widespread investment in real estate. Those are not countries where entrepreneurship or capital formation flourish. The typical rags-to-riches story in America starts with someone accumulating capital via the purchase of an appreciating home and then spending that nest egg to start up a business, send their children to college, or in some other way invest in their future.

In recognition of this, the government long ago decided to broaden home ownership by standing behind the debt of the GSEs, thereby allowing them to borrow at below-market rates. Fannie and Freddie were supposed to supply liquidity to the mortgage markets, and indeed they have. The cost of that implicit guaranty has to date been exactly zero. The GSEs have long maintained below-average credit losses, and even in recent years have been relatively conservative in their investments. They have never sought financial help from the government.

Nonetheless, the critics of the GSEs (and there are many) argue that these companies enjoyed the advantage of an implicit government guaranty but used that backing to enhance shareholder profit. They invested in mortgage bonds that offered attractive yields, which accrued to shareholders; they paid their executives the kinds of salaries enjoyed by other large financial services managements, and they spent money on lobbying for bills that perpetuated their advantages.

These observations are all true, but they are beside the point. These companies were owned by and accountable to shareholders; the responsibility of management was to their owners, just as with any other publicly owned company.

It is not my intent to argue the case for the GSEs. Rather, it is to suggest that the companies are in an impossible situation, which looks likely to continue. The reform measures in the bill now before Congress include the establishment of a “world-class” regulator who would have the authority to establish capital standards “and prudent management standards,” but the legislation also provides for broadening the GSEs’ mission, and especially their role in promoting affordable housing. As President Reagan might have said, “There you go again.”

It is this dual purpose that creates an eternal love/hate relationship between the GSEs, investors, and Congress. Andy Laperriere, who has been covering the housing legislation for the economics firm ISI, says the bottom line “is that the new regulatory authority may require the GSEs to hold more capital and use less leverage. The problem of trying to serve two masters continues to be present.” It certainly does.

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