Fannie and Justice

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The New York Sun

The Justice Department’s announcement that it won’t pursue criminal charges against Fannie Mae lets the mortgage financer off the hook, but pardon the poor taxpayer for wondering when he will be set free. While the end of the criminal probe marks a significant step down the road to recovery for a company that has been racked for nearly two years by a $10 billion accounting scandal, Fannie and little brother Freddie Mac have yet to be lifted from taxpayers’ backs.

Fannie and Freddie are congressionally chartered enterprises designed to pump liquidity into the mortgage market by bundling the loans into mortgage=backed securities and creating a secondary market. Over time, however, the two companies have started building their own portfolios in those securities, to a significant extent with borrowed money, as a way to bolster returns to Fannie’s and Freddie’s shareholders. Those portfolios are subject to interest-rate risks stemming from the fact that homeowners can refinance when rates drop. Fannie’s accounting shenanigans resulted from its effort to hedge that risk.

The problem is that because of their congressional charters, everyone assumes Congress would never allow Fannie or Freddie to fail. Thus, neither their creditors nor their shareholders pay enough attention to the amount of risk the pair take on. Thanks to low-interest borrowing, Fannie and Freddie between them have been able to expand to the point where their financial obligations, in outright borrowing and in guarantees on the mortgage-backed securities they create, reaches into the trillions of dollars. Their influence is so pervasive in mortgage markets that if one of them were to fail — which could happen if, for example, mortgage rates suddenly moved against them — the failure might spark a crisis in the housing market that would ripple through the rest of the economy.

Fannie and Freddie are a classic example of the privatization of profit and the socialization of risk. The risk to taxpayers will only go away once Fannie and Freddie are privatized, but lawmakers have stubbornly resisted even stepped-up regulation to limit the size of the companies’ portfolios, despite the fact that those portfolios enrich a few investors at the risk of all taxpayers. Justice’s announcement yesterday is good news for those investors. But the only good news for taxpayers will come when Congress passes stronger regulations of the enterprises or, better yet, privatizes them altogether.

The New York Sun

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