Not So Fast
This article is from the archive of The New York Sun before the launch of its new website in 2022. The Sun has neither altered nor updated such articles but will seek to correct any errors, mis-categorizations or other problems introduced during transfer.
When the Economist, the Financial Times, the Wall Street Journal, and the New York Times are all sounding the same tune, it’s a signal to us that their conventional wisdom is worth a skeptical second look. So it is in the case of Fannie Mae, where the free-market financial press has joined with the New York Times in calling for the government seizure of a private company.
“It is time to nationalise America’s mortgage giants,” thundered the Economist. The New York Times urges immediate action: “Whatever the cost to the taxpayer of a government intervention, it is likely to be less costly than watchful waiting or taking half measures, which would only allow the problems to get worse and require an ever bigger fix later.” The New York Times criticizes President Bush for “desperation to avoid a bailout on his watch” and insists that any such “government rescue” would imply “wiping out the shareholders.”
“It would be better to nationalise them,” the Financial Times editorializes, urging that that “should begin now, when it is easier to gather the will for reform.” The Wall Street Journal, normally a defender of markets, nonetheless urges Secretary Paulson to put the companies into “federal receivership” and appoint a “czar” who would “give priority to taxpayers above the current private shareholders.”
The word that gets applied to this is “bailout,” but a more accurate term would be “expropriation” — that is, the taking of a private asset by the government. If government is so good at running companies, why stop at Fannie Mae and its fellow mortgage insurer and debt packager, Freddie Mac? Why not nationalize all the other big companies that have been doing badly in the recent economic downturn — from Citigroup to General Motors — and appoint government tsars to run them, too?
When it comes to eminent domain — the seizure of land rather than a company — most free-market oriented commentators saw, in the case of Kelo v. New London, that there was something wrong with the government taking somebody’s home and turning it over to a private developer. In the case of the threatened government takeover of Fannie and Freddie, a government seizure would also benefit other private interests — all those hedge funds out there who are shorting Fannie and Freddie stock.
Some of our friends on the right are concerned about the implicit federal guarantee of mortgage-backed securities issued by Fannie and Freddie. It’s a concern we share on a philosophical basis, but at the same time, it’s hard to see that the end of phasing out the implicit guaranty justifies the means of seizing a private company. It’s no accident that proponents of a nationalization are talking about a tsar; what they propose is eerily similar to the tactics President Putin used to take over the Russian oil companies. It’s hard to think of a precedent in America.
As it is, Fannie Mae has plenty of capital. As of June 30, Fannie Mae had capital of $47 billion, reserves of $9 billion, and pre-credit cash flow of between $12 billion and $15 billion a year. At the moment, holders of Fannie Mae collateralized mortgage bonds have four lines of defense. The first is that individual mortgage-holders will pay their mortgage bills. The second is that, in the event of defaults, foreclosed-on houses will be sold. The third is that Fannie Mae will use its capital to make up the difference between the value of the foreclosed houses and the remaining value of the bonds. The fourth line of defense is the implicit taxpayer guarantee. An immediate bailout or seizure would risk moving the taxpayers to being first in line to pay from being fourth in line to pay.
What’s depressing Fannie and Freddie’s share prices now is not concern about the balance sheets of the companies or the underlying strength or weakness of the housing market. What potential investors in the companies are concerned about is the risk that their investments would be totally wiped out if the secretary of the Treasury bows to the panic in the press and the pressure to be seen as doing something about the housing market. There’s a view in the markets that, compared to the rush to expropriate Fannie and Freddie, the treatment of the Duke lacrosse team amounts to a paragon of due process.
Fannie Mae’s second quarter net loss of $2.3 billion may seem large, but it isn’t much in the context of its cash flow or its capital reserves. Fannie, after all, is at least in part in the insurance business, and sometimes insurance companies are hit by big storms such as the one now under way in the housing market. Nationalizing Fannie now would be like seizing an insurance company in the middle of the hurricane, even while it was still solvent, rather than allowing it to go on collecting premiums after the floodwaters recede. The best thing Mr. Paulson could do now to strengthen these firms and the markets would be to signal that he is not going to seize the companies. It would have the virtue of protecting not only taxpayers and shareholders but also the private property rights and rule of law on which our capitalist system is based.