Bailout of Freddie Mac and Fannie Mac in the “Ownership Society”

If you weren’t yet fully convinced that the Reagan Revolution has been consigned by politicians and pundits to the dustbin of history, you must have missed the stock market’s 290-point surge on news that the federal government took Fannie Mae and Freddie Mac under “conservatorship” on Sunday. The market should have crashed following proof positive that, under George W. Bush and Treasury Secretary Hank Paulson, corporate socialism is now the economic order of the day in Washington.

But then again, why shouldn’t investors be bullish? They now know with virtual certainty that any company that is big enough and politically well-connected enough can keep all of its profits if it succeeds, but can shift its losses to the taxpayers if it gets into financial trouble. The recent bailout of Bear Stearns, at $29 billion, was just chump-change. It may take twice that much to cover Fannie and Freddie’s deficits.

And there’s more: you, Mr. and Ms. Taxpayer, will be buying $5 billion worth of the two companies’ mortgage-backed securities later this month, will be on the hook for the $100 billion lines of credit Secretary Paulson stands ready to offer each of the so-called mortgage giants, and may become “owners” of up to 80% of their common stock. But don’t get too excited about these new additions to your investment portfolio. Many of those mortgage-backed securities are “backed” by subprime and Alt-A (a.k.a. liar) loans, which Fannie and Freddie aggressively continued to purchase even after the housing bubble burst.

The Fannie and Freddie conservatorship will be by far the most expensive federal government bailout in history. Apparently concluding that the two companies were engaging in many of the same accounting shenanigans that got them into trouble in 2003 and 2004, when it was revealed that they were overstating earnings and understating liabilities, the Bush Administration apparently concluded that a federal takeover was its only option.

Perhaps. But other than replacing incumbent management, suspending the payment of stockholder dividends, and barring Fannie and Freddie from political lobbying, there doesn’t seem to be any urgency for engineering an orderly shutdown that would get the federal government out of the mortgage-guarantee business, which it has no constitutional authority for in the first place.

Maybe one shouldn’t be so hard on the lame ducks. After all, both presidential candidates have endorsed, a bit tepidly to be sure, the administration’s actions. Sens. McCain and Obama also have voiced their support for a taxpayer-financed $50 billion loan to America’s automakers, should that industry’s fortunes continue to sag.

We now know what George Bush really meant by the “ownership society.” For more details, see here and here.

William F. Shughart II is a Distinguished Research Advisor and Senior Fellow at the Independent Institute, the J. Fish Smith Professor in Public Choice at Utah State University, past President of the Public Choice Society as well as the Southern Economic Association, and editor of the Independent book, Taxing Choice.
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