Lowell Manning: Freddie Mac and Fannie Mae

According to National radio this morning $12b US Federal support has been given to American home loan giants Freddie Mac and Fannie Mae.

Common sense suggests both Freddie and Fannie should be (re) nationalised as soon as possible to help stabilise the world financial system.

Fannie Mae (Federal National Mortgage Association) was set up in 1938 as a government owned source of home loans and loan guarantees. It was privatised under Congressional Charter in 1968. Freddie Mac (Federal Home Loan Mortgage Corporation) was likewise created by Congressional Charter in 1970, I think under the guise of providing "competition" to Fannie Mae in the secondary home loan market.

Both (nominally private) businesses operate in the secondary mortgage market. They buy mortgages, securitise them then sell them on to other investors, effectively charging a fee for the guarantees they provide in the process. However, they are meant to be working only with "conforming loans" so the quality of the loan portfolio should be good. Freddie and Fannie own or guarantee about $6 trillion of the $12 trillion total US home mortgage debt.

The reported $1 trillion "at risk" sounds to me to be about right. It's about two thirds the proportion of sub-prime sector loans "at risk" according to the Bank of International Settlements (BIS).

The primary source of risk is the flow-on effect of the sub-prime bust that has significantly reduced house prices in some parts of the US. As a result some homeowners now owe more than their property is worth and some of that group are defaulting on their loans.

For Freddie and Fannie, $1 trillion "at risk" doesn't mean foreclosures of anything like that amount. It's main practical impact is to reduce the credit rating of that segment of their portfolio. While not formally protected by the government, Freddie and Fannie both come under the heading of GSE's (Government Sponsored Enterprises) making them, in the words of 2002 Nobel laureate in economics, Vernon Smith, "implicitly taxpayer-backed agencies".

This is exactly the process we have seen in NZ with the privatisation of public assets and subsequent efforts to "create" a market from them, for example in the electricity industry. Those efforts, I suggest, have failed here, and what is happening in the US is substantive evidence they haven't worked there either.

Since both Freddie and Fannie are much too big to fail, providing taxpayer capital to shore them up makes sense.

That, of course, raises the obvious question about why Fannie was privatised in the first place. The ultimate recourse has always been for Fannie's and Freddie's corporate shareholders to go begging to the government when the going gets tough. It makes no sense to me that private investors should reap billions in profits in good times then have the public pick up the tab in bad times. That's not capitalism; that's trough feeding at its worst.

The Friedmanite monetarist model of capitalism has plainly run its course. It doesn't work, and never did. It is now shown to be the scam it always was: to pilfer piles of profit from the public purse.

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