Julius Caesar’s decision to cross the river Rubicon touched off three years of bloodshed and strife that changed the Roman world. So it is (in less dramatic fashion) with the decisions Congress will make about whether and how to bail out Fannie Mae and Freddie Mac, the two Government-Sponsored Enterprises (GSEs) that facilitate a majority of home mortgages in the United States. These choices will change the way the federal government interacts with financial markets for years to come.
Amid concerns over the stability of Fannie and Freddie, which operate as corporations under federal charter, Treasury Secretary Henry Paulson recently sketched the outline of a rescue plan for the two scandalously mismanaged lending giants – reportedly allowing the federal government to step in with as much as $300 billion of taxpayer-funded credit or stock purchases.
Democrats in Congress hope to tie the new scheme to legislation that would permit the Federal Housing Administration to renegotiate and then guarantee decaying subprime loans (coincidentally, up to $300 billion worth).
Many will recognize a familiar ring to this proposal. The Savings & Loan crisis, after all, cost taxpayers some $150 billion to resolve. How could a bailout of Fannie and Freddie be worse? Easily.
For instance, the federal government closed down and otherwise “resolved” the finances of more than 1,000 S&Ls with combined holdings of about $500 billion. Today Congress confronts the financial health of only two entities, which hold or guarantee 10 times that amount of money, in the form of mortgage paper.
In addition, Savings & Loan deposits were explicitly insured by the federal government up to $100,000. Until now, Fannie and Freddie had carried only an indeterminate, “implicit” backing by taxpayers and a small line of credit from the Treasury. If Congress carelessly makes the GSEs whole, it will have signaled to markets that no institution should worry about inconvenient things like balance sheets and sound business models. Uncle Sugar will cover the losses.
It is true that a number of politicians had cozy relationships with S&Ls, but this wheeling and dealing doesn’t match the systematic influence campaign on the part of Fannie and Freddie. Together, the two GSEs employ more than 140 lobbyists and have spent $170 million on lobbying activities over the past decade. And it worked. Time after time, even modest reforms to GSE capital standards and business practices were stymied.
Any lawmaker claiming the mantle of fiscal responsibility should be reluctant to vote for this type of bailout. But at the very least, Congress must end incentives for risky behavior in mortgage markets and shrink the undue influence that GSEs have exerted on politics and finance. For example:
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Any new GSE regulator should be required to consider systemic risks, as well as design capital standards and portfolio limits.
Any infusion of tax dollars should be delivered to the least-risky level of capital held by GSEs. This would mean making the taxpayer investment a form of “senior subordinated debt,” so that dividends and interest payments would take the hit first. Recklessness shouldn’t be rewarded.
A “hard” cap (of far less than the reported $300 billion being sought) should be placed on the Treasury’s authority to back GSEs. All provisions should be limited in duration, to encourage regular congressional review and speedy repeal.
Once any loans or share purchases involving tax dollars take place, GSEs should be prohibited from conducting any kind of political or lobbying activity. And the Treasury, in consultation with other regulators, ought to have decision-making power over GSE executive selection and compensation.
Finally, in the longer term, competing housing finance franchises should be created by breaking up GSEs and auctioning off the new private entities in a manner similar to FCC spectrum auctions.
Many in the administration and Congress argue that the stability of international markets and the U.S. housing sector call for immediate action before these reforms can be implemented. Nonsense. Of equal importance to heading off an economic meltdown in the present is ensuring that government policies don’t create similar meltdowns in the future.
Caesar’s move across the Rubicon ended badly – for him and, over time, for the Roman people. Congress should pull U.S. financial policy back from the river’s edge, before current and future taxpayers are forced to wade into unknown depths of red ink.
Pete Sepp is Vice President for Policy and Communications of the Alexandria, Va.-based National Taxpayers Union, a 362,000-member, nonprofit, nonpartisan citizen group founded in 1969 to work for lower taxes, limited government, and economic freedom at al levels. http://www.ntu.org/
