The Magazine

The Fannie and Freddie Follies

Spare the rod, spoil the child.

Jul 28, 2008, Vol. 13, No. 43 • By LAWRENCE B. LINDSEY
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Should the United States drop into a historically memorable economic downturn in the near future--a clearly possible if far from certain event--economic historians will likely cite July 11, 2008, as a critical date. It will be not unlike October 28, 1929, which we know today as Black Monday. I propose that future historians call it "Fickle Friday" for the confusing signals out of Washington whipsawed the market and led to a diminution of confidence in the government's ability to right the financial system.

Dawn broke on the East Coast that Friday with our two biggest Government Sponsored Enterprises (GSEs), Fannie Mae and Freddie Mac, trading down 50 percent from their close the day before. These two are the main conduit through which home mortgages pass in the marketplace. The proximate cause of their problems was a New York Times story saying that the Bush administration had plans to nationalize them and wipe out their equity value in the process. After the story broke, a mildly positive day in the European markets turned to one of major losses, and New York markets were set to open sharply lower. Nearly everyone associated with the money markets was talking about how the government would have to do something and soon.

The Bush administration began the day of confusing signals by announcing a presidential event at 11 o'clock--which turned out to be about gas prices--and a National Economic Council "Administration announcement" at 4 P.M., which turned out to be about an EPA issue. There was also to be a 10 A.M. statement by Treasury secretary Henry Paulson, which was widely hyped. It ended up being delayed by 25 minutes and turned the hopes of a rally based on great expectations into a midday fizzle. The secretary did not appear, and a written statement was released saying, "Today our primary focus is supporting Fannie Mae and Freddie Mac in their current form as they carry out their important mission." The markets viewed the phrase "in their current form" as showing some real detachment between policymakers and the facts on the ground. Equities were rapidly sold off, hitting lows not seen for two years.

But Senate Democrats improved on the administration's record for confusion. The Senate had been working on a Federal Housing Administration reform bill, sponsored by banking committee chairman Christopher Dodd, all week. One of the key provisions was a tax on all of Fannie's and Freddie's lending, amounting to about $300 to $400 on each mortgage. No sensible person could think that imposing heavier taxes on institutions whose stocks were in a death spiral was a good idea. But the taxes were dedicated to a new housing slush fund that would go to (largely Democratic) governors, mayors, and left-leaning community groups like ACORN. (The last--the Association of Community Organizations for Reform Now--would be a leading recipient of the bill's largesse despite, or perhaps because of, its being one of the few institutions in the country to have seven of its members convicted of voter fraud for generating fictitious voter lists.)

Then at 2 o'clock in the afternoon Senator Dodd went in front of the television cameras to defend Fannie and Freddie. He said that they were sound institutions, had access to capital, and had significantly tightened their lending standards. Then he mentioned that he had been in conversations with the Treasury and the Fed about the possibility of providing a new liquidity facility to Fannie and Freddie. Markets began to turn. Reuters piled on with a story that Federal Reserve chairman Ben Bernanke had told Freddie Mac CEO Dick Syron that they would have access to the discount window to cover any short-term liquidity crises. The Dow, which had been down nearly 200 points skyrocketed to positive territory. It turned out the Reuters story was false, but the Dodd statement had given them sufficient grounds to run it, and the Fed did not deny it until after the markets closed. Still, equities were turning back down at the close as cooler heads realized there was enormous uncertainty about the soundness of the housing giants and about the size or form of any government bailout.