Imagine investing in a business based on the following model: when times are good, you reap the benefits (dividends, rising stock price) and when times are bad (big losses, declining stock price and a huge need of additional capital), the government backs you up. Nice investment huh?
This is precisely the deal that shareholders of Freddie Mac and Fannie Mae have in the home mortgage market. It should come as no surprise that many Washington insiders are in on the deal and actively lobby to ensure regulatory pressure is minimized. In particular, they lobbied to resist raising capital requirements as the loan portfolios surged.
As a Government Sponsored Enterprises (GSE’s) originated to meet a compelling public need (essentially defined as improving affordable home ownership), these enterprises are allowed to borrow at lower rates from the bond market and operate with lower capital requirements than traditional mortgage lenders because there is an implied financial backing from the federal government. With over $5 trillion in home mortgages, one could plausibly argue that these GSE’s have been quite successful.
The question of an implied government guarantee comes into play when the GSE’s are financially stressed. While the mortgages underwritten by Frannie and Freddie were more traditional and they never entered the “sub-prime” market, they are still facing losses due the weakening economy and falling real estate values. Last weekend, the Treasury Department and the Federal Reserve worked diligently to implement a plan to provide additional capital to these entities if their losses increased. Additionally, the Fed allowed them to borrow directly from the Federal Reserve if they needed liquidity.
The reasons behind the decision for government intervention are very real. Combined, Fannie Mae and Freddie Mac comprise almost half of the overall mortgage market. If they suffer continued liquidity problems, it could potentially bring the mortgage market to its knees--especially on the heels of the sub-prime mortgage debacle.
Situations such as this are becoming increasingly more prominent as an election issue because individuals who are struggling with their mortgages continue to see a fragment of the concern that is offered to GSE’s and Investment Banks (as a result of the Bear Stearns implosion). It is becoming a classic debate of how much government should be involved in our financial markets and to whom, if anyone, it should provide relief.
The first question in this debate is if the big guys (financial institutions) are the beneficiaries of government intervention, why aren’t the “little guys”
(i.e. homeowners who can’t meet their mortgage obligations) being helped. If you are quick to point out that these homeowners made their own bed, remember that these institutions made their bed as well. It’s quite the moral dilemma for both the “give them a hand” crowd as well as the “it’s too big to fail” market folks. If you were a policy maker, would you intervene? If so, where would you draw the line?
...here's the operative quote: 'When underdogs choose not to play by Goliath's rules, they win.'
Jack Uldrich in "How the IP Can Win" Join the discussion
