Fannie, Freddie and the American Taxpayer

As the United States government commits a bare minimum of $100 billion of taxpayer money to bail out Fannie Mae and Freddie Mac, the final reckoning depends on how effectively Washington runs the mortgage powerhouses.

According to the Christian Science Monitor, with the sheer magnitude of Fannie and Freddie – with $5 trillion in home loans on their combined books – the taxpayers’ burden is likely to add up to billions of dollars very quickly. The worst-case scenario could see the tab rise as high as the $125 billion it cost the taxpayers in the early 1990s to bail out failed savings-and-loan institutions. The rosiest scenarios hypothesize that the short-term cash infusion might be recouped with little or no net cost to the taxpayers.

Part of the reason that Fannie and Freddie are under conservatorship is that foreign central banks and investors have been divesting themselves of American mortgage debt, because they are nervous about falling prices, weak credit and the weak dollar. Since foreign ownership represents $1.4 trillion, it is a sizable piece of the puzzle.

The bottom line is that every U.S. taxpayer is now tied directly to the troubled housing market. And the stakes here are significantly higher than the government’s $30 billion bailout of Bear Stearns. The ultimate cost to taxpayers is tied directly to the depth of the housing slump. If housing prices continue to fall and foreclosures rise, the losses to Fannie and Freddie will increase. The opposite scenario would be far better news for taxpayers.

Fannie Mae and Freddie Mac are government-sponsored enterprises (GSEs), because Congress chartered them to create a stable mortgage market. They have functioned well by guaranteeing home loans or buying them outright. Even with steep declines in the number of sales and prices, investors have continued to fund home loans with a Fannie or Freddie seal of approval; this has kept mortgages relatively available and affordable.

The Treasury Department had no alternative but to intervene, become an equity investor in Fannie and Freddie, and a buyer of their mortgage-backed bonds. Their objective is to restore consumer confidence in the credit markets, reduce the cost of mortgages, and help the housing market recover.