Several financial institutions are considered too big to fail by US regulators. But most of them are small fractions of the size of Fannie Mae and Freddie Mac. The two government-sponsored enterprises hold or guarantee $5,200bn in mortgage debts. The moves to shore up the two giants over the weekend are welcome. However, policymakers must decide what they want to do with them in the long term.
Responding to fears about the mortgage behemoths’ liquidity and solvency, the Federal Reserve responded on Sunday by allowing Fannie Mae and Freddie Mac to borrow from its discount window. They now have access to emergency lending on the same terms as banks and primary dealers. Meanwhile, the US Treasury is seeking permission from Congress to increase its credit lines to the giants and for the right to purchase equity in them.
The Fed and US Treasury had little choice, but it was still the right course of action. Hank Paulson, Treasury secretary, and Ben Bernanke, federal reserve chairman, have therefore staved off short-term liquidity problems.
The Treasury proposals also establish a framework to allow them to insist that the two GSEs are adequately recapitalised. This is also welcome. With an explicit guarantee from the government, the two GSEs can continue to operate indefinitely with inadequate capital.
However, one question that the government must answer as soon as possible is what role the government would like the GSEs to fulfil in the long term.
The current structure for Fannie and Freddie is unsustainable. The GSEs are poorly regulated. They have given successive US governments an incentive to keep the housing market inflated. They socialise their risks and privatise their profits. Having saved the GSEs this weekend, policymakers should aim to bring about a decent burial for Freddie and Fannie.
They could be broken up into small pieces and privatised. A rump could be retained by the Treasury as a small counter-cyclical mortgage liquidity vehicle. The process might involve a period of nationalisation. This could mean the GSEs’ vast debts would be moved on to the public balance sheet. However, this is unimportant. It would be a cosmetic change; the government is already backing them; it is absurd that they are not now on the books.
US policymakers will be tempted to put off decisions about the future of the GSEs. However, political will for reform can often be achieved only in a crisis. It is time to correct an anomaly that has long distorted the US housing market.
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