I have commented in the past that there has been an implicit assumption that government will back the debt of Fannie and Freddie Mac. Certainly there may be many investors especially outside of the US who believe that there always was a government guarantee. The GSE’s themselves may have believed that they would always be bailed out. This is why they have driven their balance sheet to such extremely high leverage levels. Shareholders may have also believed that the government would protect the debt. They were willing to invest in quasi-government sponsored firms with accounting irregularities and high leverage that they would never take from other private firms.
The two GSE’s own or guarantee over $5 trillion in mortgage debt which represents about half of all of the mortgages in the US. These organizations are too big to fail, yet there is no reason why there should not be some cost for GSE behavior excesses. The phase that best describes the current GSE model is for “privatized profits while socializing risks” Taxpayers have to pay the bill while shareholders have been paid past profits. In fact mortgage companies created many of the new mortgage products because they could not compete in the conforming vanilla mortgages packaged and bought by the GSE’s.
The extension of the government balance sheet for helping the mortgage GSE’s is a move to nationalization of the mortgage business. Yet for this entire debacle, shareholders have not been punished by the government. Management is still in place. Bondholders have moved from Treasuries to Fannie and Freddie to receive the higher yield and have not been punished for making the bet on a bailout. The bailout is needed and the support of the mortgage market is required but the process makes a difference. There are no losers except the taxpayer.
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