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And now we’ve reached the next stage of our seemingly never-ending financial crisis. This time Fannie Mae and Freddie Mac are in the headlines, with dire warnings of imminent collapse. How worried should we be?

Well, I’m going to take a contrarian station: The turmoil over these particular lenders is overblown. Fannie and Freddie probably will need a government rescue. But since it’s already unblemished that the rescue will delineate place, their problems won’t take down the plan.

Furthermore, while Fannie and Freddie are problematic, they aren’t responsible with a view to the mess we’re in.

Here’s the background: Fannie Mae

The event against Fannie and Freddie begins with their peculiar status: Although they’re private companies with stockholders and profits, they’re “government-sponsored enterprises,” which means they receive special privileges.

The principally of importance of these privileges is implicit: It’s the confidence of investors that if Fannie and Freddie are threatened with failure, the government will come to their rescue.

This implicit guarantee means that profits are privatized but losses are socialized. If Fannie and Freddie do well, their stockholders reap the benefits, but if things go badly, Washington picks up the tab. Heads they win, tails we lose.

Such one-way bets can assure the distress of bad risks, because the downside is someone else’s problem. The classic example of how this can happen is the savings-and-loan crisis of the 1980s: S&L owners offered high interest rates to attract lots of federally insured deposits, then essentially gambled with the money. When manifold of their bets went bad, the feds ended up holding the bag. The eventual cleanup require to be paid taxpayers more than $100 billion.

But here’s the thing: Fannie and Freddie had nothing to be enough with the explosion of high-risk lending a few years ago, an explosion that dwarfed the S&L fiasco. In fact, Fannie and Freddie, from growing rapidly in the 1990s, largely faded during the height of the housing hoax.

Partly that’s because regulators, responding to accounting scandals at the companies, placed temporary restraints on both Fannie and Freddie that curtailed their lending just as trappings prices were indeed anger not on. Also, they didn’t do any subprime lending, for example they can’t: The definition of a subprime loan is precisely a loan that doesn’t meet the requirement, imposed by code, that Fannie and Freddie buy only mortgages issued to borrowers who made substantial below the horizon payments and carefully documented their income.

So whatever unwelcome incentives the implicit founded on guarantee creates have been counterpoise by the fact that Fannie and Freddie were and are tightly regulated with regard to the risks they can elect. You could reply that the Fannie-Freddie experience shows that regulation works.

In that predicament, however, how did they end up in trouble?

Part of the answer is the sheer scale of the housing bubble, and the weak glue of the price declines taking put now that the bubble has blow up. In Los Angeles, Miami and other places, anyone who borrowed to bribe a house at the peak of the market probably has negative equity at this point, even if he or she originally put 20 percent down. The result is a rising rate of delinquency likewise on loans that meet Fannie-Freddie guidelines.

Also, Fannie and Freddie, while tightly regulated in terms of their lending, port’t been required to put up enough capital

Still, isn’t it shocking that taxpayers may extremity up having to rescue these institutions? Not really. We’re going through a greater monetary turning point

And let’s be clear: Fannie and Freddie can’t be allowed to wane. With the collapse of subprime lending, they’re now more central than ever to the housing mart, and the economy as a healthy.


Original text: http://seattletimes.nwsource.com/html/opinion/2008051393_paulkrugman15.html?syndication=rss