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Thursday, August 6, 2009

Fixing Fannie/Freddie: The Latest Obama Gimmick

Fannie Mae reported another terrible quarter today.

Fannie Mae, the largest provider of U.S. home mortgage funding, on Thursday reported a $14.8 billion quarterly net loss that it said would force it to go to the U.S. Treasury trough a third time for money to stay in business.

The company noted a "significant uncertainty" of its long-term financial health in reporting its eighth consecutive quarterly loss, which illustrates its struggle to make money in the face of rising defaults and pressure to do more to stabilize the housing market.

The mortgage giant is about to ask the federal government for another $10.7 billion lifeline. The government of course now owns both Fannie Mae and its sister company Freddie Mac. Now, the administration is floating an idea to help the deal with their long term viability.

The Obama administration is considering an overhaul of Fannie Mae and Freddie Mac that would strip the mortgage finance giants of hundreds of billions of dollars in troubled loans and create a new structure to support the home-loan market, government officials said.

The bad debts the firms own would be placed in new government-backed financial institutions -- so-called bad banks -- that would take responsibility for collecting as much of the outstanding balance as possible. What would be left would be two healthy financial companies with a clean slate.

This is very similar to what the Swedish government did to their banks. In that case, the whole banking system was nationalized, the bad debt was removed, the board and upper management dissolved, and then new private banks were created out of the rubble.

In this case, it remains unclear if the management will be dissolved. In fact, its unclear if anything will happen besides the federal government completing a full bailout for these two giants in under this plan. In fact, this appears to be little less than bailing these two out from years of bad and irresponsible behavior.

The president has proposed for a total overhaul of the regulatory framework of the entire financial system and all he will do to Fannie/Freddie appears to be to take their bad debts off their hands. He will have fixed none of their structural problems. They will still continue to have a monopoly and they'll now be even more tied to the Federal government. In fact, by doing this, all he'll do is create even more moral hazard and encourage a repeat in a few years. Let's hope this is NOT the final plan for the two mortgage giants.

Here's my ideas for fixing the two giants.

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