Timothy Carney
2008-07-25 07:00:00.0
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WASHINGTON -

Private profit and public risk” is how economists describe companies like Fannie Mae, where good times mean shareholder profits and executive bonuses upward of $50 million, but where bad times mean pain for taxpayers. It’s nice work if you can get it.

How do you get such a cushy arrangement? One key factor is a huge lobbying budget and intimate ties to the White Houses in both parties, as this column discussed last week. The other key ingredient: Get really big.

Fannie Mae and Freddie Mac have now become “too big to fail” — a refrain we’ve heard for decades about companies such as Chrysler and Lockheed Martin when the government bailed them out. Now “too big to fail” is the public justification for expensive new government programs to prop up these private mortgage companies. It’s a clear example of how a greater government role in the economy usually is not about leveling any playing field or keeping corporate behemoths in check, but rather about protecting the very largest companies.

Liberal Sen. Charles Schumer, D-N.Y., issued a statement earlier this month making it clear: “Fannie Mae and Freddie Mac are too important to go under. Markets should be assured that the federal government will stand by Fannie and Freddie. The companies’ regulator has said they are well capitalized; if they need additional support, Congress will act quickly.”

Rep. Barney Frank, D-Mass., chairman of the House Financial Services Committee, sounded the same note: “It’s not a question of being just too big, but too connected. If a failure in one entity is going to cause a negative chain reaction, yes, then you have to step in and try to prevent it.”

Top Republicans echoed this “too-big-to-fail” sentiment. Treasury Secretary Henry Paulson told Congress about Fannie and Freddie: “They play a vital role in our economy and housing markets today, and they need to continue to play an important role in the future.” John McCain agreed that the companies “must not fail.”

The idea is that Fannie Mae’s or Freddie Mac’s collapse would pose a “systemic risk” to the economy. Together, these companies own or guarantee about half of the mortgage debt in the entire country. More importantly, perhaps, they make up 90 percent of the secondary mortgage market (the firms that buy or underwrite mortgages from lenders). If Fannie’s stock collapsed, if its bonds were degraded and its ability to buy mortgages from banks diminished, the suffering would spread far wider than Fannie’s shareholders, executives and debtors. A ripple effect throughout the economy could occur, causing much pain.

That’s one reason Mom & Pop don’t get federal bailouts while Fannie & Freddie do. (Another, of course, is that Mom & Pop can’t hire all of K Street’s top lobbyists.) But the awful irony is that Fannie and Freddie got as big as they did — and crowded out potential competitors in the process — thanks to active government help.

Most important was the implicit guarantee. Fannie and Freddie are private companies, but they were created by the federal government, so they are officially known as government-sponsored enterprises. Investors and lenders all assumed that the federal government would bail out these GSEs if they ran into trouble. That meant lending the GSEs money was nearly a zero-risk proposition: If Fannie can’t pay you back, Uncle Sam will.

This implied subsidy almost prohibited competition. No competitors could borrow as cheaply, which meant nobody could do business as cheaply. If you are doing the same business as someone else, but it’s costing you more, you don’t stand much of a chance. Thus nobody really competed with Fannie and Freddie.

Other federal rules tweaked the game in Fannie’s and Freddie’s favor, keeping out competition and making these two GSEs so huge. Many reformers in Washington and the media sounded the alarm that they two were getting too big and the government was helping them. But as long as the executives pocketing the huge bonuses (such as former Fannie Mae Chief Executive Officer Franklin Raines, who was Bill Clinton’s budget director) were politically connected (he’s given about $80,000 to Democrats), checking Fannie’s growth wasn’t going to be politically popular.

Now, leaders in both parties are saying, “Well, they’re just too darn big. We just have to bail them out,” as if government wasn’t responsible for making them so big in the first place.