Sept. 10 (Bloomberg) — "Sudden" is the word used to describe the change in the fortunes of Fannie Mae and Freddie Mac. And the evaporation of $100 billion or so in the market capitalizations of the two government-sponsored enterprises certainly was sudden.
Nonetheless, the instability of the mortgage companies, especially Fannie, was long visible. Indeed, Fannie can be viewed as a flower child whose fragility was evident as far back as 1968.
The story of Fannie, of course, begins earlier, with President Franklin Roosevelt. In the Depression, Roosevelt formatted the modern mortgage and supplied desperately needed capital to strapped homeowners via the Home Owners Loan Corp. Later, he established the Federal National Mortgage Association, later Fannie Mae. But these New Deal moves didn't set the stage for the current crisis because the relationship between the new entities and government was clear: They were part of it.
Today's troubles began when President Lyndon Johnson was having a hard time delivering on his guns-and-butter promise. In January 1968, LBJ proposed to Congress both a war surtax and a change in government's bookkeeping. The Federal National Mortgage Association would move off-budget, nominally reducing federal borrowing. The new mortgage company, the New York Times reported, would be "wholly privately owned."
But not entirely private. For here is where Fannie's career as a swinger — swinging between public and private, that is — took off. Either at that point, or later, Fannie and its sibling, Federal Home Loan Mortgage Corp., or Freddie Mac, enjoyed a number of government privileges.
These included a line of credit with the U.S. Treasury Department, exemption of corporate earnings from state and local income tax, exemption from registration under the 1933 Securities and Exchange Commission law and status as government securities under the Securities Exchange Act of 1934. (Those suffering from Fannie shock may even want to download the full roster of privileges from an essay by John Weicher in "Restructuring Regulation and Financial Institutions," a 2001 Milken Institute publication.)
Every era features its trademark stocks, the ones that capture the public imagination. In the summer of 1968, Fannie Mae was that stock. Wall Street wanted to do good in addition to doing well. The housing legislation that had given Fannie Mae public stock ownership also provided funds to house the poor. This association made investors feel better about any windfalls their stock was yielding.
In '68, NASA was gearing up for the moon landing in the next year. There was a sense that this new mortgage company's shares were likewise breaking the laws of gravity. Investors spoke of "different earnings dynamics" for Fannie's stock. The New York Times reported that buyers couldn't get enough of Fannie: "So powerful has been the thrust behind the issue that the published over-the-counter quotations have been consistently at odds with the closing price."
Observers were certain that Fannie had a future of fame, although it might be a questionable fame. "New Swinger on Wall Street" read the headline of a column by Robert Metz of the Times. Fannie Mae, wrote the prescient Metz, "promises to be a Wall Street swinger long after the United States converts the agency into a private corporation on Sept. 1."
The rest we know. How Freddie Mac joined Fannie Mae in the gray area between public and private. How Fannie Mae's activity looked reasonable at first: in 1980 Fannie's role in the economy amounted to about $60 billion, the equivalent of the Farm Credit System. How Fannie grew: by 1997, Fannie was a trillion-dollar presence whereas the entire agriculture sector was still stuck at that $60 billion. By 2002 the total assets of Fannie, Freddie and the Federal Home Loan Banks were more than $2 trillion.
This week the news coverage focuses on identifying the implosion's possible catalysts. One may be all the cash foreign governments had placed in so-called agency debt, the category that includes Fannie and Freddie bonds. My Council on Foreign Relations colleague Brad Setser notes that Treasury Secretary Henry Paulson probably acted with an eye to foreign markets when he announced the government takeover.
Another analysis says that Fannie and Freddie's failure is the result of crony capitalism. This is doubtless also legitimate: aside from Richard Baker, the Fannie critic who served in Congress representing Louisiana until this year, it's been hard to find a lawmaker not intimidated by the GSE arm-twisters.
Yet a third view is that Fannie and Freddie matter because they tell us that recent growth has been more illusory than real.
In the Wings
But the Fannie fiasco matters for a less obvious reason. There are other accidents waiting to happen in the social entitlements whose costs also will jeopardize U.S. long-term growth. Social Security and Fannie aren't often spoken of in the same breath — as programs go, we associate Social Security with the swinging-and-60-plus crowd, not the Swinging '60s.
What Social Security and Fannie have in common is that both have lived important segments of their lives off-budget. Tax increases are likely to pay for Fannie and Freddie. These increases will remind voters that being off-budget doesn't mean a program won't eventually penalize the taxpayer. Burned by Fannie, voters may get ready for entitlement reform.
That's hardly a consolation. Still, all that suggests the Treasury's acknowledgement of the GSEs' costs was a wise one. The first step to financial stability is getting swingers to stay on the books.
(Amity Shlaes, a senior fellow in economic history at the Council on Foreign Relations is a Bloomberg News columnist. The opinions expressed are her own.)
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