The 100-year Loan and Other Problems at Fannie Mae and Freddie Mac

The odds are increasing that Fannie Mae and Freddie Mac, the mortgage giants recently taken over by the federal government, will never return to their semi-private status, according to a report in The New York Times.

While official comments following the takeover of the two companies noted the move was intended to be temporary, some lawmakers now favor a complete nationalization of the mortgage lenders, arguing that would position the government better to guarantee loans to millions of new homebuyers. Others wish to preserve the earlier semi-private status of the companies, and a third group would like to see them entirely privatized, according to The Times. The problem: Fannie Mae and Freddie Mac have to repay the money they borrowed from the federal government, and some estimates suggest this could take up to 100 years. As that hard reality sinks in, legislators and company executives are starting to “quietly acknowledge” the likelihood of permanent nationalization, according to The Times.

The report also suggests that the government’s likely inability to at least partially re-privatize these two giant lenders means that nationalization can cripple the finances of any financial institutions it takes over. That potential outcome argues against the viability of the temporary bank nationalization solutions increasingly being floated. Wharton professors discussed the pros and cons of temporary nationalization with Knoweledge@Wharton in a recent article, with some suggesting it offers the best solution left for steadying the country’s financial system, which is fraught with uncertainty because some of the nation’s largest banks may be insolvent or close to it. In September, in the wake of the federal takeover of the mortgage giants, Knowledge at Wharton published “After the Bailout: How Can the Fed Clean Up the Fannie and Freddie Mess?” which considers many of the issues developing today.

Two newspaper articles today provide further insight into the idea of temporary nationalization as a potential solution to the banking crisis. An editorial in The Wall Street Journal argues that shareholders at Fannie Mae and Freddie Mac have been abused in the process. “With Fannie and Freddie in particular, any policy end Washington might have sought, including breaking them up, would have been entirely doable with shareholders still in charge.” The article further argues that punishing holders of equity (shareholders) while sparing creditors (at least for the moment) has been a flawed policy that leads inevitably to a full government takeover – an inefficient solution that might have been avoided.

Martin Wolf, in his Financial Times column, argues that any nationalization of financial institutions, though meant to be short-term, could last for many years. If regulators cannot distribute losses to creditors in addition to shareholders, then “the state could well own huge banks for a long time before it is able to return them to the market.” Wolf notes that the largest bank restructuring in the U.S., until recently, involved Continental Illinois in 1984 – then the nation’s seventh-largest bank. It took a decade to restructure Continental. “How long might the restructuring and sale of Citigroup take, with its huge global entanglements? What damage to its franchise and operations might be done in the process?”

Since the summer, the federal government has created a $400 billion account for Fannie Mae and Freddie Mac, which has become one of the few dependable pools of money available for mortgage lending to support U.S. homebuyers today. The federal government has also told the companies they must administer a large new mortgage modification program, refinance millions of buyers in danger of losing their homes and ease restrictions so that less-qualified borrowers can secure loans, The Times notes.

Fannie Mae last week reported a $58.7 billion loss for 2008, which destroyed all profits earned since 1992. Expect a report of record losses shortly from Freddie Mac. Earlier this week, David M. Moffett, Freddie Mac’s chief executive, resigned his position after less than half a year on the job.