There were many many phone calls made over the course of the past two days. Ben Bernanke, chairman of the Federal Reserve, and Henry Paulson, Treasury Secretary, were quite busy trying to come up with a plan to salvage the two giants of the U.S. mortgage industry: Fannie Mae and Freddie Mac. After a very nervous Friday, it was clear that they only had two days to do it.
The strategy they proposed to calm the shareholder panic and restore a semblance of normality to the mortgage markets had two main aspects. First, talk up the survival prospects for the two mortgage entities in order to convince skittish investors that they have enough money to keep the doors open. Second, promise to essentially pledge the financial resources of the federal government to back the two companies.
In less than two hours, a new business day will start. Freddie Mac and Fannie Mae have a short term objective of selling around three billion dollars worth of securities today. In essence, the Fed has promised "if you fail to invest in Freddie Mac and Fannie Mae, we will give them all the money they need ourselves at the most favorable rates". How will the investors respond? Well, they are likely to say "more power to you buddy, it's all yours."
The true lesson here is that deregulation of financial markets can carry a high price. We allowed the mortgage industry to engage in risky behavior, clinging to the fiction that they were playing with someone else's money. Now we discover that the mortage giants were "too big to fail"- because together they constitute half the U.S. mortgage market- and in order to prevent a broader economic collapse, we as taxpayers are the investors of last resort.
Some will try to tell you that the de facto bailout of the 2 mortgage giants amounts to a doubling of the USA national debt. But this ignores the fact that most mortgages are repaid in full, even in our current mess. Barron's magazine estimates that U.S. taxpayers are probably going to lose around $100 billion- which is equivalent to a year of ccupying Iraq, by way of perspective.
Of course, it would have been much much better to have never gone down this road. But I am not one of the people who will argue that letting them default would be better. My dad had a hard time in the Great Depression, I would prefer not to follow in his footsteps. As I said, the true tragedy is that this "final scene" was avoidable, if we had been willing to better regulate the financial world back in Act I.