Fannie & Freddie – Differing Views from Krugman and Rogers

New York, 15 July 2008. The US Federal Government on Sunday announced a bailout package for troubled Government Sponsored Enterprises (GSEs) giants Fannie Mae and Freddie Mac

New York, 15 July 2008. The US Federal Government on Sunday announced a bailout package for troubled Government Sponsored Enterprises (GSEs) giants Fannie Mae and Freddie Mac.

The package allows Fannie and Freddie to draw on the Treasury Department or the Federal Reserve for credit. If Congress approves a bill that will be brought before it, then the Treasury will also be able to buy shares in the two outfits.

Between them, Fannie and Freddie own $5 trillion of mortgage debt. By indirectly taking on this debt, the US government deficit has almost doubled from $6 trillion to $11 trillion. This could lead the dollar lower and may leave a very large clean-up bill for taxpayers.

The bailout has drawn very different responses from different quarters.

Economist Paul Krugman, writing in an Op-Ed piece in the New York Times, believes that the problem is not as big as some make it out to be. Although he admits serious problems in how the companies have been run and the power that their lobby wields in Washington, he believes that since by definition Fannie and Freddie cannot provide sub-prime loans, and since sub-prime was the cause of the current housing market crisis, they are not guilty of causing the current mess.

He believes that the size of the problem has caught up with everyone, since in many regions home values have fallen 20% or more from their peak. Even if a ‘safe’ borrower paid 20% for their house and got a prime mortgage within the last couple of years, they are now in negative equity territory and are at risk of default.

Famed investor Jim Rogers has taken a very different view, however. Speaking on BBC World News, he said that Fannie and Freddie have been engaged in a ‘shell game’. Even without sub-prime, there is a lot of ‘near prime’ in there, such as the ‘A Minus’ Freddie Mac offering and Fannie Mae’s ‘Expanded Approval’, not to mention the ‘low docs’.

Mr Rogers believes that when debt gets out of hand, institutions should naturally go bankrupt, no matter how big or ‘important’ they are. If not, he believes the problems will be even bigger a few years down the line, and that they will have to be dealt with eventually. Essentially he sees this as American taxpayers providing insurance coverage for the big investors in Fannie & Freddie, particularly the Chinese and Japanese central banks.

Whichever take ultimately proves to be correct, one thing is for sure; the Housing Crisis & Credit Crunch are far from over.

Ron Portobello, EconomyWatch.com