Thursday, September 11, 2008

Fannie Mae and Freddie Mac RIP

The Government Sponsored Entities (GSE) known as Fannie Mae and Freddie Mac succummed to the credit crisis and were taken over by the US government, which brings to a close their checkered history as a failed government experiment. While the Bush administration will shoulder the criticism for propping up private companies and serving the interests of the rich, this is simply not the reality of the situation. Unfortunately, many in this administration, as well as previous administrations and Congresses voiced their concerns about the "implicit" government backing these companies enjoyed, but to no avail.

By being a GSE these companies operated as if they had the full faith and backing of the Federal Government, even though they didn't, because they were quasi public companies. A little history helps to understand the dilemma. Fannie Mae was created by the government during the Great Depression to buy mortgages, which they guaranteed with the full backing of the government. In 1968, President Johnson created the current structure of Fannie Mae, but without the guarantee. In the 1970's, Freddie Mac was created and the two quasi public entities began buying mortgages and packaging them into securities, which were purchased by banks, investors, governments and others around the world, because of the implicit guarantee that if anything went wrong, the US government would back the securities.

As we all know by now, the two GSE's did fail, and while the reasons are varied, the implicit guarantee is now an explicit guarantee. The strategy of the government should be to shrink them and eventually let them become a relic of a failed business model. The best way to back mortgage securities is by a fully capitalized private entity with enough capital to guarantee the mortgages and mortgage backed securities it has underwritten. Ultimately an expensive lesson has been learned, hopefully! You can't write mortgages for people who don't have the ability to pay them, and the bank that underwrites a mortgage must have a stake in the security that ultimately buys the mortgage. It sounds so simple!

On this 7th anniversary of the horrendous attacks on our country by Islamic terrorists, I just want to let the families of those who lost their lives know there are some people in this country who have not forgotten. May you find peace!

John Kaighn

The Kaighn Report

Jersey Benefits Advisors