Political Power Let Fannie, Freddie Skimp On Capital
STEVE INSKEEP, host:
Let's examine more closely one phrase that Senator Shelby just said. He referred to shoring up the capital of Fannie Mae and Freddie Mac. Capital is basically money on hand, a buffer against a company's losses. And as NPR's John Ydstie reports part of the concern over these two companies is that they've been required to have very little capital.
JOHN YDSTIE: Right now Fannie Mae and Freddie Mac have between 80 and 90 billion dollars in capital. That sounds like a lot of money. The problem, says Christopher Whalen of the research firm Institutional Risk Analytics, is that the two mortgage giants have exposure to nearly $6 trillion of liabilities, almost all in the nation's shaky housing market.
Mr. CHRISTOPHER WHALEN (Institutional Risk Analytics): If you were going to really adequately capitalize Fannie and Freddie, you'd have to go out and raise hundreds of billions of dollars. If they were a bank, they'd have four or five hundred billion dollars in capital to support $6 trillion in total footings. So that's why people are right to be concerned.
YDSTIE: And it's why their share prices dropped into the single digits last week. Whalen says Fannie and Freddie shareholders were afraid that the companies' meager capital would be wiped out as the housing market deteriorates and they'd be left with shares worth nothing. Whalen believes that is the scenario that will eventually play out, despite the strengthening of Fannie and Freddie share prices in the past couple of days.
Mr. WHALEN: The equity holders have my sympathy. If they can get a little pop this week and get out, you know, recover some of their scalp, they should do so. I would not want to see anyone sit with the equity of these two institutions 'cause I think they're both going to be wiped out.
YDSTIE: So why did Fannie and Freddie's government regulator allow them to have such low capital requirements - about a fifth of what's required of commercial banks? The answer: political power, says former Treasury Secretary Larry Summers.
Mr. LARRY SUMMERS (Former Treasury Secretary): It was more profitable for the shareholders to operate with low capital and they had enormous political power in Congress and were able to persuade Congress to establish a capital regime that was very, very favorable to them. And the people who lent the money were prepared to accept the low level of capital because of the implicit government guarantee.
YDSTIE: A guarantee that's become explicit this week. The model allowed Fannie and Freddie to take more risks and do it with money borrowed at very low interest rates because of the government's backing. That provided big rewards for shareholders and managers as long as home prices went up. A good deal for Fannie and Freddie but a bad one for taxpayers, says Summers.
Mr. SUMMERS: The problematic aspect of the structure from the beginning has been the privatization of gain. If the companies make profit, it goes to the shareholders, and the socialization of loss. If the company's not able to meet its obligation, then the government meets the obligation. And whenever you have the privatization of gain and the socialization of loss, you're going to have something that's very popular with the people who benefit from it, but very problematic from the point of view of the broader society.
YDSTIE: The problem Fannie and Freddie face now is raising adequate capital to withstand the billions more in losses they're likely to face in the housing market. Chris Whalen says it will be impossible for them to find private investors willing to pour in the amount of money they need because of uncertainty about their future and the possibility they'll be nationalized once this crisis passes, something he says he supports.
The Treasury's rescue plan for Fannie and Freddie would allow the government to buy equity in the companies. It would be an extraordinary move, but former Treasury Secretary Summers thinks it could happen.
Mr. SUMMERS: I would not be surprised at all if the government found it necessary to make a substantial equity in investment, and I would hope and trust that if the government did find it necessary to make a substantial investment, at that point they would take over substantial control of the way in which the companies functioned.
YDSTIE: Ultimately Summers also thinks Fannie and Freddie's hybrid private/public structure should be done away with. Its public function should be taken over by the government, he says, and its private functions should operate without government backing.
John Ydstie, NPR News, Washington.
INSKEEP: And we have heard a response from the companies themselves. Fannie Mae, Freddie Mac and their regulator all say the companies do have adequate capital to carry out their missions.