From local home mortgages to international financial markets, the federal takeover of Fannie Mae and Freddie Mac has universal implications. The most telling sign of the magnitude of the situation is what the intervention may have prevented from happening. With a portfolio of nearly $5 trillion, a figure much larger than nearly every country’s economy, allowing the companies to implode could have caused a worldwide banking crisis.

This comes as little relief to the average taxpayer, who is stuck holding the bill for a financial mess that was completely avoidable.


As the U.S. Treasury Department makes available $200 billion in taxpayer dollars to back the failing institutions, the most troubling aspect of the situation is the exodus of foreign investors from the U.S. housing market. With the plummeting value of the dollar as well as speculation of a government takeover, foreign central banks have begun to sell off some of the trillions of dollars they had invested in the companies’ debt.

"If they would have been allowed to fail, it would have been far more painful for a lot of people," says Erin Quinn, senior policy and program adviser for the New Mexico Mortgage Finance Authority. Quinn says that the MFA is pleased with the decision: "We need GSE’s in the market place."

GSE stands for government-sponsored enterprise. The companies were private up until last Friday. They were created by the U.S. Congress with the public mission of making affordable mortgages available to more Americans. The first housing GSE, Fannie Mae, was created in 1938 but it was not privatized until 1968.

Freddie Mac was created in 1970 to give competition to Fannie Mae. Both companies aimed to maximize profits for their shareholders and investors while maintaining their mission.

Problems for the market snowballed when good interest rates attracted investors to the housing and real estate markets. The good interest rates were helped and largely fueled by an infusion of foreign capital investment. A cycle of speculation ensued, causing a false appreciation in the market.

Lenders began to make money off this appreciation by offering subprime loan packages to people who could not afford homes. As speculators flipped houses for profit and lending agencies offered more and more mortgages, even to those who could not afford it, the market gave a false projection that everything was growing and healthy. This is what was known as the housing bubble and it was one of the reasons why Fannie Mae and Freddie Mac became too big to fail.

When housing prices peaked in 2005 and started declining in 2006, this aligned with thousands of foreclosures that were happening as a result of the faulty lending practices by numerous institutions. This is what we are still experiencing and what is known as the subprime mortgage crisis.

"The crisis began with reckless lending," says Diana Dorn-Jones, executive director of the United South Broadway Corporation and recent participant in Lt. Governor Diane Denish’s meeting to announce a crackdown on predatory lending in the state. (The New Mexico Independent’s Denise Tessier covered that meeting in an article earlier this week.)

"Most people think their mortgage is like the 30-year, fixed-interest rate that their parents had, and they’re not," says Dorn-Jones. She speculates whether the resources that went to help Fannie Mae and Freddie Mac would have been better used by giving financial relief directly to homeowners who are facing foreclosure. "It seems logical to broaden the shoulders of the relief, a trickle up approach."

A lack of government oversight is being cited by many as what allowed the situation to get to this point. Presidential nominees Barack Obama and John McCain recently relayed relative discontent with the bailout but acknowledged that it was necessary. The current administration as well as Congress sat idle during this period of reckless lending.

Both Obama, the Democratic nominee, and the Republican McCain have clear lobbyist ties to the troubled companies. The International Herald Tribune reported yesterday that:

 

A New York investor, Geoffrey Boisi, a member of Freddie Mac’s board, contributed more than $70,000 to McCain and Republican Party committees working for his election. Both he and a Fannie Mae lobbyist, Richard Hohlt, are among the McCain "bundlers" who have raised from $100,000 to $250,000 from others, according to the campaign Web site.

 

The report also stated that although Obama doesn’t take money directly from lobbyists, he received more than $100,000 from a Fannie Mae political action committee. The New York Times noted Wednesday that the amount Obama received from the two companies’ employees and PACs was the second largest of any member of Congress since 1998 even though Obama has been in Congress since 2005. Only Sen. Chris Dodd, D-Connecticut, received more over that period.

The International Herald Tribune goes on to illustrate why Congress may have been slow to act:

 

Until now, the companies were among the capital’s lobbying powerhouses — hiring former members of Congress, administration officials and top staff members as in-house lobbyists, contracting with outside lobbying firms, and sprinkling development projects and charitable contributions among congressional districts.

While there’s plenty of blame to go around, the central theme of the buyout is that action was needed now with the benefits being emphasized in the "short-term."

"A lot of what this, again, bailout does is kick the can down the road," noted Max Fraad Wolff, an economist, writer and instructor at the Graduate Program in International Affairs, New School University, in an interview with Amy Goodman. He says that one thing that people haven’t yet picked up on is:

 

The federal government is going to be in the business now of making sure to collect home mortgage payments from Americans, who are not doing so well, and take that money and give it to investors, who they just bailed out, and take that money and give it to foreign investors, who they just bailed out. So the U.S. government is going to take over some of the collection agency duties otherwise done by banks and other intermediaries and help make that money available to affluent investors and foreign investors.

Adding to this bleak forecast, Dorn-Jones says, "I think the rescue will temporarily help the market, but eventually millions of foreclosures will put a burden on financial institutions and they’ll fail."

Although the media here in America have largely treated the issue as first-and-foremost a housing concern, the Telegraph UK ran an article late last year in which economic experts from around the world speculated grimly at what was going on in the world markets because of the mortgage crisis.

In the article, Thomas Jordan, a Swiss central bank governor, says:

 

The kind of upheaval observed in the international money markets over the past few months has never been witnessed in history … The subprime mortgage crisis hit a vital nerve of the international financial system.

 

Peter Spencer, economics professor at York University in England, in speaking about the global financial authorities, stated:

 

They still have another couple of months before this starts imploding. Things are very unstable and can move incredibly fast. I don’t think the central banks are going to make a major policy error, but if they do, this could make 1929 look like a walk in the park.

 

Not everyone has such a bleak outlook. Dr. Christine Sauer, an economics professor at the University of New Mexico and director of the International Studies Institute, says, "That’s a scary scenario, but one that I don’t quite share." She says that she does not believe the foreign investment in the U.S. will dwindle to nothing overnight. "There is a surplus of savings in the world economy, and those who are saving are looking for places where they can invest their money, including in the US."

Adam Davidson of NPR’s "All Things Considered" traveled to a conference for former finance ministers at the University of Virginia on Tuesday and asked participants to speculate about what would happen if Fannie Mae and Freddie Mac were allowed to go under.

Tim Adams, former undersecretary of the U.S. Treasury, says credit markets would seize across the board or the price that you would have to pay would be so exorbitant that people would stop borrowing and the economy would stop. "Without access to credit the economy just seizes, it just stops."

The former finance minister of Italy, Domenico Siniscalco, now a senior fellow at Merrill Lynch, the company that advised the Treasury concerning the takeover of Fannie Mae and Freddie Mac, said, "The failure of Fannie and Freddie would have meant Armageddon, a meltdown of the global financial system."

The consensus is clear that the sheer size of the mortgage finance companies dictated that drastic assistance was needed to stabilize U.S. and world markets in the short-term. It is unclear, however, how effective government intervention will be in staving off a looming economic crisis in the foreseeable future.