The recent announcement of credit lines and equity injections into the US government-sponsored enterprises Fannie Mae and Freddie Mac, who now hold or guarantee half of all US mortgages, is unprecedented and will unleash a torrent of debate. At their annual meeting ending on Monday 14 July in Glen Cove, NY, the Financial Economists Round Table, an association of eminent senior American and European financial economists, issued a succinct statement on the Government’s action which encapsulates the key issues.
The group urged that taxpayer support of Freddie Mac and Fannie Mae be structured to capture the full value associated with the conversion of the government’s implicit guarantee to an explicit guarantee.
Proposals by the Treasury to expand its line of credit to Freddie Mac and Fannie Mae and to purchase stock in the entities now make explicit the oft-denied implicit guarantee.
Given that these entities would be effectively recapitalized by the proposed injections of taxpayer funds, it is critical that the government obtain warrants or rights equal to the full and fair value of this subsidy and any upside that this support generates (similar to those received in the 1980 Chrysler bailout). This would honor the Treasury’s commitment not to bail out shareholders of government sponsored enterprises.
What is needed to deal with troubled non-bank financial institutions is a crisis resolution policy for entities that pose potential systemic risks to the financial system and economy that includes bank-like receivership and resolution procedures expressly designed to minimize costs to the taxpayers and to assure that the value of any support accrues to taxpayers and not to management, shareholders or debt holders.
Related RGE Content:1) Alternative Solutions for Dealing With Fannie and Freddie: The Debate on RGE’s Finance Blog