Henry Paulson on Fannie Mae and Freddie Mac Worldwide

Treasury Secretary Henry Paulson:

Sunday Evening: Fannie Mae and Freddie Mac play a central role in our housing finance system and must continue to do so in their current form as shareholder-owned companies. Their support for the housing market is particularly important as we work through the current housing correction.

GSE debt is held by financial institutions around the world. Its continued strength is important to maintaining confidence and stability in our financial system and our financial markets. Therefore we must take steps to address the current situation as we move to a stronger regulatory structure. In recent days, I have consulted with the Federal Reserve, OFHEO, the SEC, Congressional leaders of both parties and with the two companies to develop a three-part plan for immediate action. The President has asked me to work with Congress to act on this plan immediately.

First, as a liquidity backstop, the plan includes a temporary increase in the line of credit the GSEs have with Treasury. Treasury would determine the terms and conditions for accessing the line of credit and the amount to be drawn.

Second, to ensure the GSEs have access to sufficient capital to continue to serve their mission, the plan includes temporary authority for Treasury to purchase equity in either of the two GSEs if needed. Use of either the line of credit or the equity investment would carry terms and conditions necessary to protect the taxpayer.

Third, to protect the financial system from systemic risk going forward, the plan strengthens the GSE regulatory reform legislation currently moving through Congress by giving the Federal Reserve a consultative role in the new GSE regulator's process for setting capital requirements and other prudential standards.

I look forward to working closely with the Congressional leaders to enact this legislation as soon as possible, as one complete package.

Comments

[Marsha Keeffer]

We'll see Monday after the markets open if this plan is the financial tourniquet that stops the bleeding. The timing of the announcement was well-planned. Paulson knew something had to be said publicly before the bell.

[derrida derider]

Yep, we're heading straight for a taxpayer bailout of the whole mortgage financial sector - necessary, but deeply unfair.

Capitalism may be the best way ever discovered of building material prosperity but only a fool thinks it gives people their just desserts.

[psychohistorian]

I agree that this is not capitalism. It was bad policy to make Fannie Mae private in the late 60's and to create Freddie Mac as private right after that. I believe that this public bailout constitutes fascism. I hope that the ponzi scheme bubble that is the US economy continues to explode...it's about time....we deserve to be a third world catastrophe for our anti-humanistic ways.

Why, oh why can't we have better economics professors that explain and complain about the facts about public policy abortions like this bailout and the policy decisions that set it up. Maybe even some facts about where the private gains have gone with this scheme.

[Frank Howland]

Brad et al.:

Help me understand the dimensions of the moral hazard issue in recent and pending federal "bailouts" or "rescues" or what have you of major financial institutions. It has been claimed that the low buyout price in the Bear Stearns deal reduced the level of moral hazard danger arising from the deal, and I bet that will be the claim when Fannie Mae and Freddie Mac shareholders lose most of their money in the deal brokered by Paulson and possibly Bernanke.

However, it seems to me that the real problem in these case is that creditors believe they will get (most of) their money back and so don't monitor the managers. Managers' incentives to take risky actions rise as things get worse. Bad corporate governance means shareholders don't have enough influence over management to prevent a lot of (ex-ante) stupid loans.

Making sure the shareholders get (largely) wiped out is surely a good thing and should spur shareholders to monitor the managers more vigorously in the future, but if creditors aren't hurt, then there's still a lot of moral hazard danger. Or so it seems to me. What am I missing? Have creditors in fact lost a lot in the case of Bear Stearns and Fannie Mae/Freddie Mac?

[christopher Fay]

American economics as currently practiced is not a profession deeply rooted in reality.

Paulson is the bail-out king of our present crony capitalism system.

Laura just happens not to be into shoes; there's a difference.

[praetorian]

What am I missing?

Heh. You are asking a member of the D.C. consensus, who argued that most of the real-estate bubble was based on fundamentals (remember his "there are only a few interesting places to live" post? Almost a parody of liberal elitism.) and who now wants to throw unlimited tax dollars at the problems caused by it while tsk, tsking those of us who he ridiculed for years about moral hazard?

Wrong dude. Wrong question.

Cheers,
prat

[praetorian]

And while we are on the topic, why hasn't anyone asked our intrepid treasury secretary who much of his personal wealth is based on profits from the real estate machine set up on his watch at Goldman?

Or would that be grasping reality a bit *too* firmly with both hands?

Cheers,
prat