TOPICS > Economy

Treasury, Fed Propose Safety Net for Mortgage Giants

July 14, 2008 at 6:10 PM EDT
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Congress must soon decide on a U.S. Treasury-Federal Reserve measure to save mortgage giants Freddie Mac and Fannie Mae from further crisis. An economics editor and House Financial Committee members weigh the options.
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RAY SUAREZ: We begin with a look at the government’s emergency plan for boosting two now-shaky pillars of the housing and financial markets.

The rescue plan announced yesterday by Treasury Secretary Henry Paulson amounts to what could be an unprecedented intervention by the government to help stabilize the finances of mortgage giants Fannie Mae and Freddie Mac.

HENRY PAULSON, U.S. Treasury Secretary: … 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.

RAY SUAREZ: The companies lost half their value last week as investors lost faith that Fannie or Freddie had enough cash reserves on hand to continue buying mortgages.

The health of both companies is pivotal, since they hold or guarantee roughly $5 trillion of mortgage debt, more than half the total mortgage debt in the United States.

The companies are government-sponsored enterprises, or GSEs, created by an act of Congress, but traded and owned by investors.

Under the plan, the Treasury would seek to expand its line of credit to the companies by billions of dollars so they could finance new mortgages. It also allows the government to buy shares of Freddie and Fannie if needed.

HENRY PAULSON: 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.

RAY SUAREZ: The Federal Reserve’s directors also voted yesterday to allow Freddie and Fannie to borrow money from the Fed for the first time. They’d pay the same interest rate given commercial banks, 2.25 percent.

Before the Treasury can extend credit to the companies, Congress must approve.

And joining us once again to help us understand the moves by the Treasury Department and the Federal Reserve, we’re joined by David Wessel, economics editor for the Wall Street Journal.

A move to increase lending to firms

David Wessel
Wall Street Journal
[T]he Treasury is going to ask Congress for permission to invest taxpayers' money in the stock of these stockholder-owned companies to give them capital that they apparently cannot raise themselves on the private market.

RAY SUAREZ: Well, there's a lot of talk of bailout, and that word was widely used today, but what exactly did the federal government do today -- yesterday, excuse me -- to shore up the fortunes of these two companies?

DAVID WESSEL, Wall Street Journal: Well, they did basically two things. One is they said they would make money available to them short term if they need it, first through the Federal Reserve's ability to lend directly to institutions, and then Secretary Paulsen and the president asked Congress to increase the amount of money that the Treasury can lend them directly. That's sort of the short-term thing.

And then, in a fairly dramatic move, the Treasury is going to ask Congress for permission to invest taxpayers' money in the stock of these stockholder-owned companies to give them capital that they apparently cannot raise themselves on the private market.

RAY SUAREZ: Now, as has been mentioned a lot in the last couple of days, this is a hybrid, a privately traded company, but one that's a government-sponsored enterprise. Has the government ever had to do this kind of shoring-up operation before for a GSE?

DAVID WESSEL: Yes, the government has from time to time had to do things to help out Fannie Mae and Freddie Mac in the past, but nothing quite as big as this, nor were the stakes ever as high as this.

As you know, they hold half the mortgages indirectly or guarantee half the mortgages in the U.S., but right now the mortgage market is so broken they are basically responsible for 70 percent of the mortgages being made in the U.S. right now. They could not be allowed to fail; they could not be allowed to be unable to borrow money on the market.

RAY SUAREZ: It's a little unusual for major financial news to break on a Sunday afternoon. Why did the government act then?

DAVID WESSEL: That's a good question. You know, the same thing happened with the Bear Stearns deal back in March.

I think it's a sign of how important the Asian markets and Asian capital has become to the U.S. economy. They wanted to get this deal announced before the markets opened in Asia. And the markets opened in Asia roughly around 6:00 p.m. Sunday, New York or Washington time.

RAY SUAREZ: And there was a big debt auction today, wasn't there, also?

DAVID WESSEL: Right. Freddie Mac had to sell $3 billion worth of short-term paper. And they wanted to make sure that that auction went well.

RAY SUAREZ: Did it?

DAVID WESSEL: It went very well. I think the risk that if it didn't go well, which was unlikely, would be seen as a real lack of confidence in the firms, so that was another reason to get this done well in advance of today's opening.

RAY SUAREZ: Well, these big moves, the faces we're seeing commonly are that of the secretary of the Treasury and the chairman of the Federal Reserve. Why is Congress intimately involved in what happens now?

DAVID WESSEL: Well, the Fed can lend them money, short term out of its own pocket. But in order for the Treasury to lend them more money, and especially in order for the taxpayers to be putting money into these companies, buying shares of stock or preferred stock in these companies, that's classic fiscal policy. They're spending our money. And that's what Congress's role is.

As you know, Congress has been thinking about a reform bill for the GSEs for some time. It sort of is just beginning to move finally in its last stages. And I think one reason the Treasury and the Fed moved this weekend was they wanted to get these changes made before that thing gets out of Congress.

RAY SUAREZ: So the plan was announced, the markets in the United States opened this morning, and did they buy it?

DAVID WESSEL: They bought the $3 billion. The stock of Fannie and Freddie shot up, and then the stock in Fannie and Freddie fell back down to where it was.

RAY SUAREZ: What does that mean?

DAVID WESSEL: I have no idea. I think that there's a lot of -- it's very hard to figure out what the market is thinking of these companies. Most people think that, if they need the government to back up their debt, the government will.

But there is so much anxiety in the market these days about the U.S. housing market, about mortgage markets, and about the size of their capital cushion relative to the amount of mortgages that they guarantee or own that people are on a hair trigger.

RAY SUAREZ: David Wessel, thanks for joining us.

DAVID WESSEL: A pleasure.

The government may bail them out

Rep. Barney Frank
D-Mass.
I don't think either one of these institutions is insolvent. I do think that the market has overreacted.

RAY SUAREZ: And as David mentioned, this plan must now be approved by Congress. We turn now to two members of the House Financial Services Committee who will weigh in on the proposal in the days ahead.

Democrat Barney Frank of Massachusetts is the committee's chairman, and Scott Garrett, Republican of New Jersey, a long-time critic of Fannie Mae and Freddie Mac.

Mr. Chairman, let's start with you. These moves to shore up the two companies, do you support them?

REP. BARNEY FRANK (D), Massachusetts: I do. Essentially what you have here, frankly, is President Bush taking his leading economic appointees and having them go to the stock market and say, "We're from the government. We're here to help you."

And, in fact, I think he's right. I think it's an appropriate kind of help.

I don't think either one of these institutions is insolvent. I do think that the market has overreacted. And I think, given the importance of these institutions, particularly at a time when the private market, having made a lot of serious mistakes in the mortgage area, has sort of dried up in response, I think it is important to keep them going.

RAY SUAREZ: And, Representative Garrett, how about you? This power Freddie Mac and Fannie Mae to use the open window for emergency borrowing and the possibility of the federal government buying shares in the two companies to shore them up, what do you think?

REP. SCOTT GARRETT (R), New Jersey: I think what amazing things can happen over a weekend. You know, ask most people what they did this weekend and they went down to the Jersey Shore or something like that.

What does the secretary of Treasury and the Federal Reserve do during this weekend? They threw out several decades of precedent. Republican and Democrat administration after administration said that the federal government does not have an obligation, explicit obligation to back up or shore Fannie Mae or Freddie Mac, or the GSEs.

I believe the chairman has said that in the committee in the past, that we are not going to be here to guarantee them if they make the wrong decisions in their future, what have you.

And here, over one weekend, surprise, once again, the Federal Reserve has stepped in and has become in some people's mind a fourth branch of government, being engaged in both monetary policy and now fiscal policy, as well, a totally unelected body just spending basically the taxpayers' dollars.

RAY SUAREZ: But Representative Garrett -- go ahead, Congressman.

REP. BARNEY FRANK: I want to take issue with that, because that's unfair to the Federal Reserve. This is not a rogue agency.

Mr. Garrett may be uncomfortable because the president of his party is the one in charge of this, but the Federal Reserve is acting at the behest of the president and the secretary of the Treasury.

Yes, there were questions about whether this was the right thing to do or the wrong thing to do substantively, but to say that this is -- the Federal Reserve, an unelected body doing it, they're carrying out the policy that the president asked them to carry out.

Secondly, in terms of bailing them out, no, I never felt any obligation to the shareholders or the bond holders of Fannie Mae and Freddie Mac. I do feel some obligation to the American economy.

And it's precisely because the private market, with this irresponsible subprime lending has caused such difficulty, that I do think a public response is necessary to alleviate the economic distress this is causing.

RAY SUAREZ: But what about Congressman Garrett's other point, that this turns its back on decades of past practice?

REP. BARNEY FRANK: Well, one, sometimes that's a good idea. You know, past practices aren't always right.

But, secondly, it's a response to a crisis that didn't happen decades ago. We have -- as you and I have discussed, Paul -- some new things in the financial market.

Problems caused by securitization

Rep. Scott Garrett
R-N.J.
Fannie has been in the marketplace, raising capital in the spring, where Freddie has been doing just the opposite. A regulator could have been in place to address the capital requirement over a year ago.

REP. BARNEY FRANK: Securitization is part of the problem here. It used to be decades ago, when you were talking about this, people who were getting mortgages were going to pay back the person who gave them the mortgage. You had a tight lender-borrower relationship. Then came securitization, and securitization gave people the license to take some risks that they weren't fully calculating.

So, yes, given the innovations in the mortgage market over the last 20 years and the damage that that has caused, as well as the good that it's done, we've got to calibrate our response differently than before.

RAY SUAREZ: Representative Garrett, how about that, the idea that times have changed because securitization did something fundamentally different to the mortgage market?

REP. SCOTT GARRETT: Well, times certainly have changed, but the systemic problem with Fannie Mae and Freddie Mac have not changed.

And that's why, ever since I came to Congress five years ago, I said we have created an institution here that basically has no limits, but has the implicit guarantee of the federal government.

And now we see it has come to pass that it has grown beyond anyone's imagination when it was first created and has grown without any regulatory oversight and placed enough, sufficient enough to get the job done.

And to that extent, well, here we are wrapping up the 110th Congress, and we're still waiting to get that legislation passed. We could have had this done really, this so-called world class regulator put in place some time ago, at the beginning of this 110th Congress, but instead, unfortunately, we haven't gotten it passed.

We got it through the House and back through the Senate again. And the reason for that, quite honestly, is politics. There's portions to this bill that are unnecessary, as far as the regulatory reform bill.

Had we had a clean piece of legislation, a piece of legislation that simply had the so-called world class regulator in place, we could have had this -- maybe averted this problem, because the regulator, who would have been in place and who would have had the capital requirements in place.

And Freddie Mac would have been doing what Fannie has been doing. And here I blame Freddie more so than Fannie. Fannie has been in the marketplace, raising capital in the spring, where Freddie has been doing just the opposite. A regulator could have been in place to address the capital requirement over a year ago.

RAY SUAREZ: Chairman Frank, your response?

REP. BARNEY FRANK: That's very inaccurate history. Very inaccurate history. In fact, in 2005, when the Republicans were still in power, I collaborated with Chairman Oxley -- I was then the senior Republican -- or the senior Democrat.

And we passed a bill that had the world-class regulator without what Mr. Garrett refers to as extraneous. That's the low-income housing trust fund, is what he's talking about, trying to help build low-income housing.

But the fact is, in 2005, when the Republicans controlled both houses, we passed such a bill. And it got killed in the Senate by the problems over there.

When the Democrats took office in 2007, one of the first things we did was to again pass this world-class regulator. We did it under Democratic control in April of 2007. And it was approved by the Bush administration. It did bog down in the Senate.

But historically, again, when the Republicans were in power, they couldn't pass it at all. We are passing it now a little late, but it's the Democratic Congress unlike the Republican Congress that is on the verge of getting the world-class regulator passed.

The other thing I would say, though, is this. And it's true we should have had a better regulator. But the problems of Fannie and Freddie do not stem from decisions they made.

They stem from the damage done to the mortgage market in general by irresponsible private lending in the subprime market.

And by the way, the hero of today is Ben Bernanke, because he proposed some rules to restrict subprime lending, which the Fed has had the power to do for 15 years. And if Alan Greenspan had done 10 years what Ben Bernanke has done today, in terms of restricting irresponsible lending, we would have avoided much of this problem.

Stability won't be permanent

Rep. Barney Frank
D-Mass.
[T]hey're not the only financial institution that it's in trouble. The mortgage market is in a shambles because unregulated, irresponsible subprime lending has infected everybody.

RAY SUAREZ: But hasn't it been known, Mr. Chairman, for years that the reserves of these two agencies were too low? Weren't they urged to top up their reserves and...

REP. BARNEY FRANK: Yes. And, by the way, let me repeat. In 2005, I joined in getting a bill passed -- and we did pass the bill in the House -- to upgrade the regulator and to increase the pressure on them, the right to order them to increase capital.

And in 2007, within three months after the Democrats had taken power, we passed such a bill. It got held up because the Senate is only 51-49 and there was partisan fighting over there. But, yes, we've been in favor of pushing them to do it.

But I still say that the problems did not come primarily because of their lack of capital. It came because of the subprime crisis, because they're not the only financial institution that it's in trouble. The mortgage market is in a shambles because unregulated, irresponsible subprime lending has infected everybody.

RAY SUAREZ: Representative Garrett, is that right? Were Fannie and Freddie ganged up on by forces outside their control?

REP. SCOTT GARRETT: I don't think that they have ever been ganged up by anyone. And one of the suggestions I've heard around the halls of this Congress is, if they want to raise the issue of raising their levels of capital, maybe they can stop by contributing so much money in campaign contributions here in Washington and save some of that for their balance sheet.

I'm being flippant, of course. But these are two of the most influential lobby entities here in Washington. And it's because of that influence that we have not been able to get things done both before and during the 110th Congress.

REP. BARNEY FRANK: No, that's simply not true. That's not true. In 2005...

REP. SCOTT GARRETT: It is...

REP. BARNEY FRANK: ... we passed the bill in the House. It got bogged down by the Senate's filibuster rules. And this year we passed the bill. Senator Shelby was objecting to it at first. The fact is...

REP. SCOTT GARRETT: Well, then I hope the chairman will join me, then, in order to get -- we realize we have a problem here right now, that if we passed in the past, with just a world-class regulator without the extraneous materials, so let's do that right...

REP. BARNEY FRANK: Once again, your history is bad, because the Senate passed the bill. We're not in it -- we're not bogged down. We're ready to pass it.

You're probably going to vote against it, because you don't like the low-income housing trust fund, because you don't want to help us build low-income housing. The fact is, is that the Senate passed the bill and it's about to go to the president's desk. We don't need to strip out low-income housing.

RAY SUAREZ: Representative Garrett, finish your point.

REP. SCOTT GARRETT: Yes, my only concern with the low-income housing is -- interesting about this, if Fannie and Freddie are in such dire straits, why would we want to tag on a program to it, where on the one hand we're having the U.S. taxpayers bail out these entities, and on the other hand we're trying to extricate or extract from them any revenue that they have to go elsewhere to a housing fund?

We need to allow these funds to build up as much capital as they humanly can possibly do in this period of time. We don't need anything else tagged on to them.

We don't need any other taxes on them, which in fact what this is, is a middle class tax cut, by putting it on them, allow those funds to stay stand as they are, if we're going to pass as it is.

REP. BARNEY FRANK: Well, you changed your argument there, because you were saying that this was holding the bill up. In fact, the low-income housing...

REP. SCOTT GARRETT: And it has held it up.

REP. BARNEY FRANK: No. In 2005, when your party was in power...

REP. SCOTT GARRETT: I'm just talking about the 110th Congress. Let's...

REP. BARNEY FRANK: Well, you can't just talk about the 110th Congress if you're trying to be historical. You can't just pick the one year to talk about.

When your party was last in power, we passed a bill that I...

REP. BARNEY FRANK: ...excuse me -- we passed a bill that I strongly supported. It did not have an affordable housing trust fund, and it got bogged down by Senate politics.

The fact is that we now are about to pass it. You're wanting to get rid of the affordable housing trust fund is that you're opposed philosophically to federal funding to help build affordable housing. I understand that. But it's not holding up this bill.

RAY SUAREZ: Well, before we go, Representative Garrett, if this helps Fannie and Freddie stabilize for the near term, can you fix it, once you keep it from sliding into insolvency?

REP. SCOTT GARRETT: Well, no. I think, if you're going to fix it, you should fix it now once and for all, whichever way we come to do that.

However, we should do it with hearing and what we call in Washington regular order, go through the committee process in both the Senate and the House. And we should not be doing a rush to judgment on this.

We should not be having the secretary of Treasury coming in with additional programs right now, which I haven't even seen. I don't know whether the chairman has seen -- I've heard that's going to be voted in the next couple of days.

REP. BARNEY FRANK: Can I ask you a question? Are you for holding up moving on the world-class regulator? We have that bill. It's been through the House over a year ago. The Senate's passed it.

What we're talking about is doing the world-class regulator and improving the FHA and doing some other things that have had hearings and have had a lot of debate.

RAY SUAREZ: Well, gentlemen, I have to leave it there, but Chairman Frank, Representative Garrett, thank you both.

REP. SCOTT GARRETT: Thank you for the opportunity.