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The Macs Attack

Throughout the week, Clay Risen, the managing editor of Democracy, will be covering economic developments for us on The Plank. 

The good news is that Washington, or at least Congress and the Office of Federal Housing Enterprise Oversight, have taken two big steps in recent weeks to move the government into a better position to buck up the housing market. First, Capitol Hill raised the cap on mortgages that Freddie Mac and Fannie Mae can purchase. The old amount, $417,000, was too low for many homeowners in hot markets; the new amount, variable based on regional conditions but going as high as $730,000, will allow most homeowners and would-be homeowners to secure lower interest rates on their mortgages (federally backed mortgages being much safer). Second, yesterday OFHEO announced it would drop the amount that Freddie and Fannie have to keep in reserves, allowing them to move billions (and billions more of leveraged capital) into the mortgage-backed securities market.

The bad news, as most observers have pointed out, is that this is yet another example of the federal government assuming risk at a time when the downsides to risk exposure are evident and everywhere. The Fed did it Sunday, offering loans to J.P. Morgan in its pursuit of Bear Stearns. But the OFHEO move is even riskier, since Freddie and Fannie will be using their newly available cash to leverage even more, up to $200 billion, on the private markets, which they will then use to buy mortgages and mortgage-backed securities. As Johns Hopkins' Thomas Stanton told The New York Times this morning, "I think it's very dangerous and it's a sign that people are frightened ... At a time in which finance companies are holding questionable assets and facing losses, regulators typically require more capital, not less."

Federal risk exposure is, for now, probably inevitable. There are smart and dumb ways to manage it, of course. But the roots of the problem lies in the Janus-faced construction of the two companies. On the one hand, they offer implicit government backing of risky mortgages; on the other, they operate and profit in the market like public companies. If they do poorly, the government steps in; if they do well, their shareholders, not the taxpayers, get the money. What this means is that U.S. taxpayers are exposed to risk without really knowing it, or benefiting from that risk's upside. If the federal government is going to step into the real-estate market--and it looks like, in the short term, there aren't many alternatives--then something has got to give.

One general answer, which could come in a variety of forms, is to make the real relationship between the government and Fannie/Freddie more transparent. Bush has repeatedly said that the government does not absolutely guarantee those mortgages, but the market clearly doesn't believe him. Instead, he should reaffirm the guarantee, and maybe even extend credit through the Treasury to support their efforts. That would entail taking on a bit more risk, but probably not much net. In return, Freddie and Fanny could recompense the government with company stock. Even The Wall Street Journal extends a qualified endorsement to this idea: "Fan and Fred would get the money to return to the mortgage markets, but once the crisis ends at least the taxpayers would get some upside from the risk they are taking now." That would, they note, be one step toward nationalization, something they don't want but I, for whatever it's worth, think is a good idea. But it's significant that at this point, we can both agree it's better than the status quo.

--Clay Risen