What Will Be Done With Fannie and Freddie?

The buzz today comes from the Washington Post’s article about plans for Fannie Mae (NYSE:FNM) and Freddie Mac (NYSE:FRE) that the Obama administration is kicking around.

Briefly, the thinking seems to be that you set up a good bank/bad bank structure, let the government work out the bad bank loans over time and spin off the good bank in some sort of new mortgage finance structure. The devil, as they say, is in the details. Particularly, whether the new entity is public, private or some combination of the two.

There probably won’t be much argument that we need to dispose of the corpses of Fannie and Freddie sooner rather than later. The government has pledged up to $400 billion in aid to both and has so far pumped in $85 billion. I doubt that anyone has a good handle on exactly what it’s going to cost to unravel all of their bad loans but it has to be done, so we might as well get on with it and take our lumps.

The real point of contention is what you put in their place. The old model, privately owned but implicitly supported by the federal government didn’t work too well. It enabled management to richly reward itself while assuming enormous risks pinioned on a minuscule equity base. There was never any margin for error as we found out to our everlasting sorrow.

Nevertheless, it is going to be hard for the Congress to resist going back to something like the old model with its steady stream of cash available for lobbying and campaign donations as well as a willingness to roll out loan programs designed to appease political interest groups. A truly private company would undoubtedly engage in lobbying and donations but would be more immune to political interference, while a government agency solution would solve the lobbying issue but would be bound to be terribly politicized.

It would be nice to think that any final solution would enjoy a rigorous debate and rethinking about the degree to which we want to stimulate and subsidize homeownership but I think that there is scant chance we would see that. All indications are that there is little appetite for scaling back the degree to which the government supports the housing industry and, of course, between the homebuilders and real estate lobbies, the pressure is tremendous to maintain the status quo.

This really is a pretty important discussion and decision. It’s going to have ramifications for housing — a big piece of the economy — for decades. Based on recent events I think that further government involvement rather than less is probably going to be the outcome.

I hope, however, for a different one.