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Saturday, July 12, 2008

GSEs bailout coming?

This NYT article analyzes a possible takeover of Fannie Mae and Freddie Mac by the Federal government if things get worse.




Below graph explains the role of Fannie and Freddie in housing market.





(click to enlarge; source NYT)







But Federal government won't have to do so. All the government has to do is to talk to reassure investors the two GSEs have the government backing. With government's assurance, the companies should have no problem raising more capital in the market. But the equity share may be more diluted. It's not good for stock holders.





So what about moral hazard? In my view, GSEs are created semi-government institutions and they have never existed in the first place. But since they are already here, government will have to bail them out. Yes, even at Taxpayers' expense. Imagine the Federal government let Fannie and Freddie go under, it will jack up mortgage rate and foreign investors will lose confidence in all government-issued bills or bonds. The US will fall into severe recession right away. In order to avoid future bailouts, after the crisis, plans should be devised to make GSEs completely private, cutting off government ties once and for all.