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July 14th, 2008

Fannie Mae and Freddie Mac

By Ben Eltham

The US financial crisis rolls on and on, with the latest victims being giant mortgage firms Fannie Mae and Freddie Mac.

These corporations (their weird-sounding names come from the nicknames stock brokers gave them years ago) were created by Roosevelt in the 1930’s (at least Fannie Mae was; Freddie was only created in 1970) to deal with a previous financial mess - the failure of tens of thousands of banks in the Great Depression.  For decades, they served out a dull, worthy existence as the guarantors of home mortgages - as Katie Benner at Forbes.com explains:

Their mandate is to maintain a market for mortgages - buying loans from banks, repackaging them as bonds, and selling those securities to investors with a guarantee that they will be paid.

Privatised in the 90’s, the banks became subject to market forces - including greed.  But Fannie Mae and Freddie Mac were not sub-prime lenders: in fact, they were required by law to only guarantee sound mortgages. Unfortunately, as Paul Krugman writes in today’s New Yortk Times, the scale of the American property crash has now caused many “prime” mortgages to fail too. Fannie Mae and Freddie Mac were left holding the bag.

The scale of the disaster in American property markets is breath-taking. The two corporations together guarantee something like $5 trillion in mortgage debt. They are simply too big to be allowed to fail, something US Treasury Secretary Henry Paulson acknolwedged on Sunday with an announcement that the US taxpayer would bail them out.

It’s another instance of the US economy’s rampant tendency to privatise profits, but socialise losses. As Christopher Whalen tells Forbes, “Nobody every believed that Fannie and Freddie were truly private and they never should have been.”