Sunday, July 20, 2008

What will the government do about Fannie Mae and Freddie Mac?

In What will happen to Fannie Mae & Freddie Mac? I

One is to take over Fannie Mae and Freddie Mac. I'm sure there is a worse choice but none come to mind at the moment. What we don't need is another works program for bureaucrats. Worse, it would be subject to even more political influence that it is now.

They could gift money to Fannie Mae and Freddie Mac to bail them out. This is a possible solution but where will the government get the money? By borrowing it or printing it. In a time when the dollar is already depressed, this isn't a good idea. It will cause import prices, including oil to rise even further.

They could extend credit to Fannie Mae and Freddy Mac (as has been proposed). This would allow Fannie Mae and Freddie Mac to borrow at rock bottom prices to cover their near term shortfalls. The problem is that this might decrease the credit rating of the US government and increase the cost of our national debt.

As I said earlier, letting Fannie Mae and Freddy Mac fail would be terrible. However, it would not be a national crises level of terrible. Most of the worst loans were bought by foreign investors and foreign governments. The heaviest conversion of retirement accounts took place when the loan products were merely questionable rather than the border line fraudulent loans of 2004. I doubt if the government will but they could just say: "thank you for the cash infusion, did you even look at what you were investing?" Still, I don't think that'll happen. We rely too much on foreign investment dollars to burn investors world wide.

I think that the government will extend credit. While that will put the US credit rating at risk, it will only have a negative impact if the situation worsens. The only way for the situation to get worse is for investor confidence to stay bad or get worse. I think that the lending reforms that have already taken place in Fannie Mae and Freddie Mac have gone a long way toward solving the situation that led to the lack of investor confidence. Having the full weight of the US government to back them up should bring investors around. If that happens, the government's credit rating will not be negatively impacted. If anything it will get better as we emerge from this "crises."

Jeffrey J. Miller, Economist, MBA
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