Federal Judiciary

#ad#Those numbers help put the GSE bailout in perspective, yet they tell only part of the story. Fannie and Freddie currently own or guarantee roughly $5.5 trillion worth of mortgages -- over half the residential market. If these liabilities were included in the federal budget, Americans would better appreciate the true fiscal impact of rescuing the GSEs.

But Fannie and Freddie are not counted in the budget, a maneuver 'worthy of Enron's playbook, except not quite so hidden,' as Bloomberg columnist Jonathan Weil has written. Their exclusion 'makes a joke' out of the U.S. balance sheet, says former SEC commissioner Paul Atkins. The argument for bringing them on budget became even more compelling in December, when the Obama administration removed a cap on their Treasury Department credit line, essentially giving the GSEs a blank check. A few months later, after House Financial Services Committee chair Barney Frank (D., Mass.) suggested that GSE debt obligations were not backstopped by the federal government, Treasury spokeswoman Meg Reilly affirmed that 'there should be no uncertainty about Treasury's commitment to support Fannie Mae and Freddie Mac as they continue to play a vital role in the housing market.'

In other words, the GSEs enjoy a government guarantee, as they have for many years. Before their 2008 collapse, that guarantee was implicit; now it is more straightforward. Fannie and Freddie are fully controlled (and mostly owned) by Washington; their mortgage activities are sustained by U.S. taxpayers; and their bonds are widely considered to be as safe (or nearly as safe) as Treasury bills. Despite the housing meltdown, demand for GSE-issued securities has recently been soaring. 'The perception that these bonds are guaranteed by the U.S. government,' notes the Wall Street Journal, 'has been a lure to many foreign investors.'

That perception is amply justified. Nevertheless, on May 17, 46 senators (all Democratic caucus members) voted against a financial-reform amendment requiring the GSEs to be put on budget for as long as they remain in federal conservatorship or receivership. The measure, introduced by Idaho Republican Mike Crapo, would also have reestablished curbs (at $200 billion apiece) on Treasury assistance to the mortgage twins. It won the support of seven Democrats -- Evan Bayh (Ind.), Michael Bennet (Colo.), Russ Feingold (Wis.), Herb Kohl (Wis.), Ben Nelson (Neb.), Mark Pryor (Ark.), and Mark Udall (Colo.) -- along with that of 40 Republicans (Alaska's Lisa Murkowski did not vote), but fell well short of securing the 60 votes necessary for passage. Bayh and Feingold were the only two Democrats who joined all 41 Senate Republicans in backing the McCain-Shelby-Gregg amendment, which would have set an expiration date for the Fannie/Freddie conservatorship and launched a transitional process leading to the termination of the GSEs' government charters and subsidies. This amendment was rejected on May 11, 43 to 56.

#page#The lack of muscular GSE reform makes the Dodd-Frank bill a hopelessly inadequate response to the 2008 financial crisis. While the legislation does authorize Treasury to study ways of ending the GSE conservatorship and changing the housing-finance system, it's unclear whether the Obama administration and top Democrats would be willing to cut Fannie and Freddie loose.

#ad#Prior to the crisis, the GSEs operated under a perverse business model: They could amass private profits with the aid of public largesse and an implicit government guarantee that enabled them to borrow money at low interest rates. In December 2008, mortgage-finance consultant Edward Pinto, who served as Fannie's chief credit officer from 1987 to 1989, told Congress that 'Fannie and Freddie went from being the watchdogs of credit standards and thoughtful innovators to the leaders in default-prone loans and poorly designed products. They introduced mortgages which encouraged and extended the housing bubble, trapped millions of people in loans that they knew were unsustainable, and destroyed the equity savings of tens of millions of Americans.'

In a new paper, George Mason University economist Russell Roberts points out that the GSEs bought roughly twice as many home-purchase loans made to below-median-income buyers in 2003 as they had in 1997. It was during this period -- from the late 1990s through 2003 -- that 'Fannie and Freddie played an important role in pushing up the demand for housing at the low end of the market. That in turn made subprime loans increasingly attractive to other financial institutions as the prices of houses rose steadily.' From 2004 to 2006, Roberts adds, commercial and investment banks played a larger direct role in the subprime market than the GSEs did, though Fannie and Freddie were still very active in the mortgage markets in ways that contributed to the subprime problem. In 2006, they bought 390,000 loans with less than 5 percent down, compared with just under 269,000 two years earlier. In 2007, they purchased more than 608,000 such loans.

Today, after imploding and being seized by Washington, the GSEs ostensibly have unlimited access to taxpayer assistance. At the very least, their operations and liabilities should be incorporated into official U.S. budget calculations. This is not a matter of left-right politics; it's a matter of fiscal candor. As economist Doug Elmendorf, President Obama's CBO director, told the Wall Street Journal back in September 2008 when he was a Brookings fellow, 'Trying to keep these entities off the government's books, given the government's financial commitment, would perpetuate the illusion that they aren't the government's problem, even when they are.'

-- Duncan Currie is deputy managing editor of National Review Online.

Full post as published by Bench Memos - National Review Online on July 16, 2010 (boomark / email).