Let Fannie and Freddie Go Broke

For all the talk of a “rescue plan” for Fannie Mae and Freddie Mac, I think that there’s a much better solution: let them go broke. Congress should end debate on the rescue plans and, if it does not, President Bush should veto any plan he gets. The massive decline in Freddie and Fannie’s stocks today shows that the rescue plans probably won’t reassure the market anyway. If Freddie and Fannie really are private companies–which their \executives have always claimed in public–it follows that their stockholders should assume the great bulk of the risk.
That said, there will be real pain if Congress doesn’t rescue Fannie and Freddie. Without Fannie and Freddie around, banks would have to hold non-Jumbo mortgages on their own balance sheets. As a result, anyone with a credit score below about 800 would likely have a difficult to impossible time getting mortgages until purely private firms spun up their MBS operations. Temporarily, as a result, home values would fall and homes would remain on the market longer. A quarter of zero or negative economic growth might result as well. But even this worse possible case scenario of a “Freddie and Fannie recession” would have the mostly positive side effect of squeezing inflationary pressures that appear to be mounting as a result of rising commodity prices.
But simply letting Freddie and Fannie work things out in bankruptcy court or directly with their creditors–while phasing out their federal charters–would stimulate the emergence of a purely private, much less concentrated, and likely better functioning mortgage industry. At the margin, yes, mortgage rates in the conforming market would probably rise a tiny bit. But we’d have a better, healthier, more stable market for Mortgage Backed Securities. And, in the end, the American people would win.