Cato Scholar Comments on Fannie and Freddie Bailout

Monday, September 8, 2008

Gerald P. O'Driscoll Jr., senior fellow:

The Treasury's Bailout Plan announced Sunday by Treasury Secretary Paulson is a politically constrained fix, not a long-run solution. There is no solution until the ownership structure is changed. There has been a de facto nationalization of the two enterprises, but not de jure nationalization. There is the danger that the two enterprises will arise Phoenix-like from the ashes and return to haunt financial markets as hybrid entities with government backing.

As Secretary Paulson candidly admitted, the tough decisions on Fan & Fred's ownership structure have been left to the next administration and the next Congress. My advice to the presidential winner would be to make the hard decisions in his first six months in office. First, Paulson's plan to downsize them by selling off their portfolios beginning in 2010 must be aggressively implemented. Whatever role the institutions have played in the past in underwriting mortgage-backed securities, there never was a public policy justification for the enterprises to hold large portfolios of them. That saddled Fan & Fred and the taxpayer with interest-rate risk, which helped bring them down. Second, the ban on political lobbying must be kept in place. That renders them political eunuchs, as well they should be. The market solution is to get their assets into private hands. As their assets are downsized, we can seriously contemplate making Fan & Fred go away.

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