At heart, Fannie and Freddie had become classic examples of “crony capitalism.” The “cronies” were businessmen and politicians working together to line each other’s pockets while claiming to serve the public good. The politicians created the mortgage giants, which then returned some of the profits to the pols — sometimes directly, as campaign funds; sometimes as “contributions” to favored constituents.
Because the government was universally believed to guarantee their debt, Fannie and Freddie could borrow at better rates than true private‐sector firms — and accumulate far greater risks. The politicians and regulators that should’ve reined them in did not — because the giants bought influence, and because of their apple‐pie image as “promoting homeownership.”
And, because government backing let Fannie and Freddie dominate the mortgage‐underwriting market, private‐sector criticism was silenced. Local banks that wanted to offer mortgages dared not speak out against them. Large banks dared not complain about the giants’ government‐given advantage because they needed to be able to buy securities from Fannie/Freddie.
Homeowners became hostage to a system that depended on securitizing mortgages with guarantees from Fannie and Freddie. That made them part of the constituency opposed to reform.
The essential problem: Fannie and Freddie were private firms, with stockholders who garnered billions in profits over the years. Yet the government was understood to guarantee their debt. That is, it bore the risk if they failed, as they now have.
Ever since their “privatization” (Fannie in 1968 and Freddie in the 1970s), many politicians knew that the giants were operating in a financially unsafe and unsound manner — and the warning cries grew louder in recent years. Their capital was insufficient — as Paulson told us on Sunday.
Paulson had hoped to get out of office without dealing with this mess. Financial markets pressed the point, however, by bidding down Fannie and Freddie stock and driving up their borrowing costs over the summer.
By delaying action, Paulson effectively eliminated all other options (such as downsizing or privatization) except the present bailout. In July, he announced with fanfare his plan to backstop the two, getting broad authority from Congress to spend taxpayer funds and intervene in the companies. He said he never expected to fire this “bazooka” — but now he has.