Morning Bell: The Left’s Crony Capitalism Explodes

Conn Carroll /

Yesterday all three major financial indexes fell after an article in Barron’s reported the Bush Administration is planning to exercise the authority to recapitalize Fannie Mae and Freddie Mac. A Treasury spokeswoman denied the report, but FusionIQ CEO and equity-research director Barry Ritholtz told the AP: “You don’t pass that sort of legislation unless there’s some sort of intent to use it.” If Treasury does use taxpayer money to bail out Fannie and Freddie, the existing common shares would effectively be wiped out. This is why shares of Freddie and Fannie plunged 25% and 22% respectively yesterday. Both stocks are down more than 90% from a year ago.

To get a sense of the coming losses the U.S. taxpayer is on the hook for, consider that in the past four quarters alone, Fannie and Freddie have lost a combined $14 billion and those loses are expected to continues for at least a few more quarters, with some experts predicting losses through 2011. According to Barron’s, a more realistic appraisal of Freddie and Fannie’s exposure to subprime loans and investments shows that each company may have a negative $50 billion asset value. That would be a $100 billion price tag for taxpayers, all thanks to big government.

Apologists for massive government intervention in the economy have been spinning Freddie and Fannie’s failure for months. Paul Krugman wrote last month, “the storm over these particular lenders is overblown. … Furthermore, while Fannie and Freddie are problematic institutions, they aren’t responsible for the mess we’re in.” Krugman does acknowledge that the subprime mess is terrible for the economy, but he asserts: “Fannie and Freddie had nothing to do with the explosion of high-risk lending a few years ago, an explosion that dwarfed the S.& L. fiasco. In fact, Fannie and Freddie, after growing rapidly in the 1990s, largely faded from the scene during the height of the housing bubble.” Krugman is just factually wrong here as we have documented before. A new Washington Post report today further exposes just how terribly wrong he is.

According to internal documents obtained by the Post, “even late in the housing bubble, Fannie Mae was drawn to risky loans by a variety of temptations, including the desire to increase its market share and fulfill government quotas for the support of low-income borrowers.” In other words, not only was Fannie neck deep in the subprime market, but it was its big government mission that put it there. The result? “At the end of June, Fannie Mae owned or guaranteed $388.3 billion of Alt-A and subprime mortgage investments. … Alt-A loans accounted for almost half of the red ink the company attributed to foreclosures and other bad loans during the quarter ended June 30.”

Conservatives had been warning about the systemic risk Freddie and Fannie posed for years. But responsible legislation to reform the government-sponsored entities was defeated by Freddie and Fannie liberal allies, especially former Walter Mondale and Barack Obama campaign adviser James Johnson. If Treasury does use taxpayer money to bail out Freddie and Fannie, it should then proceed to break up both GSEs and allow them to be replaced with a much larger number of genuine private-sector companies that will not have the ability to dominate the market.

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