Candidates Must Decide on Government Role in Financial Markets

New York (HedgeCo.Net) – The recent controversial moves of Henry Paulson and the U.S. Treasury have Washington divided not only on the future of Fannie Mae and Freddie Mac, but on government’s new role in the U.S. mortgage market.   

On Monday, Paulson and Federal Housing Finance Agency Director James Lockhart placed the two mortgage giants in a conservatorship, allowing the government to replace chief executives and eliminate their dividends, while giving them themselves the power to purchase up to $200 billion of stock in the companies.   A new program has also been launched to purchase mortgage-backed securities from the two firms, starting with $5 billion worth this month.  In accordance with the government assistance, Fannie and Freddie will have to eventually reduce their holdings of mortgages and mortgage backed securities.  

This decision was months in the making, after downplaying problems and staving off rumors of a government bailout.  Finally, Bush came out and called the situation an “unacceptable” risk for an economy that has been battered by the subprime fallout and the worst housing slump since the great depression.  

"Allowing the companies to fail or further deteriorate would damage our home mortgage market, and could weaken other credit markets that are unrelated directly to housing," Bush said in his statement.  "Americans should be confident that the actions taken today will strengthen our ability to weather the housing correction and are critical to returning the economy to stronger sustained growth."  

The two companies guarantee about half of the nation’s $12 billion in outstanding mortgages.  For months, amidst rumors of capital shortages, Fannie and Freddie denied any problems.  It was only after Paulson hired Morgan Stanley to probe into the company’s finances did it come to light that the two firms were overstating their capital and did not have sufficient reserves.  Concerns over their finances sent stock prices plummeting and mortgage rates soaring. 

Overall, Fannie and Freddie suffered about $14 billion in losses, leaving the government with a tough decision to make.

Democratic Senator Charles Schumer agrees with the course chosen.  “Paulson has threaded the needle just right by taking necessary action to stabilize U.S. financial markets while minimizing the liability for taxpayers,” he said. “This plan will be met with broad acceptance in Congress because it doesn’t prejudge the ultimate fate of Fannie Mae and Freddie Mac."

But while some current political figures may be on board, it is really going to fall on the next administration to determine the role of the government in matters such as this, and ultimately, the fate of the both Fannie and Freddie.  

"The new Congress and the next administration must decide what role government in general, and these entities in particular, should play in the housing market,” Paulson said in Washington.  “There is a consensus now that they cannot continue in their current form.”  

However, the fear of alienating voters has forced both candidates to spew nothing more than political rhetoric while never fully disclosing their position on this issue.  While Obama pushes for “some” invention and McCain expresses that there must be a surge of “confidence,” it is unclear what either of their stances are on the role of the government in matters such as this.  

Lately there has been an increase in the government’s role in the financial markets.  Six months ago, the Fed infamously funded the $30 billion in financing needed to rescue Bear Stearns and facilitate the purchase by JPMorgan.  There are several permanent courses of action that may be taken with Fannie and Freddie, including a full blown nationalization that would cement the government’s role in the markets permanently.  Whatever the course chosen, it will most likely fall on the watch of the next presidential candidate.  It’s about time to put politcal jargon aside and pick a side.

Julie Scuderi
Senior Editor for HedgeCo.Net

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