Saturday in Colorado Springs, Colo., Alaska Gov. Sarah Palin said, “The fact is that Fannie Mae and Freddie Mac have gotten too big and too expensive to the taxpayers. The McCain-Palin administration will make them smaller and smarter and more effective for homeowners who need help.”
I can’t even start to dissect what’s wrong with this statement, so I will let the reader assess Palin’s understanding of the role of the GSEs in the financial system. From my perspective, I would have hoped to have more comprehension from a candidate at a time when the estimate of a resulting $300 billion taxpayer liability is viewed as plausible.
[Update: 9/11/08, 7:22pm Pacific In response to Brian J‘s comment, I am posting a link to W. Scott Frame and Lawrence J. White, 2005, “Fussing and Fuming over Fannie and
Freddie: How Much Smoke, How Much
Fire?” Journal of Economic Perspectives 19(2), 159-184. (non-gated version). For those who want facts, please read this article. The Journal of Economic Perspectives is an official publication of the American Economic Association. From the paper:
Fannie Mae and Freddie Mac participate in the secondary mortgage market:
Mortgage originators come to them with pools (bundles) of mortgages and either swap these assets for securities or sell them outright to one of the two companies.
Under Fannie Mae’s and Freddie Mac’s “swap programs,” an originator exchanges a mortgage pool for a mortgage-backed security that is issued and guaranteed by one of the two companies and that represents an interest in the same pool. Fannie Mae and Freddie Mac promise the security holders that the latter will receive timely
payment of interest and principal on the underlying mortgages, less an annual “guarantee fee” of about 20 basis points (0.20 percent) on the remaining principal. In essence, Fannie Mae and Freddie Mac are providing insurance to holders of mortgage-backed securities against default risk on the underlying mortgages and are thus bearing that risk themselves. This securitization activity illustrates one of
their two core businesses: mortgage credit guarantees.
The other core business of Fannie Mae and Freddie Mac is their investment
portfolios. These portfolios consist largely of mortgage-backed securities that they have purchased in the open market, as well as mortgages that they purchase from originators under their “cash programs.” Fannie Mae and Freddie Mac fund these assets largely by issuing debt, as the two companies are highly leveraged with total
equity that is less than 4 percent of total assets.
There are no government payments made to these two GSEs; of course, the government did not receive any share of the profits. There was a realization that these entities constituted a set of contingent liabilities. One set of estimates was $288 billion, very close to the $300 billion figure I cited.
(I was going to write about competitive depreciation in a Taylor rule framework, but this item called for immediate discussion.)