The Everyman Plan

Columnist Steven Pearlstein answered questions yesterday with online readers. Here are excerpts from the conversation.

Washington: When is someone going to bail out the common everyday man? We are pumping billions of taxpayer dollars into Fannie Mae, Freddie Mac, IndyMac Bank . . . but I can't get anyone to help me keep from losing my home to foreclosure? Steven Pearlstein: Who do you think is the primary beneficiary of this? It's the common man. The common man who has a mortgage. The common man who owns residential real estate. The common man who has his deposits in a bank that has its capital invested in "safe" instruments like Fannie and Freddie paper. If you want to see blood on the floor, let Fannie and Freddie default on their credit, and the world financial system will collapse. Trust me. And who do you think will have his lifestyle affected more by that, Donald Trump or the common man? So please, let's not turn this into class warfare. Nobody is doing this to "bail out" rich investors. People don't get rich buying Fannie and Freddie bonds. They are held by banks, pension funds, money-market funds, insurance companies -- intermediaries for the common man.

Bowie: Just how stable are the top 10 investment banks? Certainly, the mortgage crisis has impacted others! Do you envision other runs on banks?

Steven Pearlstein: At this point, anyone would be crazy to assure you that no investment bank will suffer a "run" by having its short-term creditors pull the plug, leaving it without cash. These investment banks are complicated machines, but basically they borrow short and lend and invest long, so if their short-term funding is interrupted, they have to declare bankruptcy and unwind/sell their loans and investments at distressed prices. The Fed backstop is meant to prevent that liquidity crisis. But let's be clear: It cannot prevent a failure, if the long-term value of those assets prove to be less than the liabilities. If the Fed gets a whiff that any of these banks is really insolvent -- that is, its assets won't be sufficient to cover its liabilities -- then it will slam the lending window shut on such a bank and put it into some sort of receivership. That's why the Fed has people at all of these banks every day now.

More regulation? I find it interesting that the Fed is working so hard for a soft landing -- why wasn't there more regulation to prevent the irrational upward climb as well?

Steven Pearlstein: You are right to point the finger at the regulators, particularly the Fed, which didn't step in earlier when the lending was clearly getting out of hand and Fed officials were busy denying there was a housing bubble, and a takeover bubble and a credit bubble. They could have reduced this problem if they were not so wedded to the ideology that the market is always right (or self-correcting) and that it is wrong for regulators to substitute their judgment for the market's.

Perry, Kan.: Why does the federal government want authority to purchase stock in both? Is that a bailout for stockholders?

Steven Pearlstein: No, you can be sure it will be a bad day for shareholders if the government has to purchase that stock, which would probably be preferred stock. That means the government's investment is preferred over all others, which means if there is any money left after all the debts are paid, the government gets it. And the government would also get first call on any positive cash flow of the business for its dividend payments, before any other dividends are paid to any other shareholders. Basically, the stock of existing shareholders will be valued at a very low level if the government steps in to provide capital. That cushion is needed to assure the more important group, the bondholders/creditors, to continue lending money into the Fannie-Freddie machine, so they can continue to buy, package, insure and sell loans, and keep the mortgage market in operation.

Annapolis: Anything that gets done needs to be accompanied by changes in the compensation structure of the executives who ran their firms into these problems. If that doesn't happen I would suggest not to give any help.

Steven Pearlstein: Completely agree. The compensation for Fannie and Freddie executives cannot and should not be tied too much to the change in stock price or the growth in earnings per share. And the people who invest in these companies ought to understand that they are not growth stocks, and that there are times, such as now, when the mission of the company is to provide liquidity to the mortgage market even if it is not the profit-maximizing strategy.

Falls Church: Isn't it time to explore whether the very existence of Fannie and Freddie has distorted the mortgage market too heavily? Since they have gone way beyond their traditional liquidity role in recent years, one has to wonder how much of the private lenders' retreat from the market is directly attributable to crowding out from Fannie and Freddie.

Notice, for instance, that the markets for car loans and credit cards don't seem to have dried up like mortgages have.

Steven Pearlstein: Yes, they grew their balance sheets unnecessarily (and profitably, it seemed at the time), but the retreat of the private lenders is not directly attributable to crowding out. In fact, during the bubble, Fannie's and Freddie's market share actually declined and their balance sheets shrank as a result of regulatory pressure. As for those car loans and credit cards, watch out. They are the next shoes to drop.