Editorial -- A Fannie-Freddie Fix

Friday, November 28, 2008

IT LOOKS like Lawrence Summers will be the economic ideas man inside the Obama White House. As a former Treasury secretary and Harvard president, he is well qualified for his new post, which carries the formal title of director of the National Economic Council. And we have a suggestion for his first special task: devising a long-term solution to the mess at Fannie Mae and Freddie Mac.

When the Bush administration took over the two companies, which specialize in securitizing home mortgages, this year, it pledged that the move would make the mortgage market more liquid. This was true, in the sense that Fannie and Freddie -- which own or back more than $5 trillion in mortgages and which reported combined losses of $54 billion in the third quarter -- would probably be in even worse shape now if the government had not acted.

However, the government's action created new uncertainties about the two firms, and those uncertainties are impeding housing's recovery. One market worry -- the precise nature and strength of the government's guarantee -- was partly resolved on Tuesday when the Federal Reserve announced that it would buy Fannie and Freddie's mortgage-backed securities and some of their debt. But the more fundamental question of Fannie and Freddie's future remains unresolved. Market wariness toward their debt reflects investor doubts as to whether they will remain government-sponsored enterprises, or GSEs, owned by private shareholders but with taxpayers on the hook for their losses -- or whether they will be reformed.

Mr. Summers is the right person to lead a Fannie-Freddie rethink because he so clearly comprehends what went wrong. In a July 16 posting on the Creative Capitalism Web site, he provided this succinct postmortem: "The illusion that the companies were doing virtuous work made it impossible to build a political case for serious regulation." "When there were social failures the companies always blamed their need to perform for the shareholders. When there were business failures it was always the result of their social obligations. Government budget discipline was not appropriate because it was always emphasized that they were 'private companies.' But market discipline was nearly nonexistent given the general perception -- now validated -- that their debt was government backed. Little wonder with gains privatized and losses socialized that the enterprises have gambled their way into financial catastrophe."

In a Post op-ed on July 28, Mr. Summers suggested that after the current crisis has passed, the government could divide the firms' "functions into government and private components, the latter of which would be sold off in multiple pieces. The proceeds could be used to fund the low-income housing support activity that was previously mandated to the GSEs." Whether or not that precise formula is best, Mr. Summers is clearly right that the hybrid public-private model no longer makes sense -- a point that his future boss, President-elect Barack Obama has also embraced. Now all that's left is for the new administration to place a high priority on fixing Fannie and Freddie, give Mr. Summers the assignment, and start working with Congress to make it happen. For a presidency that promises fundamental change, we cannot think of a more appropriate undertaking.

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