Saturday, July 12, 2008

Paying up for Weak Oversight

The bad financial news at the end of this week focuses on the weak foundation of the two largest mortgage brokers Freddie Mac and Fannie Mae. These two businesses buy mortgages from originating banks, bundle them together, and then sell them to investors as mortgage-backed securities. As more and more Americans foreclose on their homes, Freddie Mac and Fannie Mae have had to dig into their cash reserves to continue to pay out the interest on the mortage-backed securities, even though they're no longer taking in the money from mortgages-gone-bad. In turn, the companies are having a hard time borrowing money to pay the interest owed to investors. It's another Bear Stearns.

Unfortunately, according to an article in the New York Times, it seems that tax payers may end up bailing out and paying investors their guaranteed interest on the mortgage-backed securities if Freddie and Fannie fail. The article argues that the two companies lobbied hard over the past decade for little oversight as their fortunes grew.

Now that there's been a reversal of fortune, they turn to the government for a bailout.

Not only will the taxpayers pay, but people trying to secure mortgages, and stockholders who are being hammered by this current unstable market (earnings over the past 2 years have been erased in a matter of months) will pay.

The problem is that if the government doesn't do something, and the companies tank, it means the credit market will freeze up. And, that will hurt Americans broadly, too.

If there had been oversight. If government regulators had been doing their jobs. If Congress and the Fed had been engaging in proper oversight, perhaps we wouldn't be in this economic quagmire today. Regulation and regulators have a place in the free market. When they don't, the consequences can be dire.

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