Summary of Freddie and Fannie Bailout
September 8, 2008
Brad DeLong provides us with a nice summary of the deal reached over the weekend:
OK. Here is what is going on:
Fannie Mae and Freddie Mac give the Treasury each 80% of their (common) stock and $1B (each).
The Treasury promises to keep Fannie and Freddie solvent according to GAAP by lending it money at 10% per year.
The Treasury promises to keep Fannie and Freddie liquid by buying its MBSs, financing the purchase by selling more Treasury bonds, and then holding the GSE MBSs to maturity.
The Treasury, the Fed, and the FHFA will agree on an additional amount–a “commitment fee”–that Fannie Mae and Freddie Mac must pay to the Treasury starting in March of 2010.
This deal seems to me to be motivated by five things:
Paulson’s desire to make sure that there is no way in hell that either Fannie or Freddie can ever be adjudged insolvent according to GAAP–which would trigger all kinds of bond-market unpleasantness.
Paulson’s desire to make sure that there is no way in hell that either Fannie or Freddie will wind up illiquid–out of cash.
Paulson’s desire to make sure that there is no way in hell that Fannie Mae’s and Freddie Mac’s stockholders profit substantially out of this.
Paulson’s desire to make sure that there is no way in hell that the CBO can calculate that this deal is likely to cost the government money–if CBO threatens to so conclude, he can always up the commitment fee.
Paulson’s desire to keep the options open for his successor to shape the long-term debate about how to restructure these GSEs.
One comment on this issue. There is a lot of talk about how this deal bails out “large corporations,” but like any economist in public finance asks about tax policy, one must ask the same question here – what is the true economic incidence of this policy decision (relative to the status quo of doing nothing)? Who really wins and who really loses? And how does the short-run incidence (and overall net benefit) differ from the long-run incidence (and overall net benefit) given the moral hazard dimension?
For more, here’s Tyler Cowen’s overview of the blogosphere reaction.