Fannie and Freddie Can’t Afford To Bail Out Subprime

The government is hoping Fannie Mae and Freddie Mac will come to the rescue of subprime lenders and borrowers by buying up more of those loans and working with consumers to save their homes. But both companies are showing rapid declines in their assets — neither look like they are in a position to bail anyone out right now.

Fannie and Freddie are government chartered buyers of mortgage loans. By buying those loans, they allow the immediate lender — your local bank or mortgage broker — to get their money back and make new loans. Fannie and Freddie make money as consumers pay off their loans and through securitizing the loans to other investors and receiving fees along the way. Because of their government sponsorship, Fannie and Freddie are able to borrow money at almost riskless rates historically because most lenders assume the government ultimately stands behind them. In other words, everyone assumes you and I as taxpayers would bail out Fannie and Freddie if the going got tough. As a result these two companies control an enormous share of the home loan market directly or indirectly.

Treasury Secretary Henry Paulson is quoted in today’s Wall Street Journal saying, “If we ever needed them it’s during times like today, and they’re most valuable when there is distress in the mortgage market. I’d like to see them playing an even bigger role.” In other words, the government hopes Fannie and Freddie will be able to find the scratch to bailout enough home loans that the subprime mess won’t get any worse.

That’s not going to happen anytime soon, from the looks of things. Both Fannie and Freddie are getting hit harder than anticipated by the subprime disaster. On the same day Secretary Paulson was beating the drum for Fannie and Freddie to pick up the pace, Freddie reported a $2.03 billion loss for its third quarter. And Fannie only recently had to issue $500 million in preferred stock to raise money.

The bottom-line is that Fannie and Freddie are already being squeezed. They are well-capitalized and no one expects them to fail. But if they are pushed to absorb more bad loans than they have easy capital to cover, ultimately they will face a reckoning as well. At that point, everyone will turn to look at the government with one question:

Can you spare a dime?