Saving Fannie & Freddie

With $5 trillion in mortgage assets, Fannie Mae and Freddie Mac--both government-sponsored enterprises (GSEs)--are dominant players in the home-lending market. But both are also the latest casualties of the subprime-mortgage crisis. Continuing drops in both companies' stock prices last week raised significant concerns over their solvency, prompting the White House, Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson to find a way to shore them up. Their solution: to extend Fannie and Freddie's credit and, if needed, to have Congress allow Treasury to buy shares in both companies.

While that was welcome news to many in the mortgage industry, not everyone was pleased. In a closed-door meeting this week, Secretary Paulson met with Republicans on the House Finance Committee, many of whom expressed frustration over writing a blank check to the two institutions with no guarantee or plan in place to ensure they wouldn't need help in the future. Rep. Jeb Hensarling, a Republican on the committee, was among the most vocal objectors, arguing that the deal was far too generous and is ultimately a bad deal for taxpayers.  Hensarling spoke to NEWSWEEK's Daniel Stone about why the bailout won't work, why it may set a bad precedent and whether Fannie and Freddie should be broken up into smaller units. Excerpts:

NEWSWEEK: You've been a vocal opponent of bailing out Fannie and Freddie. Why?
Jeb Hensarling: I believe that as of today, Fannie and Freddie are too big to fail. We may help them out today, but we also have an obligation to assure taxpayers that both [lenders] are not too big to fail [in the future]. My fear is that the underlying legislation doesn't address that but makes matters worse. If Fannie and Freddie are in a precarious financial position … why would we increase their loan limits and have them engage in more risky loans? Why would we lower their capital requirements? Why do we need to give a blank check to these two private companies and to prop up their stock prices. Why is Congress making the situation bigger and riskier? These are questions that need to be asked.

How precarious is the situation?
That's a challenge to figure out. People all over the marketplace are trying to figure out what is the proper risk assessment. But we make [Fannie and Freddie] larger, riskier and more dangerous entities when we go from an implicit federal guarantee to an explicit federal guarantee. At least on paper, they're holding $5 trillion of debt outstanding. If we guarantee their debt and put the credit of the United States behind them, overnight you increase the federal debt by 50 percent. Of course that would be every single debt going bad, but that theoretically is the extent of what could happen.

So you think the federal government should leave them alone, possibly to fail?
Nobody wants to see them fail … we cannot let that happen. But we can take this opportunity to ensure it doesn't happen [in the future]. It would be horrendous for our economy if they were to fail, but it would be worse if we don't solve the underlying problems.

What would be the most productive way to handle both banks' situations?
We need to look at breaking Fannie and Freddie up into smaller components, like what was done with AT&T and Ma Bell a number of years ago. Instead of having a duopoly, we should have a few dozen players in the market. So within a sufficient period of time, maybe five years, you phase out their GSE charters because there's absolutely no reason why they need the charter to do what they do. Let there be a more competitive, more innovative marketplace in the conforming loan area. You don't have to have a GSE charter to get people to collateralize these mortgages. You just don't need it. In fact, you're doing more harm than good. We need to put them on the road to privatization, which would be my choice. But to just rearrange the regulatory deck chairs doesn't get the job done.