The Costliest Bailout

I think the idea that Fannie Mae and Freddie Mac somehow “caused” the housing bubble or the financial crisis is nonsense. But as Megan McArdle observes, the Fannie/Freddie bailout looks set to have a far higher net cost than the TARP or AIG bailout. Interestingly, this most expensive action also seems to me to have been the least-scrutinized and least-controversial. TARP, you’ll recall, was a massive legislative drama with simultaneous rank-and-file revolts from the left and the right. It even initially failed to pass the House of Representatives leading to a scary stock market crash. The Fannie/Freddie bailout, by contrast, was simply announced by then-FHA head James B. Lockhart II and then-Treasury Secretary Hank Paulson at a September 7, 2008 press conference.

The stage was set for the “conservatorship” action by the little-noticed Housing and Economic Recovery Act of 2008. This bill passed the House 241-172 with 26 Republicans joining 215 Democrats back on August 4, 2007. Then in February 2008 44 Republicans joined 2 Democrats to filibuster the bill. But on April 10, 2008 it sailed through the Senate on an 84-12 vote with all Democrats joining a majority of Republicans to vote yes:


The upshot of this is estimated to be $174 billion in financial losses when all is said and done, against “only” $99 billion in net TARP losses, about half of which will be on GM and Chrysler rather than banks. There’s been so little debate or discussion about the wisdom of the conservatorship decision that I guess I don’t really even have an opinion about it—but here’s Tyler Cowen at the time approving of the bipartisan measure:

But let’s say that the Treasury did not support the debt of the mortgage agencies. The Chinese bought over $300 billion of that stuff and they were told that it is essentially riskless. The flow of capital from them and from other central banks, sovereign wealth funds, and plain old ordinary investors would shut down very quickly. The dollar would fall say 30-40 percent in a week, there would be payments system gridlock, margin calls at the clearinghouses would go unmet, and only a trading shutdown would stop the Dow from shedding half its value. Most of the U.S. banking system would be insolvent. Emergency Fed/Treasury action would recapitalize the FDIC but we would lose an independent central bank and setting the money supply would be a crapshoot. The rate of unemployment would climb into double digits and stay there. Many Americans would not have access to their savings. The future supply of foreign investment would be noticeably lower. The Federal government would lose its AAA rating and we would pay much more in borrowing costs. The deficit would skyrocket.

Of course several of those things seem to have happened anyway. At any rate, it should be clear enough by now that setting up Fannie and Freddie as faux-private companies was a terrible idea.