Former FDIC chief urges breakup of Fannie, Freddie
Government should bail out GSEs, then sell them to private investors: Seidman
By
John Spence, MarketWatch
Last update: 1:51 p.m. EDT Aug. 21, 2008
BOSTON (MarketWatch) -- The former chairman of the Federal Deposit Insurance Corp. who played a key role in healing the U.S. banking system after the savings and loan crisis said Thursday he advocates a breakup of struggling mortgage buyers Fannie Mae and Freddie Mac.
"We need a plan for breaking up Fannie and Freddie and selling them to private investors, so that the government isn't the biggest backer of the housing market," said Bill Seidman in an interview with MarketWatch in Boston's financial district on Thursday.
The former FDIC head who helped revive banking confidence after the S&L debacle in the late 1980s said "the only real productive alternative" is to nationalize Fannie and Freddy as a first step.
Shares of the government-sponsored mortgage entities have been in a death spiral this week on mounting fears they will require a bailout that could essentially wipe out shareholders. However, Fannie shares bounced back somewhat Thursday, gaining nearly 9% at last check.
Seidman said a government bailout of Fannie and Freddie would dwarf the tab from the S&L crisis, estimating it would involve assets between $5 trillion and $6 trillion.
The government should put in new management and run the companies for the sole benefit of borrowers, while balancing obligations to the housing market with financial costs, he said.
"The government better get a heck of a good guy to run Fannie and Freddie," Seidman said. "That's the biggest financial challenge of the century."
One name he floated was Treasury Secretary Henry Paulson, saying it would be an even bigger job than running the Treasury.
Paulson earlier this summer promoted a plan signed into law that extended a temporary and unlimited line of credit for the two mortgage-finance giants.
Yet Seidman said part of the problem is that the government is "half in, half out" of Fannie and Freddie, which is contributing to market uncertainty.
"For all practical purposes, Fannie and Freddie are nationalized, but the government doesn't have enough control given its interest in the housing market," he said.
The plan
The banking expert said the government should buy 95% of the GSEs, leaving shareholders with "a token amount," a move he acknowledged would lead to "huge losses" for investors. After the companies and the housing market get back on their feet, Fannie and Freddie should be broken up and sold to private investors.
"This process needs to be done in an overt, rather than covert, fashion so that market participants know what the rules are," Seidman said.
Meanwhile, he said any plan would require making Fannie and Freddie creditors whole. Because the debt is held in such large amounts by governments and banks around the world, "it would endanger the global financial system."
With the relatively recent advent of securitization markets in which mortgage loans are packaged up and sold to large investors, the private sector is more equipped to deal with a market without the GSEs, Seidman argued.
The costs of borrowing to purchase a home would likely rise, but the current system is broken, he said.
"If the government wants to provide a subsidy, why not just give it directly to borrowers and get dollar-for-dollar on its money?" Seidman said. "Of course, the problem is that this would be a government program, but it's more efficient than the system we have now."
Privatizing the GSEs "can't be done overnight" and could take years due to the problems already shaking the mortgage and housing markets, and there would be losses borne by the government.
'Catastrophic losses'
Conversely, there is a real danger that Fannie and Freddie could go under if they are unable to refinance their debt. As reported by The Wall Street Journal earlier this week, Fannie and Freddie have $225 billion of debt they need to roll over by the end of September. "This is when the market could effectively shut them down," Seidman warned.
Yet if the GSEs go down, it would be "catastrophic" because the mortgage securities are in most banking systems around the world.
"It could cause total panic in the global financial system, which is based on credit," he said.
"Some people say let them fail and let the market sort it out, and the market will sort it out," Seidman added. "But in the meantime that could mean the end of the market and the financial institutions and banks. They tried that during the Great Depression. The market will work, but it's a question of cost, and the cost would be the collapse of the banking system."
Since the U.S. financial system is based on credit, the government almost has no choice but to help any big financial institution in danger of failing, he said.
He predicted the private sector could eventually take the place of the GSEs and help provide liquidity to the mortgage market. "Fannie and Freddie are private institutions that had special privileges in the marketplace, which forced competitors out of business."
However, until the privatization shift is able to happen, the respected market observer said the government has to step in to prop up Fannie and Freddie.
"My experience in government says whenever possible, the government shouldn't run it," Seidman said. "But this is one of those times when the government has to run it."
