Fannie and Freddie: Budget Busters

It's looking increasingly like Fannie Mae and Freddie Mac are going to cost the US government much more than AIG.  In its latest long-term budget outlook released in late January, the CBO projected that the AIG bailout would ultimately cost the Treasury $9 billion dollars.  Indeed, the entire private financial industry bailout is ultimately expected to cost less than $30 billion; of the $99 billion that the CBO expects we will ultimately lose on TARP, half of the loss comes not from helping the "banksters", but from the Obama administration's decision to bail out the automakers.  A further $20 billion will be spent on the Home Affordable Mortgage Program, aka the administration's mortgage modification plan.

By contrast, the nationalization of the Government Sponsored Entities is expected to cost the Federal government $64 billion between 2011 and 2020, on top of the $110 billion we've already spent.  Fannie and Freddie have long defended themselves on the grounds that their underwriting standards weren't nearly as bad as those in the private sector.  But they've certainly been better at socializing their losses; firms that controlled maybe half of the mortgage market will end up costing the taxpayer four times as much as the other troubled financial institutions.

And that CBO report was issued before yesterday's announcement that due to an accounting change, Fannie and Freddie were going to buy back many of their non-performing mortgages rather than continue to make payments to the investors.  For those who haven't been following along at home, Fannie and Freddie guaranteed loans they packaged for resale, which means when homeowners default, they have to make the payments.  This is expensive, so Freddie and Fannie have decided to repurchase the loans.

This is actually probably good news for the taxpayer over the long run, because they'll be borrowing money to buy out the investors at lower interest rates than the interest rates on the non-performing loans for which they're currently covering the payments.  But it raises some disturbing questions.  First, why is an entity that is essentially an arm of the US government paying out extra cash in order to maintain some accounting fiction?  And second of all, how long before they have to do this again?

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Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

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