EDITORIAL: Billions more for banking bailout

The Washington Times (Link) (January 14, 2010)

The second banking bailout isn�t getting the attention it deserves because Democrats don�t want to talk about the disaster at Fannie Mae and Freddie Mac.

The Obama administration waited until Christmas Eve to announce it was lifting the $400 billion cap for funds available to cover Fannie�s and Freddie�s financial losses. The Treasury Department admitted that taxpayer losses well surpassed that fortune, so taxpayers are on the hook for an unlimited amount more for these two losers.

By contrast, between the 1980�s and 2004, the savings and loan crisis cost American taxpayers about $124 billion. After adjusting for inflation, the S&L mess will have cost less than half the money already lost by Fannie and Freddie - and their red ink continues to flow.

The hard lessons learned from the S&L crisis during the 1980�s and 1990�s have been forgotten. The basic problem behind those bank failures was the government encouraging excessive risk-taking by banks. The Federal Deposit Insurance Corp., the government agency that insured bank deposits, charged all banks the same insurance premium no matter how risky their investments were. From the standpoint of depositors, risk did not matter, as deposits up to $100,000 were insured by the FDIC. All depositors cared about was who paid the highest interest rates.

However, to earn enough money to pay higher interest rates meant banks had to make riskier investments. More conservative banks, which chose less risky investments, went out of business because they didn�t earn enough to pay depositors higher interest rates.

No sane private insurance company would have behaved like the government - charging clients the same premium regardless of risk. Higher insurance premiums would have offset the greater returns banks made on riskier investments and prevented them from paying higher interest rates. The FDIC should have been privatized, but at least one lesson was learned, and the insurance premiums now vary somewhat with the riskiness of a bank�s assets.

Fannie and Freddie ignored that lesson, and in so doing, they caused the financial system to take insane risks. Fannie and Freddie are responsible for America�s banking meltdown in two ways. First, they used subsidies to deliberately encourage lenders to give mortgages to people who wouldn�t come close to qualifying under any normal conditions. The more of these risky loans an organization such as Countrywide made, the more of a subsidy it received.

The second cause was simple fraud. Fannie and Freddie consistently mislabeled the bonds they bundled together, lying to investors about the number of subprime mortgages that were being included. Of the 26 million subprime and Alt-A loans outstanding in 2008, Fannie and Freddie held or guaranteed 10 million, and other government agencies had another 5.2 million. Combined, that is almost 60 percent of the total. Another 7.7 million of those mortgage-backed securities were issued by banks, but Fannie and Freddie mislabeled the mortgages they passed on to the banks. Very risky mortgages were mischaracterized as AAA-rated ones.

In 2005, with Republicans in control of Congress, the Senate Banking Committee passed tough regulatory legislation that would have established more auditing and oversight of the two agencies. However, Senate Democrats threatened to filibuster the bill, and it never came to a final vote. While screaming that the financial crisis was caused by private companies, the Obama administration has fought any effort to place any regulations on Fannie and Freddie. Continuing to offer unlimited taxpayer cash to Fannie Mae and Freddie Mac is throwing more good money after bad.