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The Last Sucker

The stock market decline of Fannie Mae and Freddie Mac is more rapid and dramatic than anyone expected, but it should be no surprise that the two eventually would wind up in some sort of trouble. For years, conservatives and liberals alike have had issues with both of the entities, and although the specifics of the complaints have differed, the common theme of the complaints centered on the problematic nature of the Fannie and Freddie’s very existence. The two were created by Congress to provide money and stability to the mortgage markets. They are the largest buyers of home loans, which they repackage into securities for sale on Wall Street. They also are assumed to have the implicit backing of the government, even though they were converted into private companies. Here’s a good backgrounder from Econobrowser. Anyway, this meant for years that everyone assumed the government would step in if their portfolios tanked, but no one really believed that would ever happen or be necessary. They didn’t believe it because that would put the government in the position of being the last sucker if the housing market were to collapse and mortgages go sour.

So mortgage companies and banks complained for years that Fannie and Freddie’s implied government backing gave it an unfair advantage in the marketplace. On the other side, community groups and housing activists maintained that the two put market interests above their mission to promote homeownership. When Fannie Mae moved to quickly get foreclosed properties off its books, activists in Cleveland charged that Fannie turned the properties over to speculators who only added to neighborhood blight. When Fannie and Freddie, to stay competitive, waded into the subprime market, legal aid lawyers who deal with predatory lending victims contended their presence encouraged more abusive subprime lending.

Now fears that the two will run out of capital and the government will be required to rescue them are roiling Wall Street. Some of this fear may be tied to the often irrational behavior of the financial markets. But there’s probably more to it; in the back of many an investor’s mind is the realization that "last sucker" theory could come true. As economist Dean Baker notes, it’s time to look back at the warning signs and figure out why regulators and analysts didn’t take this possiblity more seriously. And why Congress ever set up the government to become the mortgage market’s last sucker in the first place.

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