UPDATE: GSE Bailout Would Be ‘Entirely Manageable’ -Goldman
By Daniel at 26 August, 2008, 5:16 pm
By Maya Jackson Randall
Of DOW JONES NEWSWIRES
WASHINGTON (Dow Jones)–Anxiety over a possible U.S. government bailout of Fannie
Mae (FNM) and Freddie Mac (FRE) is unwarranted, according to Goldman Sachs
economists, who say rescuing the struggling mortgage finance giants would be an
“entirely manageable event.”
Taxpayers will face “some cost” if the Treasury Department were to act on its new
powers to bailout the government-sponsored mortgage firms, wrote the economists
from Goldman, the firm formerly headed by Treasury Secretary Henry Paulson.
But they say it can be done in a way that won’t explicitly add debt to the
federal balance sheet.
“While the GSEs (government-sponsored enterprises) are extremely large and hold
or guarantee a portfolio of mortgages roughly equivalent to the outstanding U.S.
Treasury debt, the two are not comparable,” the Goldman economists wrote in a
recent report. “A more appropriate comparison is the federal budget deficit
compared with the financing cost and ultimate cost to taxpayers of any potential
intervention. From this perspective, any potential GSE-related action would be an
entirely manageable event in the context of the federal budget.”
Peter Wallison, an American Enterprise Institute fellow and former Treasury
general counsel, agrees that a bailout would be manageable, but said that’s not
the only factor that needs to be considered.
“The question is whether it would be good policy to bail them out in some way
now,” he said. “In my view, there is no reason to inject any capital into the
GSEs, or for the government to buy their debt or their mortgages.”
In their report, the Goldman economics research team said the notional amount of
GSE debt and guarantees is about the same amount of Treasury debt outstanding -
between $5.3 trillion and $5.44 trillion.
Still, pointing out that GSE debt is backed by assets that generate income, they
said the true cost of a government bailout is the difference between the inflow
of payments from individual homeowners and the outflow of payments to
bondholders.
“The cost of GSE intervention would be small in the federal context,” they said.
“The cost of intervening in the GSE situation - if the Treasury decides this is
necessary - would be substantially smaller than the notional amounts of debt
suggest.”
In laying out several actions the Treasury Department could take to prop up the
firms and the broader mortgage market, the economists said an incremental first
step could be the purchase of debt.
“This would show more tangible determination to support the GSEs at relatively
little near term cost,” they wrote, adding that the Treasury would likely earn a
positive spread on that investment.
They added that the option they see carrying the smallest immediate price tag
would be for the government to take no action at all, although the corresponding
market uncertainty could likely depress financial markets.
Another way the government could intervene is by lowering Fannie and Freddie’s
capital requirements, Goldman said. That would come with no immediate fiscal cost
while improving their capital position.
Still, regulators are legally limited in how much they can lower the
requirements. So they said that option would probably do little to address
longer-term capital concerns.
Overall, the economists described a direct injection of capital as “the cleanest”
way for the U.S. government to aid the GSEs because it would directly bolster the
firms’ capital position.
Wallison, however, said Goldman’s list of options is lacking.
“All of these options are unnecessary expenditures of taxpayer funds,” he said.
In particular, he argued that one injection of capital would start a cycle, only
leading to further money infusions later.
According to Wallison, the best option is one Goldman fails to mention, but one
he plans to explain in a paper due out later Tuesday.
“The best policy is for the government to wait until they (Fannie and Freddie)
become critically undercapitalized and then place them in receivership, which is
authorized under the new law,” he said. “The receiver can then operate them so
that they keep the mortgage market functioning over time and eventually the
receiver can nationalize, privatize or liquidate them, depending on what Congress
and the administration decide they want to do.”
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