The Return Of Bad Bank

Just when you thought Helicopter Ben and his sidekick Foulmouthed Timmy couldn't frak up this economy any more, here comes the WaPo with another trial balloon for putting Fannie and Freddie through the Bad Bank Machine.

The "bad bank" would be a depository for Fannie Mae's and Freddie Mac's toxic assets. Then, the government could create new companies, if it chose to do so, that would attract private investment in support of mortgage finance.

Options for the "good banks" include consolidating the firms into one government agency, leaving mortgage finance to private banks or maintaining a hybrid model.

The National Economic Council has looked at the "bad bank" option, among many others, in several internal policy papers. Any final decision would come after talks involving the White House, the Treasury, the Department of Housing and Urban Development and the Federal Housing Finance Agency.

A major problem is that the firms own and insure trillions of dollars of existing mortgages. With the economy still in a deep recession, joblessness rising and defaults on home loans expected to continue to go up, there is great uncertainty over the size of future losses at Fannie Mae and Freddie Mac. That, in turn, is likely to drive investors from committing money to the companies.

Fannie Mae and Freddie Mac existed for years as odd hybrids, created by government to support housing but owned by private shareholders. (They are now majority-owned by the government.) Over the years, the unusual status has fed concerns that the firms exploited their quasi-governmental role to borrow money at very low rates and therefore grow far larger than was sustainable. At the same time, they had a duty to shareholders to maximize profits, leading them to take on bigger risks.

Until the future of the firms is worked out, the Obama administration has been using them to carry out its housing recovery program, including restructuring mortgages to avoid foreclosures.

In addition, the Federal Reserve has bought well over $1 trillion worth of mortgage-related securities and debt from Fannie Mae and Freddie Mac. That further helped to lower interest rates on home loans. The government also has pledged up to $400 billion in direct investments in the firms.

So, the government buys the trillions in toxic assets and craptastic mortgage junk at taxpayer expense...and then what? Hold on to it until the market improves? How long will that take? What price will the taxpayer pay for these assets? I've talked before about the "no right price" solution that makes bad bank untenable: there's no correct price to sell these assets at. If the taxpayer pays too much for the assets in order to free Fannie and Freddie, then they stand to lose money should the housing market continue to tank (and all indications are it will.) If they pay too little for them, it won't cover Fannie and Freddie's further losses and we'll be right back in the soup where we were in October.

The thing is the government just can't make these toxic assets vanish. Rolling them over into a holding company is one solution, but it's a solution that may take decades to make money, and that is if it makes money at all. Meanwhile, the government's on the hook for the liabilities, adding to that $23.7 trillion it's already on the hook for. Without massive reform for the new Fannie and Freddie, they'll fall apart again as the market continues to go south. We've still got a ways to go on the housing market collapse.

All this is doing is sweeping the broken shards of our economy under the rug in a huge pile, and then hoping nobody notices. Somebody's going to have to eat those Fannie/Freddie losses. They are in the trillions of dollars, total. It looks like the loser here is going to be the taxpayer.

Big surprise.

[UPDATE 7:04 PM] Now Fannie Mae execs are saying the mortgage company needs another $10.7 billion to stay afloat. And of course, they'll get it.

Poof.