In Greek mythology, a chimera — composed of the body parts of several animals — was considered a monster. Ancient Greeks were rightly afraid of such unnatural combinations, unlike modern Americans, who will now pay dearly for allowing the unchecked growth of two mortgage monsters known as Fannie Mae and Freddie Mac.
As The Heritage Foundation points out, they’re not government agencies, but they were never really private either. Like Social Security — which is also in deep financial trouble — Fannie Mae is a relic from the New Deal and Freddie Mac was chartered by Congress in 1970. Both were established to further a policy objective: Make homes affordable for lower- and middle-income families. We all know how that turned out.
Neither Fannie nor Freddie paid taxes or followed the same rules imposed on truly private financial institutions. Both operated under the unspoken promise that the federal government would not let them fail. That promise was kept this weekend when Treasury Secretary Henry Paulson took over the two mortgage giants, assuming what could be $50 billion in bad debt from a housing bubble that these chimeras helped create when they snapped up almost half of all U.S. mortgages. When they got into trouble, the economic repercussions were as big as they were.
The government’s implicit guarantee emboldened Fannie and Freddie to plunge into the risky subprime mortgage market headfirst. Without a place to dump that enormous risk, private bankers would never have signed off on thousands of questionable mortgages in the first place. So the very structure of these quasi-governmental entities — not government, but not quite private either — doomed them in the end.
It was a classic case of private profits and public losses. Past and present executives of the mortgage behemoths, many of them former political operatives, couldn’t lose in this rigged game. They became true Beltway bandits, but instead of donning orange jumpsuits, they’re walking away with tens of millions. Now taxpayers will have to foot the bill.
What should we learn from a debacle conservative radio talk host Mark Levin described as Enron squared? First, such chimeras don’t work because they operate outside the rules imposed on everybody else — for a reason — by capital markets and government regulators. Second, it’s not only patently unfair, but inevitably distorts economic incentives when you privatize the profits but socialize the risk.