Your Move, Mr. (Next) President

By Jane Sasseen The rescue plan for Fannie Mae and Freddie Mac, announced in a rare Sunday news conference by Treasury Secretary Henry Paulson, left many questions unanswered, not least of which is how much the bailout could ultimately cost taxpayers. But one thing is crystal clear: after years of politically and ideologically charged debate about what is the correct structure and business model for the two mortgage giants, that decision will be left squarely in the hands of the whoever wins the election. “The next President gets to decide what the role of Fannie and Freddie will be,” says Daniel Clifton, the Washington-based policy analysts for Strategas Research Partners, an institutional investment advisory firm. The aggressive plan proposed by the Treasury to essentially nationalize the two companies is intended to stabilize the markets, restore confidence in the bonds of the agencies, particularly among the foreign central banks and other large entities abroad who have tremendous holdings in the debt.

Had they backed away from the agencies' debt, the risks to the dollar, global financial markets and US credibility would have been enormous. And by buying up deteriorating mortgage backed securities from the two firms, the Treasury also hopes to bring down US mortgage rates so that more buyers can come back into the market.

But the plan does little to address the long-term question as to whether Fannie and Freddie should still have some sort of a public function in supporting the housing market, as their current mandate now states, in addition to the private market function of boosting returns for shareholders. Critics have long argued that the conflict behind those two roles -- and what was once the implicit federal guarantee for their bonds, which just became extremely explicit -- has encouraged the firms to grow too large and take too much risk. While that benefited shareholders and executives hugely for many years, the taxpayer has now had to step in and absorb the potential losses that have resulted.

That means either John McCain or Barack Obama will have to decide on the structural changes needed to prevent another blowup from occurring when one of the two assumes office. So what are their views? Both campaigns quickly backed the bailout plan, agreeing that the moves were needed due to the grave risks to the financial system if one of the mortgage giants became insolvent.

Beyond that, however, their approach differs substantially. McCain, says campaign adviser Douglas Holtz-Eakin, believes that the firms need to be privatized and shrunk so that they are no longer a threat. Like many Republicans, he believes the entities -- which he likens to giant hedge funds buying up mortgage-backed securities -- are no longer needed to provide public support to the housing market. "We believe these institutions should not be making money" through government support. "They need to be put in the private sector, or shut down entirely if the private sector is not interested in them."

As for the public function they now serve in supporting affordable housing, he adds that the entities are not the best vehicle for achieving that goal. "There is a need for a low-income housing policy, but Fannie and Freddie's approach in meeting affordable housing goals are incredibly inefficient and poorly targeted. And the idea that we still need specialized entities to channel capital into the mortgage markets is simply untrue. they've outlived their usefulness."

The Obama camp also views a restructuring as necessary, as reflected in the statement Senator Obama put out soon after Paulson finished his press conference. "Given the substantial role that Fannie Mae and Freddie Mac play in our housing system, I believe that some form of intervention is necessary to prevent a larger and deeper crisis throughout our economy," he said. "But once we ride out the current crisis, the plan must move toward clarifying the true public and private status of our housing policies."

But like most Democrats, he believes it is far too simplistic to simply argue that the firms should be shrunk and turned back over to the private market. There is an enormous public market in Fannie and Freddie debt; the two firms backstop half of all the mortgages outstanding in the US. Obama's advisors warn that this is a case in which the details of how the government proceeds are incredibly critical. "Privatize and shrink" is little more than a soundbite, they argue: it's far from clear how to do that without while protecting taxpayers and without disrupting the existing market. And they believe that while a better balance has to be reached between the mortgage giants' conflicting public and private goals, that has to be done without eliminating the mortgage firms' obligation to support the housing markets altogether.

It's a critical issue for the US economy--and one which will be hotly debated in the markets and among economists. But don't expect to hear a lot of that on the campaign trail. At the end of the Democratic convention, as the fears of insolvency at the two companies that ultimately led to the Treasury bailout plan were building up in the markets, Tom Gallagher, the head of Washington research for investment firm ISI Group, noted how little either campaign was talking about the problems at the mortgage giants and the broader financial crisis -- or their views on what they would do to to resolve them. "They can't do anything about the crisis for another 5 months," he said, adding that the issue wasn't likely to be much of a vote-getter. Given the complexities involved, that's not likely to change.

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