The Case Against Hybrids

The fallout from the collapse of Fannie Mae and Freddie Mac stock continues. Yes, the markets have rebounded somewhat. A little good financials news here and there has prevented another freefall, just like with the Bear Stearns weekend of doom earlier this year. But we're in a weird time. J.P. Morgan Chase announces that its income fell 53 percent and the stock soars because it all could have been so much worse.

In this atmosphere, it's easy to lose track of the big goal with any Fannie Mae assistance plan. The goal is not just to help Fannie and her little brother, Freddie Mac, through the next few weeks, but hopefully to come up with some kind of prescription that will avoid any crises in the future.

A couple of thoughts: One is that we should really think hard about abandoning Freddie and Fannie in their current form. Treasury Secretary Henry Paulson has said that he wants to keep the duo as shareholder-owned companies, but it seems crazy to keep them as such with that implicit government guarantee that suddenly looks a lot more explicit. One option is for the government to just take over the damn things and let them, in fact, become government-run corporations or, in time, government agencies. Sebastian Mallaby of the Washington Post and the Council on Foreign Relations put this forth. His take is that in the long run, we're better off with the feds just running it all. The other way to go is full privatization. Bert Ely, the prescient and persistent Fannie critic has outlined a series of steps that could be taken to more fully privatize the agencies. The same happened with Sallie Mae, the student loan agency. My take is no hybrids—they're great cars, but with agencies like these, it's either in or out for the feds. Any combination of public and private is a recipe to recreate what we've seen thus far—private property and socialized risk.

Larry Summers, the former Treasury Secretary and Harvard University president, who has had the courage to take on liberal orthodoxy in the past, has thoughts on the Creative Capitalism blog today about all of this. He writes:

What went wrong? The illusion that the companies were doing virtuous work made it impossible to build a political case for serious regulation. When there were social failures, the companies always blamed their need to perform for the shareholders. When there were business failures it was always the result of their social obligations. Government budget discipline was not appropriate because it was always emphasized that they were "private companies." But market discipline was nearly nonexistent given the general perception--now validated--that their debt was government-backed. Little wonder with gains privatized and losses socialized that the enterprises have gambled their way into financial catastrophe.

I don't know what the very best way out of the mess is. On balance, it seems like it was the right thing to extend a government hand to Fannie last week. But going forward, the larger restructuring that takes place shouldn't leave us vulnerable to this kind of calamity again.

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