Who Killed Frannie?

Bethany McLean, from her new perch at Vanity Fair, has delivered a 10,762-word magnum opus on Fannie Mae and Freddie Mac, which spends most of its time giving a detailed history of what Hank Paulson called the "Holy War" between the companies' proponents and opponents in Washington.

McLean is good on what did and did not happen at the beginning of September, when the government decided to take Fannie and Freddie into conservatorship. But was the decision payback for all the bullying that various Washington politicians had suffered, over the years, at the hands of Fannie Mae? I doubt it -- especially given that the prime decision-maker, Paulson, was closer to the pro-Fannie than the anti-Fannie side of the debate. (Legendary Fannie boss Jim Johnson was chairman of Goldman Sachs's compensation committee during Paulson's tenure as CEO, for starters.)

I suspect that for all McLean's narrative skills, the truth of the story is simply that, as Don Rumsfeld might have put it, "stuff happened". The conservatorship of Fannie and Freddie was not the culmination of decades of Washington infighting, it was just another case of Paulson's ad hoc style of policymaking, where he would make a big decision over breakfast and then move on to the next crisis.

What's more, as McLean shows, the decision was actually much less momentous than many people thought at the time. Sure, the shareholders were pretty much wiped out -- but most of that wipeout had already happened before the conservatorship was enacted. But the government guarantee didn't change much: it went from "we'll pretend there isn't a guarantee" to "we'll pretend there is a guarantee", and the spreads on Frannie's debt actually went up rather than down. And Frannie's business model didn't actually change at all. "Steve Ashley, former chairman of Fannie's board, asked what the government wanted Fannie to do that it wasn't already doing," reports McLean, and to this day no good answer has been given to that question.

In the present market, it's very easy for Fannie and Freddie to get bigger -- and that's exactly what they have been doing, as banks are increasingly reluctant to write mortgages they can't turn around and immediately sell to the GSEs. But under the terms of the conservatorship, they have a bit of time to get bigger, and then -- in some vague and undefined manner -- they have to turn around and become much smaller, very quickly.

When has any government agency ever voluntarily shrunk itself so much? I feel that Paulson ordered Frannie to do the impossible, and then happily left the implementation of that order to his successor. Which only means that this story is far from over, and that McLean will have more to tell in future.