March 8, 2008 Memo From Jason Thomas of the NEC to Robert Steele Undersecretary of the UST
Government Bailout Is Necessary, Likely, And Potentially Helpful Fannie Mae is demonstrably a failed social experiment. A realistic assessment of its balance sheet shows its net worth to be overstated by tens of billions of dollars and the company to be already insolvent. Even with all its accounting legerdemain, Fannie's losses are an accelerating horror show, with shareholders losing $1.5 billion in 07Q3 and $3.7 billion in 07Q4. Those losses are just the beginning. As shareholder capital gets wiped, the government will have no choice but to seize the company and place it in conservatorship or receivership. Importantly, mortgage-backed security holders guaranteed by Fannie Mae will see no losses. The government will likely allow debt holders to fare okay, with either no or token losses, perhaps 1%. Shareholders, both common and preferred, are likely to be left with nothing. However, these shareholder losses have already been locked in by the company's credit decisions over the past few years and cannot be helped. It must be remembered that Fannie is the biggest mortgage risk holder in the biggest mortgage crisis. A fully government-owned guarantor of mortgage debt might be exactly what is called for given the current housing crisis. While various proposals have been floated to expand the FHA to meet this role, it has neither the infrastructure nor the expertise to address the broader mortgage market. A nationalized Fannie Mae would be refocused to directly address the various problems of illiquidity, affordability, and sustainability in the mortgage market. Without the need to satisfy a fiduciary duty to shareholders, Fannie might finally be able to perform its affordable housing mission in a helpful and proactive manner.