The Federal Home Loan Mortgage Corporation (Freddie Mac) and the Federal National Mortgage Association (Fannie Mae) together own or guarantee almost half of the $12 trillion home mortgage debt. These are two of the largest financial institutions in the country.

Although Freddie Mac and Fannie Mae are government sponsored enterprises, they are privately owned. They enjoy special privileges. They need not register their securities with the government, pay state and local income taxes, and are conferred special treatment for investment purposes. The securities issued by them have the aura of a government guarantee. In the credit markets, these securities are priced as low risk investments. This enables them to place their securities at lower yields in the financial markets than would have been otherwise possible.

Both companies were created to facilitate the availability of mortgage finance to homeowners at affordable rates.

When the sub prime crisis hit America, the fortunes of these two companies were affected to a great extent. The widespread repossession and distress sale of home through out America caused a general decline in home prices which led to negative equity and delinquency in respect to several mortgages that these two companies had owned or guaranteed. They were terribly over-leveraged to such an extent that the edifice came crashing down. The problems were so serious that the government had to step in and pass a law to prevent these two companies from collapsing.

There are some lessons to be learned from all this. The concept of privately owned entity and government sponsored enterprise are contradictory. Lenders carefully consider the financial health of a privately owned entity and limit exposure to prudent level. They are subject to market regulations such as registration of securities, payment of state and local income tax, etc.

A government sponsored enterprise has an aura of implicit federal government backing. It enjoys several benefits and is not subject to strict scrutiny by lenders and investors. It is not subject to the same market regulations as a privately owned entity.

The government has so far managed to keep the liabilities of Freddie Mac and Fannie Mae out of its balance sheet. But because they are government sponsored enterprises, the government may be forced to turn to the tax payer to bail them out.

The shareholders of Freddie Mac and Fannie Mae have made huge profits over the years on account of the special privileges the companies enjoyed as government sponsored enterprises.

Because of the government sponsored enterprise status these two privately owned entities enjoy, the shareholders of these two companies have been able to rake in profits, but now that these two companies are in financial distress, they have turned to the government who had to bail them out. In the end it is the tax payer who is forced to pick up the tab for the financial mismanagement of two privately owned entities because they happen to be government sponsored enterprises.

The new law does not address the issue at all. So long as these two companies enjoy special privileges as government sponsored enterprises, the shareholders will rake in the profits and the government will have to step in (at the cost of tax payers) every time these companies are in financial distress. The law should have made these companies subject to tougher market regulations.

Related posts:

1. Why the Housing Rescue Bill Will Fail
2. Can the Housing Rescue Bill Really Work?
3. Why the efforts to rescue the economy may fail
4. Fannie Mae & Freddie Mac: When Will the Government Learn?
5. America’s Free Market…or the Lack Thereof