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Shouldn’t Uncle Sam bail out homeowners, too?

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Last week’s government bailout of Fannie Mae and Freddie Mac has left some readers wondering: What about the millions of families who have lost their homes — or are still at risk of foreclosure? Isn’t the government going to do anything to help them out, too?

If the taxpayers are going to bail out Freddie and Fannie, wouldn’t it be fair to convert all the (adjustable-rate) mortgages into 30-year fixed-ate loans and let the market reboot itself? It doesn’t make sense to reward the establishment that placed so many into ARM loans and then ask those with ARM loans or who just lost their homes to spend upwards of $50 billion to save the robbers. Both sides in this equation should get the benefit of the bailout.
— Dennis, Port Orchard, Wash.

The issue of just who should — and shouldn’t — get bailed out has been a central theme in the ongoing debate about just how government should respond to the collapse of the housing bubble and resulting credit bust. Unfortunately, there’s been little agreement, from the White House to members of Congress to the Federal Reserve to voters and readers.

The argument against bailouts is that it rewards bad behavior — or at least bad financial decisions. If you go to the casino and lose money, you don’t expect the government to cover your losses. (True, Uncle Sam expects to collect a piece of your winnings, but we’ll leave the debate about tax policy for another column.)

The problem with letting Fannie and Freddie “pay” for their past mistakes is that we would all pay. And no matter how much the government spends cleaning them up, the tab would have been a lot higher if these two giant companies were allowed to default on their debts.

No one can say for sure exactly what might have happened, but a default would almost certainly have scared off investors who put up money for new mortgages, sending borrowing rates much higher. The Treasury would have had a harder time siphoning up the global capital needed to fund our government’s habit of spending hundreds of billions of dollars more every year than it collects in taxes. That’s not exactly what the housing market or the economy needs at the moment.

But it’s fair to say the government has been quicker to help lenders and investors than it has been to help homeowners. The massive rate cuts by the Federal Reserve are perhaps the biggest bailout to date; by lowering the cost of money, the central bank has boosted profits for lenders to help them cover the losses from all the bad loans they made.

As for homeowners who are now losing their homes, Congress and the White House spent more than a year debating what to do to help them. The housing bill passed this summer will help some. But converting adjustable mortgages to fixed-rate loans won’t help those whose houses are now worth less than the balance on their mortgage. Some people now falling behind on their payments simply couldn’t afford the house to begin with. Converting their loans to fixed rates wouldn’t help them much either.

The argument against government “bailouts” is still alive and well. And judging by the government's refusal to stabilize Lehman Bros., prevailing. A $30 billion backstop last year helped close the sale of battered Bear Stearns to JP Morgan. But with the Treasury still sorting through the potential cost of the Fannie and Freddie bailouts, there seems to be little interest in adding Lehman to the list.

How will the takeover of Fannie and Freddie directly affect me? Through my personal income tax, increase in property tax? Exactly how?
Marti, Hillsdale, Mich.

You won’t be getting a bill from the Treasury for the cost of the takeover. And the guarantee of Fannie and Freddie’s loans won’t have an impact on your property taxes — except perhaps by speeding the recovery of the housing market, at which point the value of your house may start rising again.

It’s not at all clear just how much the mess will cost once it’s cleaned up: There are just too many unknowns at the moment.

The biggest unknown: How much further will house prices fall before they begin to stabilize? The mortgages that Fannie and Freddie are holding — and the Treasury is now guaranteeing — are backed by real estate. If the value of that real estate goes down, so does the value of those assets. It’s also not clear how many homeowners who are still keeping up with their payments will eventually fall behind and default. The higher the default rate rises, the bigger the losses.

If all goes well and the economy and housing markets recover fairly quickly, it’s possible the government could end up making money on the deal — because it took a stake in the two companies in return for covering its debts. It’s also possible the Treasury will be on the hook for tens — perhaps hundreds — of billions of dollars in losses. No one knows.

The takeover has already had one important — and positive — development for all of us. Long-term interest rates, including mortgage rates, dropped sharply in the days after the bailout was announced and are expected to remain low. That could help speed the housing market’s recovery. But it’s too soon to know how much impact those lower rates will have.

Who authorized this takeover of Fannie/Freddie?
Curtis, Address withheld

Congress did.

One of the major issues in the yearlong debate about the housing relief bill passed this summer was the fate of these two government-sponsored entities. Over the years, they developed a number of friends on Capitol Hill, thanks to a formidable lobbying effort. That’s one reason Congress allowed Fannie and Freddie to carry a relatively thin capital cushion. Critics had been warning for years that their capital base was too thin to carry them through a nasty downturn.

Fannie and Freddie didn’t do themselves any favors when it turned out they weren’t exactly sure how much money they’d made or lost. In June 2003, Freddie Mac said it had misstated earnings by $5 billion between 2000 and 2002 — inflating results for some periods and cutting them in others. In December 2004, Fannie Mae said it also had trouble keeping its books, bringing the resignation of top managers and demands from regulators that it build up more capital. Two years later, Fannie Mae restated earnings for 2002, 2003 and the first half of 2004 by $6.3 billion.

Since then, things have gone from bad to worse. As the housing market collapsed, Fannie and Freddie began posting huge losses — close to $20 billion so far — and warned that more losses were coming. So when it came time to enact a housing relief bill this summer, the White House insisted that the bill include a provision to create a tougher regulator for Fannie and Freddie with the authority to let the government step in and take them over if needed.

The question now is: What is the government going to do with these two entities? Many of Fannie and Freddie’s critics say the real problem is that they got too big — creating outsized risks if something went wrong. Some of those now overseeing Fannie and Freddie would like them to get smaller. Once the housing market recovers and the financial system stabilizes, there may be plenty of private lenders out there to take up the slack. But we’re not there yet. Until then, it will probably be business as usual — or as close to usual as possible — for Fannie and Freddie.