When feds rush in

tauringhuang.

Jul 31st 2008 | WASHINGTON, DC
From The Economist print edition

How much should government meddle in the market?


FROM afar, the government’s latest rescue package for America’s tottering housing market seems a model of bipartisan accord. As investors dumped the stock of Fannie Mae and Freddie Mac, pushing down the share price of the mortgage giants and increasing worries about their solvency, George Bush advanced a plan to shore up these “government-sponsored enterprises” (GSEs), which own or back around half of all mortgages in the country. Democrats tacked it on to a large housing bill already making its way through Congress, and on July 30th, Mr Bush signed the whole package into law. Even Barack Obama and John McCain favoured it, though they were too busy campaigning to vote.

Hank Paulson, the treasury secretary, will have short-term permission to buy equity in Fannie and Freddie, limited only by the federal debt ceiling, which the Democrats duly raised to $10.6 trillion. That liquidity backstop comes with a new, more powerful regulator for the GSEs. And the Federal Reserve will now “consult” with the enterprises in order to contain the risk to financial markets.

In return for passing Mr Bush’s rescue plan intact, the Democrats got their housing bill past the White House. Under the plan, the Federal Housing Administration can guarantee the refinancing of $300 billion of distressed mortgages into cheaper, fixed-rate loans, as long as lenders who take part agree to write down principal to 90% or less of a home’s current value. Generous subsidies for home-buyers will also get fatter. A tax benefit for the troubled automobile firm Chrysler also sneaked into the bill, and Congress also this week approved a programme to encourage banks to issue so-called covered bonds.

Many in Washington are unhappy. “Socialism,” declares Jim Bunning, a Republican senator. Most of the Republicans in the House—149 of them, including John Boehner, the party’s leader in the chamber—opposed the package, despite the appeals from the White House. These political fault lines will only deepen.

AP

Paulson the “socialist”Should the Treasury ultimately bail out Fannie and Freddie, the Congressional Budget Office gave $25 billion as its best estimate of the cost, though this is plainly not a reliable figure. Christopher Dodd, the chairman of the Senate’s banking committee, dismisses the figure as “two months in Iraq”. But it is too much for congressmen who worry about the government risking taxpayers’ money to prop up private entities. Many think the pair shouldn’t have been created in the first place. Now the fear is that their status as quasi-governmental institutions has been firmly cemented with a new regulator and an explicit federal guarantee of their solvency. Nancy Pelosi, the speaker of the House, indicated after the bill passed that Congress may reconsider the “hybrid nature” of the firms in the future, setting up a future tussle between those who favour privatising their functions, those who want to nationalise them and the powerful lobbyists working for the GSEs.

Meanwhile, Republicans fret about the moral hazard of rescuing distressed borrowers, some 400,000 of whom could benefit from the Democrats’ refinancing plan. The programme could also flop; lenders must agree to hefty write-downs in order to take advantage of the deal, and it is unclear how many will agree to that. But that could be even worse for conservatives: should the refinancing programme fail or another financial institution collapse, some Republicans worry, the Democrats will have a pretext to push for more aggressive—and more expensive—intervention in the housing market.

A newly riled right might not be able to stop the Democrats. Still, another fight would inflame a broader debate, dormant until recently on Capitol Hill, about just how much the government ought to meddle with this struggling economy