Wednesday, September 3, 2008

Should Fannie Mae And Freddie Mac Merge?

New York Times columnist Andrew Ross Sorkin proposed that Fannie Mae and Freddie Mac should merge in an article titled, "And They Could Call it Frannie." He stated that by merging, the new company could save billions each year on overhead, among other advantages. The article started by saying this is a “bold” idea, and I would certainly agree with that statement. I for one am certainly not a proponent of a Fannie and Freddie merger, but let’s take a little closer look at Sorkin’s arguments.

Sorkin estimated that “Frannie,” as he calls it, could save around $1.2 billion annually on overhead costs. That savings, in turn, would add about $18 to $19 billion in market cap to the new company overnight. The next savings opportunity comes with foreclosure servicing, where Sorkin estimated that the company could save an additional $300 million annually thanks to economies of scale. Of course, as Sorkin pointed out, one of the results of a merger would be the loss of hundreds--if not thousands--of jobs, but he also claimed that these job cuts are coming one way or another, as Fannie and Freddie look to cut expenses. The biggest benefit, in Sorkin’s mind, is that this merger would lower the likelihood of a government bailout and would cost taxpayers nothing.

Now here is the problem with Sorkin’s plan as I see it: Current circumstances have already shown us that these companies are too big and too powerful. The government has no choice but to back their debt; if they don’t, they know that the mortgage market will collapse, taking the real estate market and economy with it. Fannie and Freddie have repeatedly demonstrated that they operate knowing this government guarantee is there, which leads them to take excessive risks. In addition, both companies have suffered from leadership issues over the years. By combining these companies into one giant company, some risks would be increased. If the two companies individually already had too much power, how much power will they as a merged company have? How much increased leverage will this mega company have over the government of our country? The leader of this new company would instantly become one of the most powerful people in America. What happens if this leader turns out to be bad? If this company failed, it would most likely be a death blow to the economy and would pose a serious threat to our political stability.

We don’t need one mega company; instead we need to split these companies up. Just as it is good to diversify investments in order to spread risks, we need to think in the same way about these companies. We need to make it so that if any one of the companies fails, it doesn’t have as much impact on the country as a whole. We need to spread out our risk. Sure, this plan would likely lead to increased mortgage rates, as the smaller companies would lose the government guarantee, leading investors to demand somewhat of a premium on the debt, but the government shouldn’t be guaranteeing this debt anyway. In the short term this plan would require some adjustments, but considering the long term, it is the best solution.

1 comment:

Anonymous said...

You know, there's nothing stopping other people from buying up and securitizing mortgages, which is what the GSEs do. There's no need to "break them up" to allow competition. In fact, during the housing boom, the GSEs lost a lot of market share to other, smaller players who were willing to buy more marginal and exotic mortgages than the GSEs would buy. What's limiting competition right now is just that the market for mortgage securities dried up, not that the GSEs forced anyone out, or that anyone passed a law forcing them out. It's just business. Sometimes business is good, and sometimes it's bad. That's not really something you can - or should - try to "fix".