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Bailout: Why, why now and what next?

Treasury Secretary Henry Paulson during the news conference announcing a federal takeover of Fannie Mae and Freddie Mac.

TEXT OF STORY

Bob Moon: It's official: The giant mortgage underwriters Fannie Mae and Freddie Mac are being taken over by the government. The move could potentially cost taxpayers $200 billion, but it could also help reverse the housing and credit crisis. Treasury Secretary Henry Paulson says the cost of allowing the companies to fail could take an even higher told on our wallets.

On the line to help us understand this move is Thomas Stanton, who teaches about Fannie and Freddie at Johns Hopkins University. Thanks for joining us.

Thomas Stanton: Sure, glad to be here.

Moon: Why did the government have to take this action and why now?

Stanton: The government had to step in because Fannie and Freddie were undercapitalized and were under immense stress. And what we've learned from past bank and savings and loan failures is that when management comes under that kind of pressure they may feel the need to do something imprudent, take a big risk to try to recoup their losses.

Moon: Has the government maneuvered correctly here? This seems to be a pretty delicate dance.

Stanton: I think the government has done an excellent job. Secretary Paulson has essentially stepped in and figured out a way to reassure both the financial markets -- and particularly foreign investors in Fannie and Freddie's debt obligations, mortgage-backed securities -- and also assure that Fannie and Freddie continue to provide and be a conduit for federal support. There's a second step to this process. The business model of this half-public, half-private government sponsored enterprise has failed us and failed us pretty badly. The Treasury's power to do what they're doing go away Dec. 31, 2009. Secretary Paulson basically tossed the problem back to Congress and said, "Congress, you have got to decide where we're going with these two huge multi-trillion dollar institutions."

Moon: So, there's this question hanging out there, what happens now? Let me run past you something Secretary Paulson said.

Tape of Secy. Henry Paulson: It would not have been in the best interest to the taxpayers for the Treasury simply to make an equity investment sin these enterprises in their current form.

Moon: And he went on to say there's a consensus cannot continue in their current form. Doesn't that kind of insure that share prices aren't going to do well now, because investors have to keep wondering and worrying about the future of these two firms.

Stanton: Investors in Fannie Mae and Freddie Mac really enjoyed the benefits of immense leverage that these companies had. In 2002, and this is an extreme example, Freddie Mac recorded a return on equity of 47 percent. Leverage was great when things were good and now investors have gotten hurt by the leverage when things are bad. It just moves in reverse. Shareholders are in a little bit of trouble here and that's because they invested in thinly capitalized companies that took on a huge amount of risk.

Moon: Thomas Stanton of Johns Hopkins University, thank you for joining us.

Stanton: Thank you.

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I agree that the government is doing the righ thing. The power that the two GSEs held over congress was non partisan -- both sides caved constantly to the lobbying. Now I am wondering if there is a case for merging the two and benefitting by shrinking the headquartes staff. Freddie was created in the late 70s (right around the time of the S&L debacle) mainly to provide another source of liquidity to the market. Over the years, they acted as duopoly, even to the extent of "fixing" market share.

Why have two problems rather than one?

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