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September 8, 2008
The historic Fed-backed bailout of Bear Stearns occurred on March 17, 2008.  The historic U.S. government seizure of Fannie Mae and Freddie Mac occurred on Sunday September 7, 2008. Remember these dates as they will likely be in a trivia game one day.  A question that will not be included in the trivia game is how much the Dow rallied by shortly after each bailout was made…

Paulson’s Exit Strategy

Akin to a lender making an indebted gambler whole and then fretting about lending the gambler more money, Treasury Secretary Paulson was worried about the unknown costs and uncertainties associated with bailing out Freddie and Fannie.  As the New York Times highlighted, these worries had been festering since Paulson was handed the authority to bail in July:

Mr. Paulson started telling friends that after winning authority to intervene, he “felt like a dog who’d caught the bus and didn’t know what to do with it.”

An even more specific highlight of these worries was expressed in Paulson’s statement on Sunday.

“To promote stability in the secondary mortgage market and lower the cost of funding, the GSEs will modestly increase their MBS portfolios through the end of 2009. Then, to address systemic risk, in 2010 their portfolios will begin to be gradually reduced at the rate of 10 percent per year, largely through natural run off, eventually stabilizing at a lower, less risky size.”

With the U.S. housing market still dealing with waves of foreclosures, falling home prices, and ominous inventory levels, the last thing any competent loan officer would want to do is try to stabilize this situation by lowering their lending rates and/or by buying more mortgages. With control of Fannie/Freddie and the Treasury now directly intervening in the MBS market, this is effectively what the U.S. government is doing.  And, by Paulson’s admission, they want to take the prudent step of doing less of this starting in 2010.

As if yesterday’s announcement were not proof enough that the GSEs are backed by the U.S.A., Paulson again suggested that the government needs to be clear about its intentions with regards to GSEs. Although a little lengthy, the following paragraph is worth posting in full.

The new Congress and the next Administration must decide what role government in general, and these entities in particular, should play in the housing market. There is a consensus today that these enterprises pose a systemic risk and they cannot continue in their current form. Government support needs to be either explicit or non-existent, and structured to resolve the conflict between public and private purposes. And policymakers must address the issue of systemic risk. I recognize that there are strong differences of opinion over the role of government in supporting housing, but under any course policymakers choose, there are ways to structure these entities in order to address market stability in the transition and limit systemic risk and conflict of purposes for the long-term. We will make a grave error if we don't use this time out to permanently address the structural issues presented by the GSEs.”

Rather than clearly divulge the ways (plural) he believes the GSE-story can have a happy ending, Paulson leaves us wanting more.  Personally, I can not wait until Paulson updates and expands his GSE roadmap, and he explicitly comments on what he thinks must happen after his ‘time out’ declaration ends.

But alas, remember that even during his intense 18-hour/day deliberations to save the GSEs last month
Paulson found the time to remind us, “I look forward to doing other things next year”.  In other words, with Paulson to step down in January 2009 the GSE mess will be left on someone else’s desk.  Thankfully, Paulson has left a post-it note reading, ‘try to do something about the size of the GSEs starting in 2010.’

In short, Paulson has worked diligently to keep gamblers whole during his tenure because he had absolutely no idea how else to tackle the threat of systemic risk. If the U.S. housing market is a more stable creature come 2010 perhaps someone else will be able to fashion an idea...


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