What’s more, Sen. Bunning wants to see Fannieand Freddierestructured. Whether Paulson meant to or not, he left the impression that the government will backstop the two housing lenders without changing their business plans. The key issue right now is the portfolio/hedge-funds that both GSEs operate. Most of what Fannie and Freddie do is buy mortgages from local lenders or big banks, package them, and then resell them to institutional investors around the world. But oftentimes Fannie and Freddie buy the mortgages and put them in their own portfolios. This creates huge credit risk. And then they try to hedge their risk through various derivative contracts which create even more credit risk.
The stock market crash of Fannie and Freddie is directly related to their portfolio risk. Market sellers believe huge mortgage write-offs are coming, and that neither Fred nor Fan has enough real capital to safely take the earnings hit from the portfolio losses. What must be done here in return for government backing, at the very minimum, is to severely limit the GSE portfolios and over time force them to gradually sell off these portfolio holdings. Doing so would reduce taxpayer risk. It also would move Fan and Fred in the direction of future privatization.
Mr. Paulson didn’t talk about portfolio management changes, so I think Sen. Bunning is quite right in his criticisms. Notice that Fannie and Freddie stocks fell again yesterday after the Paulson hearing.
One more point: Sen. Bunning was highly critical of Ben Bernanke as the Fed head basically threw the dollar under the bus in yesterday’s hearing. Bernanke talked tough in June on dollar defense and inflation. But he was a dove yesterday. Today’s 5 percent CPI report as well as an increase in the core CPI illustrates Bernanke’s folly and Bunning’s wisdom.
The only good thing to come out of yesterday was President Bush’s drill, drill, drill message, which caused oil prices to fall sharply. But neither Paulson nor Bernanke hit the right notes in their testimonies. We should be giving Sen. Jim Bunning credit, not making fun of him. Taxpayer bailouts are very serious business. Some are even calling it Republican socialism. And a chronically weak dollar is merely feeding the problem rather than solving it.