Fannie, Freddie and moral hazard

Fannie Mae (FNM) and Freddie Mac (FRE) ended an eventful week on a low note Friday. William Poole, president of the Federal Reserve Bank of St. Louis, warned in a speech to the U.S. Monetary Policy Forum in New York that the government-sponsored mortgage lenders could be the source of “substantial problems” should house prices continue to decline sharply this year.
 
Poole, a longtime critic of Fannie and Freddie, said there are two ways the government can discourage financial actors from taking excessive risks: by not bailing out firms that fail and by forcing firms to maintain adequate capital. Poole said that while U.S. banks have generally been well capitalized and therefore able to absorb the losses tied to the debt market problems of the past year, “I am more skeptical of the financial strength of the GSEs.” The comment comes days after Fannie and Freddie, which bear much lighter capital requirements than do banks, reported a combined fourth-quarter loss of $6.1 billion.
 
Poole continues that if Fannie and Freddie end up shouldering outsize losses that deplete their capital, the blame would lie with the implicit government guarantee of the companies’ obligations.

“I do not have any information on the GSEs that the market does not also have,” Poole says. “Nevertheless, in assessing the risk of further credit disruptions this year, I would put the GSEs at the top of my list of sources of potentially serious problems. If those problems were realized, they would be a direct result of moral hazard inherent in the current structure of the GSEs.” (Hat tip: Abraham Pumblechook.)