It's Bailout Time


The L.A. Times reports:

The Bush administration said it would ask Congress to authorize the Treasury Department to lend Fannie and Freddie more money than current limits permit and buy stock in the two companies.

Also Sunday, the Federal Reserve agreed to permit the companies to borrow directly from the central bank, as investment firms were allowed to do after the near-collapse of Bear Stearns Cos. in March. The money would tide Fannie and Freddie over while the administration and Congress rush the emergency measures through….

The plan is certain to be highly controversial, with critics saying it bails out shareholders of companies that took excessive risks during the housing boom in recent years.

Critics of government intervention say such rescues encourage irresponsible investing—thus bringing about financial-market bubbles—because investors believe the government will bail them out at taxpayer expense.

Well, yes. Meanwhile, Karen De Coster makes a pertinent point:

In listening to the constant chatter about the Fannie-Freddie crisis, one thing struck me as funny—Bloomberg analysts appeared to be perplexed that both companies are ranked Aaa by the credit-rating oligopoly, yet derivatives traders were trading both at levels that implied a credit rating at least five levels lower.

Credit ratings by the government-granted oligopolists are not the market; trading actions based on actual knowledge and/or informed interpretations of known events are the market. The act of trading credit-default swaps (tied to debt sold by Fannie and Freddie) does not hinge on implied promises on the part of the government. Sure, implied government backing has caused the security prices to be skewed for Fannie and Freddie. But what's happening here is that the market participants, in spite of an implicit government guarantee, are coming to their senses and realizing the insolvency…of both Fannie and Freddie.