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Former Fed Poole:Govt Plan A Nationalization Of Fannie, Freddie

Last update: 7/14/2008 2:04:58 PM

     By Michael S. Derby     Of DOW JONES NEWSWIRES   

NEW YORK (Dow Jones)--The federal government's plan to rescue housing finance firms Fannie Mae (FNM) and Freddie Mac (FRE) amounts to a nationalization of those troubled firms, a former Federal Reserve official said Monday.

In an interview with Dow Jones Newswires, William Poole, who led the St. Louis Fed until this spring, said the government's move over the weekend to support the firms was "absolutely necessary," given that their collapse would be catastrophic for the broader financial system. The government's actions mean Fannie Mae and Freddie Mac are "in de facto receivership," Poole said.

But at the same time, the government's steps also mean debt issued by these two quasi-government agencies effectively ranks equal with U.S. Treasurys.

"De facto, the obligations of Fannie Mae and Freddie Mac are now full faith and credit obligations of the U.S. government" because the two firms "are not going to be allowed to fail," Poole said.

The Treasury's plan means that for all practical purposes, Fannie Mae and Freddie Mac "are being nationalized," if only on a temporary basis.

Following a week of turmoil and plummeting stock prices, the Treasury Department late Sunday said it would seek from Congress the authority to buy equity in the firms as needed, along with approval to increase the line of credit the firms have with the government. The Federal Reserve joined the effort and said it would allow the two firms to borrow directly from the central bank if necessary, at discount window terms.

The show of support appears to have worked, at least temporarily, given the successful auction of short-term debt by Freddie Mac Monday morning.

Both companies continue to insist that they hold adequate capital reserves and maintain access to capital markets in general. Their stock see-sawed sharply Monday as investors first welcomed the government's rescue plan before renewed concerns sent the shares lower again.

Fannie Mae and Freddie Mac are firms set up by the government to ensure the smooth functioning of the mortgage market, and they have been ensnared by the troubled conditions seen in the housing sector. Last week, the firms saw their share prices fall sharply amid broad concerns over their capital cushion.

The two firms have long been controversial for having an implicit government support for their activities, and that perception has allowed them to borrow at lower rates.

Poole, now a scholar with the Cato Institute, has long criticized Fannie Mae and Freddie Mac, over what he sees as a series of short-comings. In the interview, he stressed his views are those of an observer, and are informed by the expertise he gained at the St. Louis Fed.

Poole also said that the Fannie and Freddie intervention, coming on the back of Fed efforts to save foundering investment bank Bear Stearns last March, has seriously compromised Wall Street's ability to assess risk.

The nation is now in "a very bad situation" in terms of moral hazard concerns, Poole said. Creditors "know that they will be protected in the event of any adverse circumstances," he added.

It's now clear some companies have been deemed too big to fail, although there's little clarity what the threshold is for government intervention. Poole warned that with the government saving both agency lenders and investment banks, the impulse to intervene "could spread to systemically important non-financial firms" like large airlines or car companies.