Market Bugle - by Mike Landfair

But in the financial markets everyone has always assumed that this demurral was just window-dressing, and everyone, it turns out, was right.

The G.S.E.s are curious, because there’s no obvious reason for them to exist in the form they do: instead of creating private companies to do all these jobs, the government could just do them itself. In fact, that’s how Fannie Mae got started, back in 1938: originally, it was a government agency endowed with the authority to buy mortgages, in the hope that this would expand the supply of credit to homeowners. It wasn’t until 1968 that Fannie was privatized. (Freddie Mac was created two years later, and was private from the start.) The main reason for the change was surprisingly mundane: accounting. At the time, Lyndon Johnson was concerned about the effect of the Vietnam War on the federal budget. Making Fannie Mae private moved its liabilities off the government’s books, even if, as the recent crisis made clear, the U.S. was still responsible for those debts. It was a bit like what Enron did thirty years later, when it used “special-purpose entities” to move liabilities off its balance sheet.

Had Fannie and Freddie been ordinary private companies, there would have been a natural check: companies with more debt are usually seen as riskier, and that makes shareholders and bondholders less willing to invest in them. Or, had Fannie and Freddie been government agencies, budget constraints would likely have limited the scope of their lending. Since neither the market nor the state checked their growth, they were able to swell extravagantly. (Regulators might have reined the companies in, but, thanks in part to ardent lobbying by Fannie and Freddie, Congress failed to provide them with sufficient power to do so.)