Fannie Mae, Freddie Mac and the Peso Problem

A government bailout of the GSEs should not be a surprise.   After all, for a long time the markets have been predicting that sooner or later there will be a very expensive bailout.  What do I mean?  According to Freddie Mac (quoting the OMB)  "mortgage rates are 25 – 50 basis points lower because Fannie Mae and Freddie Mac exist in the form and size they do."  Now, that is almost certainly an exaggeration but to the extent that interest rates are lower due to the GSEs some significant part of that is due to the market valuing the government’s implicit guarantee.  In other words, interest rates are lower because the market is valuing the implied insurance.  Now, the whole point of insurance is that sometimes the insurer must pay.  Thus the market has been telling us all along that sooner or later the taxpayer was going to pay.

Maybe the taxpayers will have to pay today or maybe in some future tomorrow but the benefits of the GSEs are intimately tied to the costs – there is no such thing as a free lunch.  The lunch may look free for a long time – as in the classic peso problem – but what that means is that when the bill comes due it will be big. 


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