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Nationalisation isn’t a policy usually associated with the US: So, the government takeover of mortgage giants Freddie Mac and Fannie Mae is a fairly momentous move. Discomforting though the concept of government acquiring private firms may be to economic liberals, it is the right decision in this particular case. The two firms together own or guarantee half of the US mortgage market estimated at $12 trillion. Any collapse of the firms would risk the whole financial system. Also, many foreign central banks, particularly in Asia (the People’s Bank of China among them) hold a vast amount of Freddie Mac and Fannie Mae bonds—-it is not in their interest to see the two firms collapse. The US housing market continues to be in a bad slump and there is little prospect of early recovery. Under the circumstances, the future of the two firms looked bleak—credit lines were drying up. The game is about confidence, and the two firms were reaching a point of an overwhelming no-confidence vote. The government takeover will infuse the necessary confidence to stabilise the firms and calm market worries.
Any fear that markets would respond to this de facto nationalisation with alarm are unfounded—markets in the US and elsewhere in the world have, in fact, already reacted positively to the news. The government now needs to revamp the management of these firms to effect a turnaround, and to ultimately justify the use of taxpayers money to bail out what are privately owned firms. In the medium-term, of course, two fundamental problems need to be addressed: first, the firms should not continue to exist as government sponsored entities as this led to excessive risk taking (because of moral hazard), which precipitated this crisis. Second, the firms need to be put back into private hands as soon as possible, but it would be better to break them down into many parts. Competition is the best way to keep delinquent firms in shape. Note that there are losers in this entire process—ordinary shareholders in the two firms are wiped out; employees will likely suffer through retrenchment; tax payers will take on huge risk. Ironically enough, the people most responsible for the problems, the two chief executives will walk away from their jobs with handsome severance packages—Daniel Mudd of Fannie Mae will receive $9.3 million and Richard Syron of Freddie Mac $14.1 million. Something for the government and regulators to perhaps think about.
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