Fed’s Poole: No Guarantee of Government Bailout if GSEs Fail

Continued lack of reform at both Fannie and Freddie has left the U.S. economy exposed, St. Louis Fed president Bill Poole said on Wedneday. Poole provided a tough-language address on Jan. 17 about the risks to financial stability posed by government-sponsored enterprises like Fannie Mae and Freddie Mac, and took a hard line against what he said was a lack of genuine progress in reining in the activities of the two largest GSEs. “The GSEs have grown much more slowly and they have been more reticent in public in recent quarters than they had been during the pre-2003 decade,” Poole said. “It appears that they want to pursue a low-key strategy while memories of their accounting and control failures gradually fade. “Their aim, apparently, is to return to the environment before heightened scrutiny arose in 2003.”

The Fed president offered sobering assessment of what might lie ahead after Fannie and Freddie have put their current accounting problems behind them, saying each would likely continue to grow due to the advantaged status the U.S. government’s implied guarantee gives them. “It is simply very profitable to be able to borrow at close to the Treasury rate and invest in mortgages while holding minimal capital. Banks maintain capital ratios double or more the ratios that Fannie and Freddie maintain,” Poole said. “Banks pay deposit insurance premiums to the Federal Deposit Insurance Corporation whereas Fannie and Freddie pay no insurance premiums. Assuming that the implied guarantee would, in a crisis, lead to a federal bailout, U.S. taxpayers bear the risk while the shareholders and managements of Fannie and Freddie enjoy the profits. This situation encourages these firms to grow vigorously.” While Poole’s remarks suggest he does not believe the GSEs will be privated in the near-term, he went so far as to make it clear there is no government guarantee to investors should either get into financial trouble. While he also stressed that such a failure was not imminent at this time, Poole said “for those who believe that a GSE crisis is unthinkable in the future, I suggest a course in economic history.” Poole called for a cap on GSE portfolio growth and an increase in minimal capital requirements for each; going further, the Fed president also called for the enactment of bankruptcy legislation that would protect the interests of investors and taxpayers in the event of failure at either GSE.

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