Are Fannie Mae (FNM) and Freddie Mac (FRE) really too big to fail? That's certainly a widely held assumption across much of the political spectrum. But while it's clear that Fannie and Freddie can't be allowed to go under abruptly, a good case could be made that the two mortgage financing giants headquartered in Washington's Beltway are part of the problem in housing (BusinessWeek, 6/26/08) rather than part of the solution. If that's so, then this might be an opportune moment to let them begin slowly to wither away, argues Peter Coy in this interesting article in BusinessWeek.The trouble with the guarantees that Fannie and Freddie make on mortgages is that in good times, they're superfluous—it's easy to get a mortgage even without that guarantee—while in the bad times, such as now, it becomes clear that the guarantees are only as good as the U.S. government's credit. Now that money is tight, Administration officials are quietly discussing how to stage a possible bailout if matters get worse. It's a classic example of privatized gains and socialized losses. That's why this might be the right time to let the two wither away.
The Indian context
The recent mortgage crisis in USA have also lead to difficulties abroad. The travails of Northern Rock and its bailout had lessons for Indian banks as also regulator. Takeover of small banks which have successfully ruined themselves by bigger banking entities, mainly on the dictats of RBI, is nothing new in India. The periodical criss that afflicts the Indian banking system (especially small banks / co-operative banks) can be mainly attributed to mis-management/dubious deals, poor appraisal skills, lax regulatory environment, as also shoddy work done by auditors who are supposed to be the watchdogs and who have generally failed to blow the whistle. The rise and fall of Global Trust Bank, the Nedungadi saga etc are examples from the recent past. While RBI has been generally quick in ordering compulsory merger with bigger entities (mainly to protect depositors), it has still not yet been tested on a bigger scale with failure of bigger bank(s). May be, bigger entities don't fail, because of the oft repeated argument that they are too big to fail! That's why banks like Indian Bank (and many other similar banks) were repeatedly capitalised by the Government. Somehow there is this feeling that RBI (or Government) would come to their rescue and hence no bank in India will fail. The power of Employee Union (controlled by communists) and their voting power (during elections) gives a false sense of security to the irresponsible management(s) to continue to mis-manage. I keep wondering whether would it be a good idea to allow a few institutions to sink. That would encourage a more responsible approach to lending by other surviving institutions. But, can that happen in a democracy like India?
That leads us back to the BusinessWeek's article mentioned above wherein it quotes Presidential candidate John McCain as voicing the conventional wisdom that Fannie Mae and Freddie Mac are really too big to fail by saying "They must not fail." Democrat Charles Schumer, the New York senator, also agreed, saying: "Markets should be assured that the federal government will stand by Fannie Mae and Freddie Mac." If this happens in the USA, what do we say about forced mergers that happen in India due to RBI's dictat?
The Fed bailout of Bear Stearns, forced NYTimes to ask - "WHAT are the consequences of a world in which regulators rescue even the financial institutions whose recklessness and greed helped create the titanic credit mess we are in? Will the consequences be an even weaker currency, rampant inflation, a continuation of the slow bleed that we have witnessed at banks and brokerage firms for the past year? Or all of the above? Stick around, because we’ll soon find out. And it’s not going to be pretty."
Stick around, says NYTimes. Let's wait and watch. Who knows, we may soon find out the consequences.