Fannie Mae, Freddie Mac, and the Fed

| Thu Jul. 17, 2008 5:53 PM EDT

How comforted should we feel by Federal Reserve chairman Ben Bernanke's pronouncement that the country's largest mortgage-finance companies are in "no danger of failing"? Or this week's rebound in Freddie Mac and Fannie Mae shares?

Not as comforted as Congress now appears to be. No, we don't have 25 percent unemployment, or the bread lines of the early 1930s, but anyone who lives in Indymac's hometown of Pasadena, California knows we're seeing bank runs. And while it's all well and good for the SEC to restrict the short selling of Fannie, Freddie and primary bond dealers, when whole countries are dumping US stocks and bonds, something more drastic is required.

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The bottom line is that Fannie and Freddie's problems didn't happen overnight. The rating agencies have had Fannie on credit watch since 2004. In mid 2003, Freddie announced it had misstated earnings by $5 billion in years past. All that, notwithstanding the fact that the volume of mortgages they backed shot through the roof between 2003 and 2005.

As government sponsored entities, the finance industry and its investors have loved Fannie and Freddie. They are the perfect mortgage guarantors: too important to fail, too big to monitor for rising risk and loss. That must change.

Maybe Fannie and Freddie should be nationalized, as was FDR's 1938 intent when he created Fannie to help American homeowners get back on their feet after the Great Depression. Or maybe loan re-negotiation should be made mandatory on the part of lenders, so they get some money back rather than risk further damage to the overall system with unnecessary foreclosures.

One clear need: Legislate total transparency and accountability for every mortgage loan extended, packaged and traded for all the parties who come into contact with them.

Above all, it's time for those who continue to blame the 'whiner' borrowers to understand that the extent of credit damage in the system is way beyond the unpaid mortgages of subprime loans. The entire lending, banking and trading community has borrowed itself into this corner, bringing the rest of the economy down with it. The fix has to be strong, regulatory, meaningful and lasting.

This is uncomfortable for everyone in Washington, but ignoring it will not make it go away. Meanwhile, addressing the short and medium term problem of keeping the bigger institutions afloat—or at the very least, people's deposits safe—will require new funding sources (especially if foreign central banks slow their footing of our debt.) Unfortunately, that will also mean higher taxes and cutting the war in Iraq. McCain and Obama should make that connection.

—Nomi Prins

Nomi Prins is a former managing director at Goldman Sachs and frequent contributor to Mother Jones.

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