What If Fannie and Freddie Go Bankrupt?

The Baltimore Sun reports:

In a recent Securities and Exchange Commission filing, Fannie noted that it backs $2.6 trillion worth of single-family home loans. Underneath this pile of debt, the company has only $42 billion of capital. If the value of mortgages backing Fannie's debt falls a few percentage points, the company's capital could be wiped out. And because of the implicit government guarantee backing Fannie's debt, American taxpayers would be on the hook for whatever debt Fannie couldn't cover.

To be sure, most mortgages that Fannie backs are safe. But consider Fannie's exposure to high-risk loans: about $300 billion of stated-income "liar loans," $200 billion of interest-only mortgages, $120 billion of subprime mortgages and $330 billion of high loan-to-value mortgages.

Some of these high-risk loans fall into multiple categories and shouldn't be double-counted, but you get the picture: Fannie has significant exposure to high-risk loans and only a small capital cushion to protect itself.

Freddie Mac has a few hundred billion dollars of high-risk loans in its $2.1 trillion book of mortgages. And Freddie's capital cushion is a meager $40 billion.

Each has reported billions in losses, and they will report billions more as foreclosures accelerate across the country. What happens if their problem loans fall so far in value that their capital is wiped out? There's only one bank large enough to take over Fannie's and Freddie's debts: the U.S. Treasury. Taxpayers.

Yet despite the substantial risk facing Fannie and Freddie, many in Washington want the two companies to back more and bigger mortgages in a shortsighted attempt to blunt the impact of the housing crash.

In 2005, Mr. Paul introduced an amendment in Congress to end the implicit taxpayer guarantee backing Fannie's and Freddie's debt. He said at the time: "I hope my colleagues join me in protecting taxpayers from having to bail out Fannie Mae and Freddie Mac when the housing bubble bursts."

Sickening.