Anatomy of a bailout.

• Author: Weidenbaum, Murray
• Position: Mortgage banks - National Affairs

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"There is no substitute for integrity, good judgment, and a true sense of responsibility on the part of financial decisionmakers at every level, in both the public and private sectors."

ARE FEDERAL government loans and loan guarantees a "free lunch," or do they really cost the taxpayer? After all, no Federal money seems to be involved. For example, the Export-Import Bank of the United States guarantees loans to a airlines to buy Boeing jets. Initially, that o the X-M Bank, but that is just the beginning. Many of those foreign companies compete against U.S. airlines on international mutes. Yet, no loans or guarantees by the Federal agency go to American airlines.

Although many government lending programs are much more complicated than that, extending Federal credit appears to be a low-cost option compared to other ways of helping different interest groups. Little cash from the U.S. Treasury seems to be involved. In any event, most credit subsidies go to the housing industry--directly or indirectly.

Fannie Mae became the major source of housing finance (together with Freddie Mac, a sister government-sponsored enterprise). Fannie Mae is an interesting hybrid. Originally, it was just a government agency--but how it did change! It became a private company listed on the New York Stock Exchange with special benefits from the Federal government. Fannie bought home mortgages from banks and other companies. It needed lots of capital and credit to do that. Implicit Federal guarantee of its bonds was a big advantage, keeping the interest rates it paid lower than its competitors paid. Investors believed that the Federal government would bail them out if things went wrong (they did and it did).

Fannie's lower interest costs help to explain why it dominated the market for housing finance, but the Federal help came with strings attached. The Federal government also pushed Fannie to buy subprime (very risky) mortgages. The reason looked to be high-minded: to help low-income individuals become homeowners, even if they could not afford the houses they were purchasing.

Let us trace the way government credit programs operate. To begin with, most of them do not appear in the Federal budget, are conducted by off-budget agencies. That is why Congress encouraged them. Many do not involve any direct government expenditures at all--until they crash, like Fannie Mae, which now is, along with Freddie Mac, in Federal conservatorship. Thus, these special credit programs escaped close congressional and public review--until they went belly up. On the surface, the government merely was guaranteeing private borrowing (like the X-M Bank), leading the public to believe the Feds will guarantee its credit in an emergency (as happened to Fannie and Freddie).

What are the benefits to private borrowers? They usually pay lower interest rates than are offered in the...