Paulson to Fannie and Freddie Investors: Drop Dead

Is that a bazooka in your pocket, or are you just happy to see me?

In July, Treasury Secretary Hank Paulson told the Senate Banking Committee: "If you have a bazooka in your pocket and people know it, you probably won't have to use it." Alas, it now appears that Paulson was shooting blanks at the time; all the same, no one seems happy to see him, either.

The Treasury Department is readying a "rescue" of Fannie Mae (NYSE: FNM  ) and Freddie Mac (NYSE: FRE  ) , which will be ushered into a "conservatorship" under the auspices of the Federal Housing Finance Agency. That means you and I will pay tens of billions of dollars to bail out mortgages that went south.

This is the year that government is expanding its powers and control over vast swaths of the economy. It began in March, when Paulson teamed up with Fed Chairman Ben Bernanke to engineer the bailout of Bear Stearns to JPMorgan Chase (NYSE: JPM  ) . Paulson was also instrumental in pushing the failure that was the so-called economic stimulus package. He followed that up with a proposal to vastly expand the power of the Federal Reserve to the entire financial industry. He tried jawboning the credit markets into believing all was well (hey, wearing buttons proclaiming "Whip Inflation Now" worked so well in the '70s) and now he's brokering the dismantling of the two mortgage backers, bringing them under the defined aegis of the federal government.

The sweeping nature of the powers Paulson is aggregating to the government would be awe-inspiring, if it wasn't so frightening.

Fannie and Freddie own or guarantee some $5 trillion in mortgages, not all of which -- or even most of which -- will fail. Of course that's little salve for those of us who are responsible with our finances and didn't take on mortgages we couldn't afford. Moreover, we are now explicitly backing the mortgage for that neighbor with the McMansion on the hill. Hey, just because you're financially prudent doesn't mean Hank, Ben, and your local congressman think you shouldn't have to open your wallet.

What would happen if Wells Fargo (NYSE: WFC  ) , Bank of America (NYSE: BAC  ) , or Citigroup (NYSE: C  ) couldn't depend on ol' dependable Fannie to back the mortgages they issue? They would have to raise interest rates, tighten credit standards, and actually demand that the homebuyers risk some capital in the purchase, too, through bigger down payments. Gosh, you mean what they should have been doing five years ago?

That means no more "liar loans," no nothing-down financing schemes, and a moratorium on submarket interest rate mortgages with gigunda balloon payments a few years down the road.

That's starting to happen in the marketplace, and the years of excess are correcting, bringing housing prices back down from the stratosphere. But instead of cheering the return to normalcy, Hank, Ben, and their ilk seem to be panicking.

It calls into question just why Paulson sees the need to expand the government's purview over Fannie and Freddie now. Their stocks had been rebounding of late as they came close to instilling investor confidence in their ability to forestall an intervention.  

Yet like horseshoes and hand grenades, close is good enough when firing a bazooka. And Henry Paulson will be blasting investors to smithereens.

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Fool contributor Rich Duprey does not have a financial position in any of the stocks mentioned in this article. You can see his holdings here. The Motley Fool has a disclosure policy.


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