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We have a new post-crisis financial category: systemically important financial institutions, meaning anybody big enough and leveraged enough to possibly create “systemic risk” for everybody else. If you are a super-big and super-leveraged financial firm, the Financial Stability Oversight Council can designate you as a SIFI. But it has not so designated Fannie Mae and Freddie Mac.
To all impartial observers, this makes FSOC look incompetent.
If anybody at all is a SIFI, then Fannie and Freddie are SIFIs. If Fannie and Freddie are not SIFIs, then nobody is a SIFI.
Consider size. Fannie’s total assets are bigger than JPMorgan Chase and Bank of America, and Fannie and Freddie are each bigger than Citigroup, Wells Fargo, Goldman Sachs, Morgan Stanley, Prudential, and AIG, not to mention many others. Fannie’s $3.3 trillion in assets would make it the No. 1 SIFI of all, while Freddie’s $2 trillion would rank No. 4.
In addition to their massive size, Fannie and Freddie sport extreme leverage. Fannie is leveraged 341:1 and has a leverage capital ratio of a risible 0.29%. Similarly, Freddie has leverage of 153:1 and a leverage capital of an almost as risible 0.65%.
Leveraged real estate has a long and painful record of being at the center of many banking collapses and financial crises, as yet once again in 2007-09. Fannie and Freddie represent about 60% of the credit risk of the huge American housing finance market, making them by far the largest concentration of leveraged credit and house price risk in the world.
More than $5 trillion of the obligations of these hyper-leveraged institutions are widely held throughout the U.S. financial system and around the world by banks, central banks, other official bodies and many other investors. This includes over $1 trillion of Fannie and Freddie obligations bought by the Federal Reserve Banks.
Needless to say, with Fannie and Freddie’s insolvency in 2008, default on their obligations would have exacerbated the financial distress on a global basis, as it would in a future crisis. As then-Secretary of the Treasury Henry Paulson recounted in his memoir of the financial crisis, “From the moment the [Fannie and Freddie] problems hit the news, Treasury had been getting nervous calls from officials of foreign countries. Foreign investors held more than $1 trillion of the debt issued or guaranteed by the GSEs, with big shares held in Japan, China and Russia. To them, if we let Fannie and Freddie fail and their investments get wiped out, that would be no different from expropriation.”
In a revealing comment, Paulson added, “I was doing my best, in private meetings and dinners, to assure the Chinese that everything would be all right.”
In short, Fannie and Freddie are huge in size, huge in global systemic risk, close to zero in capital, and of fully demonstrated “too big to fail” status.
All this FSOC knows very well. But it won’t take the obvious action, which the facts demand. Why this lack of intellectual consistency? There is only one plausible theory: politics—although it is indeed unfortunate if a supposedly technocratic risk committee is governed by politics. It appears FSOC does not wish to publicly admit the truth that wards of the state, like Fannie and Freddie, majority-owned by the government itself, are giant sources of systemic risk.
If domestic politics stop FSOC from doing the right thing, how about its international counterpart, the Financial Stability Board in Basel? In addition to the American SIFIs already named, Fannie is bigger than the Global SIFIs HSBC, Credit Agricole, BNP Paribas, and Deutsche Bank; and Freddie is bigger than G-SIFIs Mizuho, Royal Bank of Scotland, Societe Generale and Sumitomo, among many others.
Why doesn’t the FSB designate Fannie and Freddie as G-SIFIs, which they indubitably are?
As a top British banking scholar patiently explained to me, it spite of the very clear merits of the case, it would not be diplomatically proper for the international body to overrule the FSOC.
So there you have it. A pretty sad performance by both.
Alex J. Pollock is a resident fellow at the American Enterprise Institute in Washington, DC.
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