Bad Bank for GSEs Seen as a Bad Idea

By Steven Sloan




Support for carving up Fannie Mae and Freddie Mac into separate good and bad banks lasted less than 24 hours, with the Obama administration insisting this is not its plan and critics arguing the idea was complex and a tough political sell. White House Press Secretary Robert Gibbs flatly denied press reports that the administration was pursuing such a plan, calling it “light years ahead of any decision-making process here.” Another administration official, speaking on condition of anonymity, said the idea was one of many, including privatization or permanent nationalization, and that no solution had emerged as a front-runner. It quickly became clear that the only person advancing such a plan was Federal Housing Finance Agency Director James Lockhart, who confirmed Thursday that he is planning to resign this month. He argued that such a solution would help rid Fannie and Freddie of its worst holdings, which would continue to be held by the government, while letting the government-sponsored enterprises return to the mortgage market. “The point is how they exit conservatorship,” Lockhart said in an interview. The history of creating bad banks is also not encouraging. Regulators have struggled to develop a plan to remove bad assets from banks, and observers questioned how such holdings could be segregated at institutions that are far larger. “It’s not even easy in small or relatively easy cases,” said Karen Shaw Petrou, the managing director of Federal Financial Analytics Inc. “Those are very complicated to do because of the moral hazard. Whom do you bail out? How do you do that? Take that into the context of $5 trillion [in debt], and it gets a lot harder.” Lockhart would not say whether this was a preferable path, but Petrou added that liquidating their bad holdings would also achieve other goals. “It does what Treasury really wants,” she said. “That’s to liquidate the market. You force a seller into it. You start to set prices, and that gets the holdouts in the rest of the banking system to either recognize losses, write them down or sell them through PPIP and be done with it.”