The Fannie-Freddie government guarantee ceases to be implicit

The Federal Reserve announced Sunday that Fannie Mae and Freddie Mac can borrow money from it if they need to. Then the Treasury Department said it's going to ask Congress for permission both to increase its credit line to the two giant mortgage lenders and to buy stock in them if necessary to shore up their capital base.

You could call it the nationalization of our mortgage lending system, with the caveat that it already was effectively nationalized: Fannie and Freddie were both created by Congress and long enjoyed the assumption among investors that the U.S. government would spring in if they ever ran into trouble--even though all the debt securities they issued came with the warning that they were "not guaranteed by the United States." Maybe from now on they'll say something like "not guaranteed by the United States, unless they really need to be."

With Bear Stearns, the Fed's decision to jump in and avoid an unruly collapse was something of a judgment call. One can argue that it's possible things would have turned out okay if Bear had simply been allowed to fail. With Fannie and Freddie there's really no such argument. At the moment they are the U.S. mortgage market. Reports the WSJ:

Some officials at the White House are believed to have preferred a tough-love approach. Under one option, according to people familiar with the outlines of policy discussions within the administration, the White House could try to install a new slate of presidentially appointed board members at the companies. The idea would be to impose more market discipline on the two companies, to curb their appetites for borrowing and investing, and to gradually shrink their enormous balance sheets.

In the past, that's proved hard for the government to do, because of the companies' relatively weak regulator and their perceived financial backing from the federal government, which allows them to borrow easily, at low cost. But as the housing market has worsened in recent months, Congress and the administration have come to depend even more on Fannie and Freddie. Reducing the two companies' ability to fund mortgages could hurt the housing market further, and delay recovery.

It's a quandary. Taxpayers are now on the line for a scary amount of mortgage debt (Fannie and Freddie together own or guarantee $5.5 trillion in loans). But as I wrote Friday, you really can't blame Fannie and Freddie for the housing bubble and bust--the subprime lending boom that created the mess was mostly funded by Wall Street firms and private investors. And keeping the two lenders not just alive but aggressively buying new mortgages seems essential to keeping the housing downturn from accelerating into an all-out collapse.