Understanding th Dilemma of Fanie and Freddie

The past actions of Fannie Mae and Freddie Mac, combined with a weakened housing market, have presented Congress and the administration with a significant challenge. Failure to respond could lead to a financial crisis (known as “systemic risk”). On the other hand, bailing out Fannie and Freddie puts the taxpayer in the position of absorbing the losses of these for-profit firms in bad times, while the firms’ employees and shareholders reap the rewards during good times (known as “moral hazard”).

To address the dilemma, the administration has requested that Congress give the Treasury unlimited authority, through 2009, to provide financial assistance to Fannie and Freddie that is not subject to the debt limit. The Congressional Budget Office has estimated this will increase the budget deficit by $25 billion in 2009 and 2010.

This paper summarizes the intended role of Fannie Mae and Freddie Mac, the reasons for their current troubles, and the administration’s proposals for their rescue. The paper also suggests what the goals of any legislative remedy should be.

Read the ful report here.