Can the feds clean up the mortgage mess they created?

I'm normally pretty much the last person to even grudgingly give a nod to anything that stinks of the outright theft that is nationalization, but when the U.S. Treasury Department grabbed Fannie Mae and Freddie Mac, I think it was doing little more than cleaning up a mess of the government's own making -- if it actually cleans anything up, that is.

Fannie Mae and Freddie Mac were always tools of public policy -- they were created to encourage mortgage lending to an extent that was otherwise beyond the comfort zone of banks that were too hobbled by red tape to be creative about funding home purchases. As Thomas Firey writes at Cato-at-Liberty:

Before Fannie Mae — the first of the twins — was created amidst the “Recession within the Depression” in 1938, home mortgage lending was highly risky for banks. State regulation kept banks small and geographically limited in order to make them better targets for taxation and political manipulation. As a result, banks could not geographically diversify their loan risk, leaving them highly vulnerable to localized economic downturns. Because they lent money (as mortgages and business loans to farms and other firms) to local borrowers for long periods of time but they had to honor local depositors’ withdrawal requests, banks were often one bad harvest and one bank run away from insolvency. For that reason, they shied away from financing long-term home loans.

The 1968 privatization of Fannie Mae -- and the later creation of Freddie Mac -- was a dodge to improve the federal government's balance sheet. The "private" entities had tax-free status, could draw on the U.S. Treasury to the tune of billions of dollars and clearly had a cozy relationship with the government. Creatures of public policy with access to taxpayer money, they enjoyed a minimum of oversight.

And they put a lot of effort into keeping things that way. The Wall Street Journal has an excellent timeline on the whole fiasco, and editorialized in July about the agencies' overt favor-buying:

Congress sets the rules in favor of Fan and Fred, which then repay the Members with cash from their rigged profit stream. This is the government lobbying itself for more government.

And, oh, what a stream of political cash it is. First, there are Fannie and Freddie's political action committees, which have already distributed roughly $800,000 to U.S. House and Senate Members this election cycle. Nearly half of the Senators have received funds and almost all of the money is directed to incumbents. Fannie gave $10,000 to Speaker Nancy Pelosi, $10,000 to third-ranking House Democrat Rahm Emanuel, $5,000 to Barney Frank, $10,000 to Republican House whip Roy Blunt, $8,500 to Majority Leader Steny Hoyer and $7,500 to Minority Leader John Boehner and . . . you get the picture.

That Federal Housing Finance Agency Director James B. Lockhart's official statement (PDF) explicitly says, "all political activities -- including all lobbying -- will be halted immediately," is a belated acknowledgment of how effective Fannie Mae and Freddie Mac have been at gaming the system.

But remember. The government created this situation to begin with. Can it be trusted to clean up the mess?

Matt Kibbe of FreedomWorks points out:

"In the Administration, Director James Lockhart repeatedly claimed that Fannie and Freddie were 'adequately capitalized' and even reduced their capital requirements earlier this year. It's a strange world indeed when the regulator who failed in his mission is now given expanded duties."

"With this plan, the U.S. government is borrowing more money from foreign creditors, in order to buy equity and mortgage-backed securities in a convoluted way in an attempt to guarantee Fannie and Freddie bonds. This is not a sustainable or rational economic policy."

What is sustainable?

How about dumping the whole rotten system and leaving banks free to make loans or not make loans based on their economic viability -- not the willingness of a quasi-public entity to shoulder the risk?

At the Cato Institute, Alan Reynolds suggests:

Potentially massive loans from the Treasury and Fed are no solution to their already excessive debt—the last thing they need is more. These two politically privileged companies pose a "systemic risk" to the economy precisely because they became much too big in the past two decades. Any serious solution must begin by requiring Fannie and Freddie to do what other troubled firms are routinely required to do—sell assets, raise capital, and reduce debt.

Fannie Mae and Freddie Mac need to be downsized and de-leveraged, relieved of special privileges and loan guarantees, and broken into small pieces agile enough to sink or swim on their own, without taxpayer support.

Breaking up Fannie Mae and Freddie Mac is probably a better bet than counting on the folks who created this situation to begin with to clean up after themselves.