This post is part 2 of 2. Click here for part 1.
Q. Why is the Federal takeover of Fannie Mae and Freddie Mac relevant to Farm Credit?
A. Fannie Mae, Freddie Mac and Farm Credit are all Government Sponsored Enterprises or GSEs. There is one other major GSE, the Federal Home Loan Banks. GSEs are created by Congress to facilitate the flow of credit into specific sectors of the economy. Farm Credit serves agriculture. The other three major GSEs serve the housing sector.
Most corporations are issued state charters, but GSEs are issued Federal charters. Because of the Federal charter, investors assume that GSE debt is safer than corporate debt. GSEs can therefore borrow money more easily and more cheaply than corporations. Congress intends that this will translate into more and cheaper credit for borrowers—homeowners and farmers.
Farm Credit is the oldest GSE, but it is far smaller than the three housing GSEs. At 12/31/07, total assets were $1.2 trillion for the Federal Home Loan Banks, $900 billion for Fannie Mae, $800 billion for Freddie Mac, and $200 billion for Farm Credit. (Yankee Farm Credit had total assets of $300 million.)
Q. Why do investors assume that the Federal charter makes GSE debt safer than corporate debt? After all, when Congress creates a GSE, it explicitly states that the U.S. government is not guaranteeing the debt of the GSE.
A. No one believes Congress. Indeed, Congress bailed out Farm Credit in the 1980s (see this earlier post), and now there has been a bailout of Fannie and Freddie.
Q. What are the possible implications for Farm Credit?
A. The primary source of funds for all GSEs is debt. All of the GSEs borrow money from the same types of investors. Those investors know that the GSEs share certain characteristics. Our cost of money has been higher than normal since around the end of April, due to the bad news surrounding Fannie and Freddie. It remains to be seen if yesterday's action will help our funding costs, or further hurt them.
Yesterday's actions may also have political implications. In his press release yesterday, Treasury Secretary Henry Paulson said: "I attribute the need for today's action primarily to the inherent conflict and flawed business model embedded in the GSE structure..."
All GSEs are subject to Congressional oversight and Federal regulation. Farm Credit is regulated by the Farm Credit Administration while the housing GSEs are regulated by the Federal Housing Finance Agency. In Congress, oversight of Farm Credit is delegated to the agriculture committees while oversight of the housing GSEs is delegated to the banking committees. So there is a degree of political separation between Farm Credit and the housing GSEs, but it is something to watch.
Q. Was this a surprise?
A. Some observers have been concerned about Fannie and Freddie for years. I have a thick file of newspaper articles about Fannie and Freddie that I started in 2000. For a time it looked like Congress might do something to reduce the risk of the housing GSEs. But in recent years it became clear that Congress would do nothing until there was a crisis. The crisis has now come.
UPDATE 10/05/08: Interesting New York Times article about what went wrong with Fannie: "Pressured to Take More Risk, Fannie Reached Tipping Point." The pressure came from all sides: banks, investors and Congress.
