More on Fannie Mae and Freddie Mac (updated x3)

Gerry O'Driscoll (former vice president and economic adviser at the Federal Reserve Bank of Dallas) warns against bailing out Fannie Mae and Freddie Mac in an article in the New York Post.

Commenting on Treasury Secretary Henry Paulson's bailout plan for the mortgage giants O'Driscoll writes

Absent from Paulson's plan is any protection for taxpayers. They'll fund the downside if losses mount at the two mortgage giants. But if Fannie and Freddie recover, stockholders and management gain. Call it "casino capitalism" - taxpayers bankrolling management high rollers.

The plan doesn't ask stockholders or management to suffer for their financial indiscretions. The players who put their companies in jeopardy get to stay in charge - Paulson says he isn't looking for "scapegoats." Someone should remind him that capitalism without failure is like religion without sin.

O'Driscoll explains there are now three possible outcomes:

* Congress passes the Treasury plan in its current form. That gives us the status quo on steroids - Fannie and Freddie continue to make risky bets and rack up more losses, with the taxpayer guarantee fueling the financial fiasco. This would be the worst outcome, but it's where we're headed.

* We could truly privatize the two companies: Remove the federal guarantee and force them to retrench and reform. Fannie and Freddie would have to raise private capital and downsize their bloated portfolios. They'd become just two ordinary-sized financial firms, whose balance sheets would be measured in billions, not trillions, of dollars. A long shot now, this would be the best outcome.

* Nationalize both companies and end all pretense that they're private. (Fannie was a government agency until 1968; Freddie was only chartered in 1970.) They could return to being federal guarantors and packagers of mortgages, and would hold no sizeable assets themselves. This last approach is called "honest socialism."

I can't help but think that O'Driscoll is right that the second option is the best, but also the least likely. O'Driscoll end his article by noting

The Treasury's provision of the government's full faith and credit guarantee to Fannie and Freddie has stabilized the situation. Rather than rush through a bad reform, Congress should get it right. Trillion-dollar businesses should never again be wards of the taxpayer.

I'm not sure any sized businesses should be wards of the taxpayer. That only lends to trouble, as we are seeing.

(HT: Cafe Hayek)

Update: A short Cato Daily Podcast featuring Gerald P. O'Driscoll Jr talking on "Shrink, Privatize Fannie Mae and Freddie Mac" is available here. A copy of the CNBC item referred to in the podcast is available here.

Update 2: Not PC recommends reading this article from the Wall Street Journal, The Fannie Mae Gang by Paul A. Gigot.

Update 3: Arnold Kling on The McCain-Stiglitz Axis.