Editorial: Stopgap solution for Fannie, Freddie

Fannie Mae and Freddie Mac's playground names belie their importance as part of the nation's financial bedrock. Legacies of the Great Depression and the Great Society, these gargantuan institutions help finance community housing projects and, most importantly, help ensure a steady supply of affordable credit for those borrowing to buy homes. Together, they hold or guarantee more than $5 trillion in mortgages — about half of American home loans.

And so when one of the worst housing downturns since the Great Depression left both perilously close to insolvency — a development that rattled financial markets around the world — the federal government had no choice but to ride to the rescue. Over the weekend, Treasury Secretary Henry Paulson announced that the feds were taking over Fannie and Freddie for the time being and would back their obligations with the full weight of the U.S. Treasury. Make no mistake: This is a massive bailout by taxpayers. And the second example this year (Bear Stearns being the first) of socializing the financial risks taken on by poorly managed private organizations.

There is little disagreement among economists, or even politicians, that the federal government had to step in. At the same time, the takeover raises far more questions than it answers. Among the most disturbing: Just how much are taxpayers on the hook for in the bailout? What other so-called "too-big-to-fail" entities remain in jeopardy? And, what are the long-term consequences of this kind of government intervention? "From the perspective of those who lend to large financial institutions, they are becoming more and more convinced a lot of this debt will be effectively guaranteed. And so debt holders have less incentive to monitor the affairs of these large financial institutions, and that's going to lead down the road to more irresponsible, risky behavior,'' said V.V. Chari, a University of Minnesota economist.

There are also very worthy questions remaining about the continued existence of Fannie and Freddie. The Bush administration has four months left in office. Paulson saw his role as that of an emergency-room physician. He stabilized the patient, and hopefully the housing market, but will leave Fannie and Freddie's futures in the hands of the next administration. That was a smart move. Several economists acknowledge that there's a limited group of people with the expertise needed to plot a strategy. It's going to take time to assemble them, evaluate courses of action and decide on the best solution.

Some observers, especially the more conservative, are stridently calling for the breakup and privatization of Fannie and Freddie. That's one of the most intriguing solutions out there. Fannie and Freddie's odd hybrid existence as public-private institutions certainly led to the current problems. But that's not a strategy to rush into. We have a housing system that's been built up around both institutions for decades. In the current economic downturn, argues the Brookings Institution's Douglas Elmendorf, it doesn't make sense to "push them off a cliff."

Of course, the danger of moving cautiously is that taking care of Fannie and Freddie may lose some of its urgency as other issues clamor for attention from the public and the next president. Voters should remember that they are now funding Fannie and Freddie's rescue, and they should demand timely solutions so that it doesn't happen again.