Why Fannie and Freddie Aren't Like Bear Stearns

In his always interesting morning column, Vince Farrell suggests that Treasury Secretary Henry Paulson "wants the U.S. Treasury to inject equity into the firms in such a way as to zero out the existing shareholders and refute the 'moral hazard' argument that you can count on the government to bail you out."

I understand this perspective, especially since it was the Treasury's attitude in the Bear Stearns situation, but I disagree.

The Fannie Mae (FNM - commentary - Cramer's Take)-Freddie Mac (FRE - commentary - Cramer's Take) situation has some important distinctions.

Who Sets the Rules

Let's not forget that the government sets the rules on what constitutes an appropriate level of capitalization for the government-sponsored enterprises as well as for banks. The government also delegates some accounting policy power to Financial Accounting Standards Board.

The long-standing U.S. policy, dating back at least to the GI Bill after World War II, is to encourage home ownership. The deductibility of mortgage interest is one important policy. The reduced capital requirements and (formerly) implicit guarantee of the GSEs are ways of subsidizing mortgage interest.

Please note that I am not commenting on the desirability of these policies. This is a description and analysis. There may come a time to change the policy, but it is not going to happen right now.

The Office of Federal Housing Enterprise Oversight, and perhaps now the Fed, determine what constitutes capital adequacy. Not Richard Poole. Not analysts who apply bank solvency standards.

The government policy makers see the current Fannie loan portfolio as performing at near-normal levels. What financial people see as a crisis comes from their forecasts of future losses. It is a "crisis" with daily media attention, mostly because of the steep stock declines. That is not the method or the data used by government regulators. Moreover, regulators are well aware that a reduced role for Fannie and Freddie makes future losses much more likely -- a death spiral in housing.

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At the time of publication, Miller had sold covered calls in Fannie Mae, although positions may change at any time. Jeffrey Miller is president and CEO of NewArc Investments, a registered investment adviser, and Capital Markets Research.

Miller writes about the market, interpreting data, and finding the right expert at his blog, "A Dash of Insight. He is writing about the 2008 presidential campaign and the implications for individual stocks and the market at Election Stocks. His investment company, with programs for both individual and institutional investors, is NewArc Investments.

Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Miller appreciates your feedback; click here to send him an email.