Corporate Cushions and Lazy Capital

Past performance is not a guarantee of future performance.

I remember a time when Fannie Mae (FNM Quote) was a failed financial company, viewed no better than a savings and loan during the lending crises of the 1980s.

The FDIC and Congress worked through the savings and loan debacle, while a restructured Fannie Mae provided much-need capital and liquidity for the financial lending system. Those shareholders who were patient with this stock saw it move from a low of $2 in December of 1987 to a high of $89 in December of 2000.

Flash forward six years.

This week, Ben Bernanke issued a warning that all financial crises involve the failure of a large entity and originate from oversight failure. He clearly spelled out a case against two government sponsored entities: Fannie Mae and Freddie Mac (FRE Quote). In the process, he pointed out that their combined outstanding debt exceeds $5.2 trillion, more than the $4.9 trillion of public government debt.

So what's Bernanke's problem with the government sponsored entities (GSEs)?

The situation is pretty clear. These are two large entities at the heart of the financial markets where investors incorrectly continue to assume an implied government guarantee. And the misplaced incentives reward the companies for taking risks.

The effect, according to Bernanke, is a pair of undercapitalized entities that, unlike banks, will not protect investors. Shareholders must bear the burden of a restructuring when it occurs.