Bailouts and Credit Cycles: Fannie, Freddie, and the Farm Credit System

Abstract:     
In September 2008, the United States government seized mortgage giants Fannie Mae and Freddie Mac. Since that time, the government has pumped $111 billion of new capital into these government-sponsored enterprises. Yet the future of these companies post-bailout is far from clear. As policymakers consider the future of Fannie and Freddie, it is useful to remember that this is not the first significant bailout of a government-sponsored enterprise. The government also rescued the Farm Credit System in the 1980s. This Article examines the historical cycles in which Fannie, Freddie, and the Farm Credit System have funded loans: They fund more loans in good economic times but fund fewer loans in poor economic times. In other words, they fund loans pro-cyclically with business and credit cycles. By repeatedly providing bailouts, however, government officials demonstrate that they want these government-sponsored enterprises to fund loans in a countercyclical manner. This Article considers the advantages and disadvantages of three possible ways to induce countercyclical behavior. It concludes that policymakers should impose countercyclical capital requirements and create an insurance system funded with risk-based premiums to insure the companies’ bonds. It further concludes that, even with these measures, occasional government bailouts may be necessary to stimulate lending during severe economic downturns.

Number of Pages in PDF File: 77

Keywords: government-sponsored enterprise, GSE, Fannie Mae, Freddie Mac, Farm Credit System, bailouts, credit cycles, business cycles, capital requirements, bond insurance

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