Time for the US "stress test"

In one of the last issues of my FT subscription, Gillian Tett called attention to the American empress and emperor who’ve been bucked naked for years.

After noting the planned “stress test” for European banks, Tett wrote:

But on the other side of the Atlantic, there is another black hole which badly needs to be discussed – this time in America’s huge government-sponsored enterprises, such as the housing giants Fannie Mae and Freddie Mac, and the interlinked Ginnie Mae and the Federal Housing

So far this year, this GSE issue has attracted scant political attention. Indeed – and astonishingly – the 2,300 page financial reform bill that President Barack Obama signed this week barely mentions these institutions at all.

She notes that the US has already spent $145b of taxpayer money to bail out Fannie and Freddie. However, given the large and ongoing exposure of both Fannie and Freddie to bad debt, the future bill ranges from a low of $390b (the CBO estimate) to almost a trillion dollars. The reality is, nobody knows.

So is there any chance of seeing a proper “stress test” on this exposure? Or exit strategy? Don’t bet on that soon. … Nevertheless, behind the scenes – and almost against the odds – there is now pressure building for a proper debate.

She notes two alternatives: privatization of the GSEs, or shifting to an explicit (and limited) financial guarantee.

She concludes:

Personally, in an ideal world, I would favour the first set of ideas, namely full privatisation. After all, it seems profoundly bizarre to have the state underpinning housing so deeply, in a country that espouses free market ideals. But, in practical terms, the second route is probably the only realistic platform for reform now. And if the state subsidy could at least be defined – and limited – that would certainly be a vast improvement on the current status quo.

After all, if there is one thing we have learnt in the past two years, it is that sooner or later investors tend to panic when they see a bottomless black hole of losses and fiscal fudge. That is why Europe is doing these stress tests today. But the fact that Washington has not yet learnt that lesson in relation to the GSEs is disappointing, to say the least. There now badly needs to be a proper debate about Fannie and Freddie – if not a public stress test too.