Fannie Mae and Freddie Mac are in a weird situation. They went from being government-sponsored entities to "privatized" entities that everyone knew were sponsored by the government, and after the financial crisis sure enough the government took them back. Now the U.S. owns two huge real estate lenders that have a ton of bad loans on their books. The situation has actually been somewhat positive in the short-run, since it's allowed the government to take pro-active policy steps to refinance troubled mortgages and help bolster the housing market, but no one of any ideological stripe is really comfortable with this as a long-term situation, especially because of the problematic balance sheets. Now the Washington Post reports that the administration is talking about using the bad bank system to help move Fannie and Freddie into the future -- take the "bad" loans and give them to a "bad" bank whose job would be recovering whatever value is left over, and let the newly healthy Fannie and Freddie continue lending and inspiring market confidence. (Note that this doesn't solve the problem of whether they should be nationalized or privatized -- and please, no more quasi-nationalized lemon socialism). Variations on this idea were used in the great Swedish bank rescue and as part of the clean up from the Savings and Loan scandals -- here's a good explanation of the mechanism from January. Here's my question: If the way to deal with toxic assets in a government-run bank is to mandate restructuring to identify bad assets, unwind them in a separate institution and write down the losses, why shouldn't that approach be used on a bank like Citi, which is owned in large part by the U.S. taxpayer but is yet to really recover from the financial crisis? Our weak financial system is still an economic liability, and it's strange to see the bad bank approach, which was brushed off earlier this year as too radical, now being applied to government-owned lending institutions while semi-government owned lenders present much larger problems.
-- Tim Fernholz
