Big Banks May Have to Pay if Fannie and Freddie Go Bust


Financial stocks took a beating at the opening of trading Thursday after a Republican congressman added language to the proposed financial regulation overhaul that would make big banks pay up if government-backed mortgage lenders Fannie Mae (FNM) and Freddie Mac (FRE) go bust.

"It would be unconscionable if we would not be dealing with the government enterprises now," Rep. Jeb Hensarling, R-Texas, told a conference committee hearing Thursday, referring to Fannie and Freddie, which were seized by the government in September 2008 when they were on the verge if insolvency.

House and Senate negotiators are currently trying to cobble together a comprehensive reform of financial regulations covering everything from systemic risk to consumer protection.

Banks Outraged

Hensarling outraged the financial services industry Wednesday night when he inserted Fannie and Freddie into the so-called orderly liquidation fund. Under these provisions, if a bank or other major financial institution fails, it would not be left to the taxpayer to rescue them. Instead, large banks would be forced to pay into the fund to make up for any shortfall left after the firm's assets have been sold off.

The House had initially demanded that a $150 billion fund be established in advance to cover any losses incurred by a bank failure, but this was rejected by the Senate. Instead, under a compromise reached earlier in the week, a failed bank would first be liquidated and its assets used to pay off its debts. If that were not sufficient, the liquidation fund would then be set up.

Fannie and Freddie, which together guarantee about $5 trillion in home loans, face huge losses because of problem mortgages from banks' shoddy lending practices and the housing bust. The government has already given them $140 billion, and estimates of their outstanding losses range from a low of $400 billion to $1 trillion.

Separate Issue?

The banking industry was quick to respond. The American Bankers Association (ABA) called the inclusion of Fannie and Freddie in the orderly liquidation authority "a very troubling provision."

"This provision could impose a tremendous additional liability on the banking industry of hundreds of billions of dollars," said Edward L. Yingling, president of the ABA in a letter to the conference committee. "It is not clear how the markets and ratings agencies would react to this, but we are deeply concerned that it would undermine the credit ratings of banks and impair their ability to attract capital."

Yingling said the issue of Fannie and Freddie should be dealt with in separate legislation.

Split Over Derivatives Rule

Senate and House negotiators are currently stuck on proposed legislation to force banks to spin off their businesses trading derivatives, complex contracts that are based on underlying financial instruments like stocks and bonds.

One amendment, by Senator Blanche Lincoln, D-Ark., would require major banks to set up subsidiaries for their derivatives trading business so the Federal Reserve would not have to bail them out in a crisis. But that will cost the banks billions of dollars in new capital, and lawmakers from New York and Massachusetts, whose districts include big banks, have opposed the measure and tried to force Lincoln to back down.