Fannie and Freddie Had an Implicit Guarantee Until It Became Explicit
Two companies that guaranteed trillions of dollars of American mortgages were placed into government conservatorship in 2008, confirming a backing that had always been officially denied.
What They Did
Fannie Mae and Freddie Mac were government sponsored enterprises, private shareholder owned companies operating under congressional charters with a public mission of supporting mortgage availability.
Their core business was buying mortgages from lenders, packaging them into securities, and guaranteeing the payments to investors. That guarantee is what allowed the securities to trade as high quality instruments and what made the long term fixed rate mortgage widely available in the United States.
The Ambiguity at the Centre
Their obligations were not backed by the full faith and credit of the United States government, and their securities carried explicit statements to that effect.
Markets did not believe it. Investors, including foreign central banks, treated their debt as carrying an implicit guarantee, reasoning that the government would not permit institutions so central to the housing finance system to fail.
That belief was reflected in pricing. Their debt traded at yields close to Treasuries and far below what comparable private companies paid.
The companies could borrow at nearly government rates because of a guarantee the government formally denied, and they retained the profits that cheap funding generated.
The Structural Problem
The arrangement created an obvious distortion. Cheap funding from an assumed guarantee produced profits for private shareholders, while the risk that made the guarantee necessary sat with taxpayers.
Economists identified this as privatised gains against socialised losses for years beforehand, and proposals to reform the structure were made repeatedly and not adopted, because the arrangement was politically convenient. It supported homeownership without appearing on the federal budget.
What Happened in 2008
As house prices fell and mortgage defaults rose, the guarantees they had written generated enormous losses. Their capital was thin relative to the obligations guaranteed.
In September 2008 both were placed into conservatorship, with the government taking control and providing capital support. The implicit guarantee became explicit.
The scale mattered enormously. Their securities were held throughout the global financial system, including by foreign central banks. A failure would have transmitted losses internationally and would have effectively closed American mortgage lending.
The Unresolved Part
The notable thing is that conservatorship was intended as a temporary measure and persisted for many years. Successive administrations proposed reform and none was enacted.
The reason is that the underlying question is genuinely difficult. Fully privatising them would raise mortgage rates by removing the guarantee. Fully nationalising them would place trillions of obligations directly on the federal balance sheet. The ambiguous middle is uncomfortable and neither alternative is politically attractive.
The Bottom Line
An implicit guarantee is a real subsidy that produces private profit and public risk, and it stops being implicit at the worst possible moment. Where the market prices a guarantee the state denies, the market is usually right.