- The number of bank failures would surge and credit conditions would further tighten, as banks struggle to conserve their capital in a market where they could no longer raise capital with the sale of their mortgages.
- Pension funds for public workers would suffer heavy losses, as they invested heavily in Fannie Mae and Freddie Mack debt thinking it was almost as safe as treasuries.
- The dollar would depreciate and push oil prices even higher, as foreign governments also invested heavily in Fannie Mae and Freddie Mac, thinking it was similar in risk to the treasury market.
For these reasons, the "too big to fail" argument will carry the day, and we already see action by the Congress and the Treasury to step in and rescue the two mortgage giants. Unfortunately, though, the measures now moving through Congress are little more than a band-aid solution, and fail to address long-term issues in the secondary market for mortgages.
"One would hope that policymakers use the current crisis to avert a repeat in the future. We may not be that lucky. Congress is pushing to increase the regulation of financial markets without weighing the consequences of those regulations, and without forcing more accountability on Fannie Mae and Freddie Mac. Indeed, the risk is that the government, and politics, will play too large instead of too small a role in financial markets as we struggle to deal with this crisis in an election year," concludes Laurenti.
