Our View: Bailed out, now they should be broken up

With the seizure of the two secondary mortgage-market giants, Fannie Mae and Freddie Mac, accompanied by an open line of credit straight into the taxpayers' wallets, U.S. Treasury Secretary Henry Paulson demonstrated that government policy is to promote what it likes to think of as stability rather than allowing large-scale companies that get into trouble to receive proper market discipline.

Nobody knows just what the cost to taxpayers of this ersatz stability will be, although almost everybody assumes that the estimate of $25 billion given in July, when Paulson got permission to put the taxpayers' full faith and credit behind the two mortgage giants, is ridiculously low. The government is committed to provide up to $100 billion to each company to support any capital shortfalls, according to the plan announced Sunday. But unless the government moves to break up and privatize the assets of the two quasicompanies, the cost to freedom and economic well-being will be even larger.

Of course, Fannie Mae and Freddie Mac are not ordinary private companies, but government-sponsored-enterprises founded on the unfounded belief that without a little prod or two from government certain essential functions won't be handled by the private marketplace. The two companies buy mortgages from front-line mortgage lenders and repackage them to be sold as "mortgage-backed securities."

As GSEs, the two companies were exempt from state and local taxes, and their required "core capital" was only 2.5 percent of assets, compared with the norm of 6 percent to 8 percent for banks. And even though the promise was not explicit until July, most market players assumed the government would dragoon the taxpayers to step in if they got in trouble. Given these advantages it is hardly surprising that they came to control 42 percent of the secondary mortgage market.

Are such companies essential? In 2005, after an accounting scandal, regulators severely constrained Fannie and Freddie's activities, to the point that they had only 14.4 percent of the secondary mortgage market. Other companies picked up the slack, and the market barely noticed. The plan announced Sunday calls for them to reduce their investment portfolios, by 10 percent a year, starting in 2010.

The dramatic government bailout should prompt Congress to break up Fannie and Freddie and privatize them — and discard the model. Privatizing profits and socializing losses is hardly a formula for increasing the blessings of prosperity.