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Freddie Mac, Fannie Mae bailout only a stopgap, U. of I. expert says

Anne Villamil
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Photo by L. Brian Stauffer
Economist Anne Villamil says the bailout of Freddie Mac and Fannie Mae is only a stopgap.

9/8/2008

Jan Dennis, Business & Law Editor
217-333-0568; jdennis@illinois.edu

CHAMPAIGN, Ill. — A government bailout of mortgage giants Freddie Mac and Fannie Mae is only a bandage for the nation’s troubled financial and housing sectors, a University of Illinois economist says.

Financial markets and the U.S. dollar rallied Monday after the weekend announcement that the Treasury Department was seizing control of the cash-strapped companies, which own or insure nearly half of U.S. residential mortgages.

But U. of I. economics professor Anne Villamil says the burst of optimism is likely premature.

“While this move has prevented an immediate meltdown, fundamental problems remain,” Villamil said. “Housing prices continue to fall while default rates rise, weakening banks’ balance sheets. There was a massive regulatory failure, and U.S. fiscal policy and personal saving rates are problematic.”

 The Bush administration announced Sunday it was seizing Freddie Mac and Fannie Mae in a bid to reverse a lingering housing and credit crisis that has left the U.S. teetering on the brink of recession.

Officials say plans to inject up to $100 billion in each of the lending giants could reduce interest rates and perhaps even boost the overall economy.

Villamil says the move will shore up investors’ confidence, making them more likely to buy the debt issued by Freddie and Fannie because the federal government is now standing behind that debt.

“Much of Fannie and Freddie’s obligations are held by foreign central banks, especially in Asia,” she said. “Had these central banks stopped buying, U.S. interest rates would have risen sharply and the dollar would have dropped, making for a very painful adjustment.”

Still, Villamil says, the bailout is merely a stopgap until deeper economic woes can be resolved.

“The current intervention has bought some time, but many problems remain to be addressed,” Villamil said.

Villamil studies financial contracts and the impact of inflation on public finance. She is co-editor of the Annals of Finance and an associate editor of Economic Theory, the European Economic Review, and the Quarterly Review of Economics and Finance.

Editor’s note: To reach Anne Villamil, e-mail avillami@illinois.edu