U.S. poised to grab more financial reins

U.S. Poised to Grab More Financial Reins

Mortgage Bailout Marks the Return Of Federal Activism

By Bob Davis and Jon Hilsenrath The Wall Street Journal Monday,
September 8, 2008

WASHINGTON -- While the government takeover of Fannie Mae and Freddie
Mac represents the most powerful federal intervention in financial
markets in decades, there are likely to be further government moves
ahead.

Federal officials are looking at how to tighten regulation of the
credit-card industry and whether to double loans to bail out the
auto industry to $50 billion. In the coming years, they will examine
how to regulate greenhouse-gas emissions from industries across the
economy and how to remake the mortgage giants so they no longer can
run up enough debt to threaten the economy. The latter could involve
creating yet another government entity to carve up Freddie's and
Fannie's assets and sell them to investors.

"Freddie and Fannie have been de-facto nationalized, at least for
a while," said former Federal Reserve official Ted Truman. "But we
don't know what will replace them."

The year-old financial crisis has bolstered the role of the government
in markets. Beyond staging outright rescues, the Federal Reserve
is scrutinizing the capital and liquidity positions of investment
banks, reconsidering rules for vast but obscure parts of money
markets and derivatives markets, and acting as backstop to a huge
swath of Wall Street's day-to-day trading. Treasury officials are
pushing banks to build new markets, such as so-called covered bonds,
which are popular as mortgage financing in Europe.

The newfound activism is reflected on the Fed's balance sheet. A
year ago, about 90% of the central bank's $875 billion in assets
were Treasury securities. Now, after a year of interventions aimed
at mopping Wall Street of its complicated and illiquid assets, the
Fed's Treasury holdings have fallen to about 50% of its assets.

The struggle between market forces and government control is as old
as the country. Alexander Hamilton and Thomas Jefferson squared off
over the role of the government in promoting early industry.

For two decades after Ronald Reagan's election in 1980, markets
were clearly in the ascendancy. Even the savings-and-loan collapse
of the 1980s, in which the government spent $125 billion seizing
failed S&L's and selling off their loans, didn't shake the widespread
conviction that market forces should be lightly restrained, if at
all.

The takeover of Freddie and Fannie, coming after a string of other
government actions, marks a return to government activism. The 2001
terrorist attacks led to the nationalization of airport workers.
The corporate accounting scandals around the same time, which leveled
energy trader Enron Corp. and communications giant WorldCom Inc.,
led to the Sarbanes-Oxley law in 2002, which tightened regulations
on companies and chief executives.

The combination of the housing crisis and credit crunch has pushed
the Federal Reserve and Treasury to insert themselves deeply into
the financial system to try to head off economic disaster. Investors
said they need to give far more weight in their decisions to potential
government actions.

It is difficult to predict how much deeper the government will
insert itself into the economy, especially during a presidential
election year. Detroit's auto makers have won Congressional
authorization this year for $25 billion in low-interest loans to
rebuild plants to make fuel-efficient vehicles -- and are lobbying
to boost the prospective loans to as much as $50 billion over three
years. Both presidential candidates back the steeper financing.

Whoever wins also will have to figure out how to regulate investment
banks, commercial banks, and other financial institutions, as well
as what to do with Freddie and Fannie. Under the plan announced
Sunday, the mortgage firms would shrink in size by about 10% a year,
starting in 2010, but the plan doesn't specify the ultimate size
or disposition of the companies.

"Some action of this kind was necessary, given past mistakes," said
former Clinton Treasury Secretary Lawrence Summers. "They assure
solvency, which is something well short of adequate capitalization,
meaning that they have deferred huge and painful decisions that are
likely to be expensive to tax payers."

Still, government plans often go awry. As the risk of the
financial-market bust wears off, Wall Street could look upon the
vast support being provided markets as an invitation to make even
riskier bets, or as a way to dump money-losing assets.

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