For those who want to know how much worse that housing market is getting they need look no further that the quarterly results of Fannie Mae (FNM). The mortgage operation lost $15.2 billion and will need another $10.7 billion from the government to continue.

The primary reason for the loss is that 4% of the loans that Fannie Mae owns or controls were delinquent, up from 1.4% a year ago. Based on that data, the government’s bailout of Fannie Mae and its near-twin Freddie Mac (FRE) is not nearly over. Taxpayers have put $85 billion into the two companies, and that tab is about to go much higher.

Fannie Mae and Freddie Mac own or guarantee about half of the home mortgages in America, which mean that they are irreplaceable. There is no other organization large enough or experienced enough to handle that level of inventory. One cannot be practically created because of the time required. The two firms have such massive liabilities that a real restructuring is impossible. The Administration has an as yet imperfectly formed idea of stripping the bad assets away from the two companies to make them viable, but it is hard to see what practical benefit that can have. The federal government will end up with the bad paper, one way or another. The taxpayer costs will stay the same. The logic behind a “bad bank” holding the most crippled part of the Fannie and Freddie balance sheets does not appear to do much to advance the cause of fixing the structural composition of the American companies that have large exposures to the housing market.

The Fannie Mae earnings and the recent discussions about changing the composition of the two companies to “improve” their financial status goes a long way to show how anxious the Administration are to try to fix problems that are not going to be fixed, at least not in the foreseeable future. The flaw with the mortgage market is not in the institutions; it is in the market itself. Fannie Mae’s earnings will get worse as delinquency rates go higher. That is simplistic, but it has the benefit of being true. Not everything can be fixed by restructuring. Like an intractable illness, the patient can be treated but not cured.

The government will end up putting several tens of billions of dollars more into Fannie Mae and Freddie Mac whether they are merged or broken into smaller businesses.

The most important conclusion from the Fannie Mae earnings is that, in addition to the costs of the deficit, and the stimulus package, and healthcare reform, there are “legacy” problems in the financial system that the government has practically obligated itself to fund. AIG may still be in that category, but it may be able to sell assets fast enough to stay ahead of another request from the government. Fannie Mae still faces enough of a headwind that it cannot be self funding or self liquidating.

Fannie Mae is the part of the taxpayer’s burden that the government avoids mentioning when it talks about the money it has to spend in the future to keep the recovery on track.

Douglas A. McIntyre

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