"The Only People Who Still Might Be Fooled Are the American Taxpayers, Who Are Ultimately Responsible When the Bills Come Due"

The Wall Street Journal ran an editorial last August pointing out that the American people are just about the only ones fooled by the government's use of off-balance sheet, SIV-type accounting to hide the debts of Fannie, Freddie, Social Security and Medicare:

The bigger issue is that all of Fan[nie] and Fred[ie]'s liabilities, whether kept inside the companies or hidden in a dark corner of the Treasury, are now Uncle Sam's responsibility. Moving their bad assets into a new Baddie Mae would only preserve the fiction that there is a difference between the government's obligations and those of Fan and Fred. Not even Barney Frank could believe that any more.

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For the moment, despite 80% government ownership, their $85 billion bailout cost (with more losses to come) and their $5.4 trillion in taxpayer liabilities remain off-balance-sheet in the mold of Enron's special purpose vehicles or Citigroup's SIVs.

The politicians who created and pampered Fan and Fred like it that way. They know that offering federal "guarantees" looks much cheaper, in the official accounting, than actual outlays. But whether it's Fan and Fred, or the Pension Benefit Guaranty Corporation or the Federal Housing Administration, these deferred promises seem to come due sooner or later. Perhaps the politicians would be less profligate in issuing such guarantees if they had to admit the cost up front.

Putting Fannie and Freddie on the national books would in an instant increase the national debt held by the public by 75%—to $12.7 trillion, from $7.3 trillion today. The nearby chart shows that this takes debt as a share of GDP to nearly 90%, or nearly double the peak it reached in the 1980s when the political class was hyperventilating even as the Reagan deficits were falling as a share of GDP. Congress would have to add that $5.4 trillion to the increase in the federal debt limit that Treasury Secretary Timothy Geithner is now requesting. But that would be truth-in-budgeting. Wall Street has sold Fannie paper to the world as if it were as taxpayer guaranteed as Treasury bills, and now we know it is.

Even as the companies careened toward failure a year ago, the Bush Administration was desperate to show it would cover all Fan and Fred debt. The Obama Treasury has been no different and has ginned up the two companies to expand their debts amid the housing meltdown by guaranteeing more residential mortgages. The Federal Reserve has bought $543 billion of Fannie and Freddie mortgage-backed securities and has plans to buy up to $1.25 trillion worth by year end. Foreign debt holders get the message. The only people who still might be fooled are the American taxpayers, who are ultimately responsible when the bills come due.

The larger issue is the integrity of the national balance sheet. As government spending soars, the political temptation to use off-balance-sheet vehicles of various sorts will only increase. Barney Frank is even pushing a bill to make the feds guarantee U.S. municipal debt. The danger is that the federal government will itself become the next Enron, with its biggest liabilities hidden from view, officially denied or tucked away in special purpose vehicles like Fannie Mae. Until the next crisis hits.

It's bad enough that the political class has played this dishonest game with the long-term liabilities of Social Security and Medicare, which are also kept off the balance sheet. But at least those IOUs are held by another branch of the government and can be legislated away by some future Congress. Debt held by the public can't be repudiated without the U.S. descending into Argentina-ville. It's time to come clean about the debts our government is racking up, and Fannie and Freddie are a good place to start.

Financial experts such as Nouriel Roubini and Bill Gross know, of course, that it is all a Ponzi scheme.

Foreign debt holders know about America's financial situation, which is why purchases of Treasuries by foreign central banks are declining.

But the American people are in for one rude shock ...