Financial markets around the world got a little breathing room this week, after the U.S. government announced it would bail out the troubled mortgage agencies Fannie Mae and Freddie Mac.
An estimate in July from the Congressional Budget Office suggested the rescue could cost American taxpayers anywhere from zero to $100 billion — with the likeliest total being $25 billion.
That may sound like a lot, but economists argue that the cost of not saving Fannie and Freddie would have been far, far greater. Together, the agencies hold loans of $5 trillion. That's the largest debt ever held by any private company in history. It's larger than any other country's debt, with the exception of that of the United States.
Allowing Fannie Mae and Freddie Mac to collapse would have been akin to letting Japan or the United Kingdom go bankrupt. Global economic leaders say even those unimaginable scenarios would have paled beside the fallout from a Fannie/Freddie implosion.
"The bankruptcy of Fannie and Freddie would have meant Armageddon," said Domenico Siniscalco, former finance minister of Italy. He added, "Meltdown of the financial system, the global financial system."
Siniscalco attended a conference for former finance ministers this week at the University of Virginia. Next to him was Tim Adams, a former U.S. Treasury undersecretary. Adams is not known for dramatic overstatements. Asked about a hypothetical collapse of Fannie Mae and Freddie Mac, he seemed at a loss for words. "Oh, wow, it would be..." his voice trailed off. "Credit markets would seize [up]."
Adams explained that many banks around the world own bonds from the mortgage agencies. If those bonds were suddenly worth far less, the banks would stop giving out loans of any kind. Consumers wouldn't be able to borrow money to buy homes, cars or basic goods. Entrepreneurs wouldn't be able to get financing for their ideas.
"If you can't borrow, you can't run your business," Adams said. "You can't go to school. You can't expand. And, therefore, the economy stops."
As the U.S. economy has faltered over the past year, some have speculated about whether things could get as bad as the Great Depression. If Fannie Mae and Freddie Mac had failed, I asked Adams, would things get as bad as that epic period of economic misery? Or worse?
"It would certainly be the event of our lifetime," he said, "and probably be felt for a very long period of time." By long, he means decades — "at least."
Every finance minister interviewed for this story said U.S. Treasury Secretary Henry Paulson had no choice but to step in. Paulson may have saved Fannie and Freddie, but America's economic reputation has taken a hit.
"For such a long period of time, the U.S. was a force for stability in world markets," said Peter Costello of Australia. "Here's an example of the U.S. exporting instability."
Costello argued that international investors now will be more wary about investing in the U.S. It's hard to know exactly what that will mean for average people — or how long the suffering will continue. One result may be a period of fewer new factories opening and lower wages overall.
Some of the former foreign finance members did point to one silver lining. They said the U.S. has lost some of its power of persuasion. For them, that's a plus.
"It's a good week for India," said Yashwant Sinha. For years, he said, the U.S. and others told him that India's financial system is too backward, too closed off from global finance. "Every consultation told us we are not managing our affairs properly. And now everyone is looking at India as an example of cautious managing of the economy and cautious opening up."
Sinha and the others expressed agreement that the American economy still dominates the world by a great margin — just not as great a margin as a few months ago.
