As Fannie Mae and Freddie Mac totter toward a government bailout, we might recall that they may have been “conceived in sin.”

In an July 28 New Yorker article, “Sponsoring Recklessness,” James Surowiecki pointed out that the primary motivation behind the privatization of Fannie Mae in 1968 and the creation of Freddie Mac in 1970 was to move their liabilities off the government’s books.

In retrospect this “sleight of hand” seems comparable to the shenanigans of Enron, which used “special-purpose entities” to move liabilities off its balance sheet.

That is, fixed-income investors never accepted the public contentions of the government-sponsored enterprises, or GSEs, that their debt obligations were “not guaranteed by Congress.” In the reckless pursuit of high stock prices, the executives of Fannie and Freddie have jeopardized our entire financial system.

Fannie and Freddie will need to be restructured.

Consider:

* The GSEs guaranteed $5.3 trillion of mortgage debt, covering about half the outstanding mortgages in the U.S., thereby “crowding out” private lenders.

* They have issued more than $5.2 trillion in debt — $1 trillion more than the U.S. government debt in the hands of the public.

* Foreign central banks hold about $1.5 trillion of Fannie and Freddie paper, making a potential GSE default a global concern.

Surowiecki coined the phrase “duck-billed platypuses of the financial world” to describe the hybrid nature of Fannie and Freddie. On the one hand, they are profit-driven corporations, owned by shareholders. On the other hand, they are designated government-sponsored enterprises because they have been created by Congress.

They do not pay state and local taxes, they are exempt from certain SEC regulations, they enjoy a credit line to the Treasury, and the GSEs’ cozy relationship with legislators allowed them to escape tough regulatory scrutiny.

Ironically, the implicit government backing of these GSEs ultimately led to their downfall. Fannie and Freddie sought to make outsized profits by overleveraging their balance sheets. On a rough basis, they have “on paper” collectively about $81 billion of equity versus some $5.2 trillion in debt. Skeptics argue that the companies have overstated the value of their assets significantly. By some calculations each company is about $50 billion in the hole.

But if the government were to guarantee the GSEs’ debt, it would double the size of the U.S. debt and possibly lower the nation’s “AAA” rating.

Their continued losses have increased the chance of some sort of government intervention.

Wall Street Journal writer Phil Izzo, in an Aug. 14 article titled “Economists Bet on Aid for Fannie, Freddie,” cited a survey of 53 economists who, on average, put the probability at 59 percent that the Treasury Department will have to step in to bail out Fannie or Freddie.

“Blank checks almost always get filled in and cashed,” Stuart Hoffman of PNC Financial Services Group said in the article.

In an Aug. 18 piece in Barron’s, “The Endgame Nears for Fannie and Freddie,” writer Jonathan R. Laing predicted that the inevitable recapitalization by the government of Fannie Mae and Freddie Mac will wipe out investors and management because the balance sheets of both companies have been destroyed.

Former Fed chairman Alan Greenspan recently questioned the continuation of Fannie and Freddie’s GSE status.

“They should have wiped out the shareholders, nationalized the institutions with legislation that they are to be reconstituted — with necessary taxpayer support to make them financially viable — as five or 10 individual privately held units” that the government would eventually auction off to private investors, he said.

Treasury Secretary Henry Paulson’s spokeswoman, Michele Davis, responded to Greenspan’s critique:

“This legislation accomplished two important goals — providing confidence in the immediate term as these institutions play a critical role in weathering the housing correction, and putting in place a new regulator with all the authorities necessary to address systemic risk posed by the GSEs.”

Over the long term, the GSEs should either become federal entities or completely independent.

I am hopeful that, despite the original sin in 1968, the Treasury might make some interim corrections by installing new management and new directors to curb the GSEs’ reckless investment and guarantee operations.

Originally published in the Sarasota Herald-Tribune