Handling the Failure of a Government-Sponsored Enterprise

Richard Scott Carnell


Fannie Mae and Freddie Mac are huge, fast-growing, highly leveraged, lightly regulated, and susceptible to failure. Prudence calls for having a legal mechanism adequate for handling their failure. Yet no adequate insolvency mechanism currently exists for Fannie Mae and Freddie Mac. Unlike ordinary business firms, these government-sponsored enterprises (GSEs) cannot liquidate or reorganize under the Bankruptcy Code. If Fannie Mae or Freddie Mac became sufficiently troubled, its regulator could appoint a conservator to take control of the firm and attempt to restore its financial health. But by then the firm’s problems could well have become too severe for the conservator to resolve. The conservatorship statute provides no means for effectuating a reorganization and does not expressly authorize a liquidation. Uncertainty about the priority and process for handling creditors’ claims could worsen the firm’s problems and increase the risk of disrupting financial markets and eliciting a costly congressional rescue.

By enacting a workable insolvency mechanism, Congress could avoid using public money or credit to rescue a troubled GSE’s creditors. Congress should specify priorities among creditors’ claims, authorize appointment of a receiver, and empower the receiver to reorganize the GSE or establish an interim firm to carry on the GSE’s business. Alternatively, Congress could allow GSEs to liquidate or reorganize under the Bankruptcy Code.

JEL Classifications: G18, G21, G28, G33, K29