In July, explaining his contingency plan for emergency support of Fannie Mae and Freddie Mac, Hank Paulson, Treasury secretary, told the Senate banking committee: “If you have a bazooka in your pocket and people know it, you probably won't have to use it.”
That is doubtless true, but once in a while you are obliged to prove you are not bluffing. So it proved with Fannie and Freddie.
July's announcement that the government was ready to lend without limit to keep the agencies going appeared to work at first. Certainly, the promise was credible. The Treasury knew, and the markets knew the Treasury knew, that the agencies could not be allowed to cease functioning.
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