Five reasons the Fannie/Freddie bailout should not happen -- and some reasons why it is anyway

• Violates free market principles. In the world of venture capital, you place your bets and you either make or lose money based on a combination of luck, good strategy, and effective execution. If I make money I don't have to give my profits to taxpayers. And if I lose my investment, I don't expect them to bail me out. Why should investors in Fannie and Freddie bonds get taxpayers to bail them out of their bad decisions?
• Will not revive housing market. If Washington really wanted to revive the housing market, it would buy and destroy all the excess housing inventory on the market. By reducing supply so it more closely matched demand, prices would bottom out. And eventually, when the economy revived, prices would start to rise as people bought homes. Today's slightly higher mortgage rates are not the reason that housing prices are plunging. And the slight drop in those rates that might result from the bailout do not justify its cost.
• Lacks sufficient data to win its case. The evidence that supports the need for such an enormous taxpayer-funded bailout is simply too vague to convince me that it's essential. If policymakers could present objective data showing that without this bailout the global economy would collapse, I might change my mind. Or at the very least, Paulson should provide an analysis that shows how much each MBS is really worth based on a realistic forecast of future mortgage payments. Why not let everyone see the data that seems to be driving the rush to bailout Fannie and Freddie? What I've seen so far suggests that the bailout is happening because a few huge bond investors might lose money without it.
• Further weakens America's balance sheet. By adding $800 billion to our $9.67 trillion in national debt, this bailout could raise America's national debt to $10.5 trillion -- 75% of GDP. This makes our country a much weaker bet for lenders since any country whose debt is greater than 60% of GDP is seen as a risky borrower. This added risk could weaken the dollar and raise the long-term cost of capital.

What is prompting Paulson to use our tax dollars for the latest bailout?

There are two likely reasons:

• Overly optimistic accounting. A so-called independent investigation from Morgan Stanley (NYSE: MS) has found that Fannie and Freddie overstated their capital and understated their losses, according to Bloomberg. I find it interesting that Morgan Stanley, which could get significant income from restructuring Fannie and Freddie, was asked to provide the basis for throwing it into conservatorship. Why not hire an accounting firm that would not benefit from such business to offer a truly independent opinion?
• High cost to refinance monthly debt. Bloomberg writes that as of "mid-August the companies had $223 billion of debt to refinance by the end of the quarter." It also reports that Paulson is concerned because investors are requiring them to pay more to convince investors to buy their paper -- "at 3.229 percent or 97.5 basis points more than Treasuries of similar maturity, the highest since at least 1998," according to Bloomberg. So the "free" market is demanding that a riskier borrower pay a higher rate to compensate for that risk means that America's taxpayers need to bailout Fannie and Freddie? By that logic, if I make a late payment on my mortgage and thus need to pay a higher rate, I should get taxpayer money to bail me out.

I think there are two more unstated reasons for the bailout:

• Wipe out Democratic powerhouse on the way out. Fannie and Freddie formerly provided significant capital and talent to the Democratic party. Through a government takeover, the White House will significantly diminish this power base. Just as it used the 9/11 attacks to justify a war in Iraq and the legalization of spying on Americans, so it is using the current situation to force through its radical plan in its final weeks in power.
• Bailout big MBS holders. As I posted, Bill Gross, whose PIMCO holds roughly $500 billion in MBS, and China's state bank, which owns another $340 billion, will benefit most from this use of our tax dollars. It seems to me that these investors can hire the talent to assess risk and reward in their portfolio. If they make a bad bet, they should prune their losses and move on. If their losses are too big to do that, let them file for bankruptcy.

This bailout is being bulldozed into existence. The U.S. government is supposed to be "of the people, by the people, and for the people." But that's not what's happening here. This is government of the elite for the elite against the people.

Update. AP reports that Paulson's plan is in effect. Herb Allison, formerly of Merrill Lynch (NYSE: MER) will run Fannie and David Moffett, a former vice chairman of US Bancorp (NYSE: USB), was picked to head Freddie. And common and preferred shareholders get a chance to talk about "capital-restoration plans."

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He has no financial interest in the securities mentioned.