Wednesday, July 23, 2008

Fannie and Freddie: What to do?

The New Yorker has a great post explaining a brief history of the mortgage giants:
When do the words “not guaranteed” actually mean “guaranteed”? Whenever the mortgage giants Fannie Mae and Freddie Mac are involved. The two companies have long been required to tell investors that their securities are not guaranteed by the federal government. But in the financial markets everyone has always assumed that this demurral was just window-dressing, and everyone, it turns out, was right. Last week, when fears of a possible collapse of the two companies threatened to spark a major financial crisis, the Treasury Department and the Federal Reserve quickly came up with a rescue package. What had been an implicit guarantee became an explicit one.
However, I disagree with the author's conclusions:
Whatever their sins, Fannie and Freddie clearly couldn’t be allowed to fail, but that’s no argument for letting them go on as they are. Either they should be forced to make it as private companies or they should be nationalized. Given that their business depends on the promise of government assistance and that their current state remains woeful (despite an upturn in their fortunes late last week), nationalization seems more sensible. If Fannie and Freddie are going to run up a tab and stick taxpayers with the bill, why should shareholders profit?
No, why should taxpayers be stuck with the bill in the first place? James Suroweiki makes the assumption that profiting shareholders are the bane of the financial markets, even though earlier in the article he clearly shows that in a free and private market, Freddie and Fannie would not have gotten away with these shenanigans:
Because everyone assumed that the government would make good on Fannie’s and Freddie’s debts, they could borrow money more cheaply than their competitors. They used this cheap debt to increase the number of mortgages they bought. Had Fannie and Freddie been ordinary private companies, there would have been a natural check: companies with more debt are usually seen as riskier, and that makes shareholders and bondholders less willing to invest in them.
Freddie and Fannie had been able to lend outrageous quantities of low rate mortgages, on very very very little capital. Why? Because though they were "privatized," they still were largely attached to the government--that is, they knew they could get away with it, and so did their investors, thus did they invest such a large amount in these banks.

Could it be that Freddie and Fannie's distortion of the market prompted other banks to follow suit? Possibly. In any case, the banks knew that they were taking a huge risk, but they also knew that the government would most likely bail them out--a hunch that has thus far proven accurate. However, Suroweicki sees the problem in a different light:
...had Fannie and Freddie been government agencies, budget constraints would likely have limited the scope of their lending. Since neither the market nor the state checked their growth, they were able to swell extravagantly
...Right. Lord knows the government constrains its own budget...since when? More likely instead, the government would further tax the nation to subsidize further irresponsible loans to irresponsible people. At the same time, it would still be probable that other banks would follow suit to keep business going--that is, to be able to compete with Freddie Mac and Fanny Mae, other banks may be prompted to make, oh I don't know, adjustable rate mortgages and other irresponsible loans?
They constructed a giant pyramid of debt on a very small base of capital (eighty-one billion dollars, by the most recent publicly available figures), and by May, 2008, either owned or guaranteed more than five trillion dollars in mortgages.
If a bailout were the case, as has been suggested in some circles, guess who would foot the bill?

They say Americans are addicted to oil. I say we are addicted to debt. We depend on banks to give us money that doesn't exist to buy things we don't need (and probably can't afford). Banks depend on us to build their capital by paying on our debts, and depositing money, so that they can create more debt, in a never ending cycle of debt accumulation and usury. Meanwhile, both of us are dependent upon a nanny state government to prop up the whole charade.

No comments: