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The diminished future of Fannie and Freddie
September 8, 2008
The US government’s near- nationalisation of Fannie Mae and Freddie Mac leaves various questions unresolved. Hank Paulson, the Treasury secretary, recognised the biggest of these in his speech on the rescue on Sunday: whether they should become public or private entities in future.
“Government support needs to be either explicit or non-existent, and structured to resolve the conflict between public and private purposes. And policymakers must address the issue of systemic risk.”
He is right that a choice has to be made. Fannie was originally established in 1938 to buy and hold mortgages insured by the federal government through the Federal Housing Administration. The idea was to provide government backing so that low income families could afford to buy homes.
That was clear enough: Fannie was a public entity with an explicitly social purpose. The problem came in 1968 when it was re-chartered into a government-sponsored private corporation that could buy all kinds of mortgages and securitise them to provide general liquidity in the housing market.
James Surowiecki has recorded the curious fact that the fateful change in 1968 was due to Lyndon Johnson wanting to get housing debt off the government books. In other words, Fannie and later Freddie became off-balance sheet vehicles for the government.
But we know what happened. Fannie and Freddie skillfully worked the ambiguity about whether they were really government-backed entities or private ones. They steadily expanded their balance sheets and profits on a slim capital base because investors assumed the government stood behind them.
Their half-public, half-private status has to be ended if a repeat of the debacle is to be avoided.
For my money, it would be damaging to have Fannie or Freddie survive as private entities in the long-term because, since the government has come to their rescue once, everyone will believe it would happen again.
I think the best idea would be to reverse the misguided 1968 charter entirely. If either is to survive in the long term, it should be as a public agency with explicit and limited social aims.
The evidence is that the private mortgage market as a whole can survive quite well without a federal agency in the middle: most other countries do quite well without one. If it cannot, then taxpayers’ money should not be used to prop it up.
For a country that is the ‘beacon of capitalism’, it makes little sense to have agencies such as Fannie Mae and Freddie Mac with government backing. As the article noted, most other countries do just fine without such agencies.
Posted by: Thurmond | September 8th, 2008 at 3:08 am | Report this commentWhere is the outrage w/ the Fed/Treasury take over of Freddie and Fannie?
Am I missing something? Why is this not blatant baloney?
How can they expect taxpayers NOT to lose money?
Why do we believe them?
What is the plan to make Fannie/Freddie profitable?
What are they hoping for? A war to distract us?!?!
The November election to be over?
What is their next trick? Hyper inflation to make housing prices stop falling and rise 40%?
This seems crazy reckless to me.
Can the US really afford the $1.5-2.5 trillion price tag? [The IOUSA movie three weeks ago, clearly says NO!!!] No taxpayer losses. WOW! I have heard of the big lie but this is unbelievable!!
They seem hopeful that we will blame FANNIE AND FREDDIE and NOT the Federal Reserve/Greenspan or US government deficit spending.
The irony is that I bet the stock market is way up on MONDAY!
From a Bloomberg story on Freddie, Fannie and Paulson, as in CYA:
http://www.bloomberg.com/apps/news?pid=20601103&sid=ajcw4yxxPGJ8&refer=news
“The Treasury noted that Fannie and Freddie securities are held by central banks and “investors around the world.”
Lockhart added that interest and principal payments will CONTINUE to be made on the companies’ subordinated debt.
The Treasury will hire independent asset managers to purchase and run the portfolio of mortgage-backed securities it will buy. The program goes beyond just helping Fannie and Freddie, as it aims “to BROADEN ACCESS to mortgage funding for current and prospective homeowners,” according to the Treasury. (YET they will cut back on future lending by the Fannies!!)
“There is NO REASON to EXPECT TAXPAYER LOSSES????? from this program, and it could produce gains,” the department said.
Lockhart said today’s action was prompted by a judgment that the companies “cannot continue to operate safely and soundly and fulfill their critical public mission without significant action????? (What action except to pour in taxpayer money?) to address our concerns.”
Paulson’s decision, taken after consulting with Federal Reserve Chairman Ben S. Bernanke, followed a review that found Washington-based Fannie and McLean, Virginia-based Freddie used accounting methods that inflated their capital, according to people with knowledge of the decision.”
Posted by: DenisL | September 8th, 2008 at 4:38 am | Report this commentThurmond:
Your comments go right to the heart of it. The fundamental question is why it is that pouring tax money into a black hole is a solution. There is something fundamentally wrong in the OECD economies if there is the necessity to prop up ailing mortgage providers and the banking system.
In providing support to a sick banking system with tax money, the US government is saying that the productive parts of the economy will need to pay for the sick parts of the economy. All this can achieve in the long run is greater pain.
The situation is one in which there is a rebalancing in the world economy. The attempts to shore up the parlous state of the banking system is just delaying the rebalancing, not altering the fundamental problems that caused the crisis. It seems that most mainstream economists have failed to note the real change in the world economy. Quite simply, they ‘don’t get it’.
I have written rather a crude explanation of the change at the link below. I had a curious conversation as I explained it to someone. They could not believe that no one had noticed - they felt that the nature of the problem is so blindingly obvious, but sometimes the blindingly obvious is only such when it is pointed out.
For what it is worth the link is here:
Posted by: Cynicus Economicus | September 8th, 2008 at 12:57 pm | Report this commenthttp://cynicuseconomicus.blogspot.com/2008/08/why-do-economists-get-it-so-wrong.html
Joseph Schumpeter (”creative capitalism”) got it right in his 1942 classic “Capitalism, Socialism and Democracy”. First he demolished the Marxian view of economics, then he analysed Capitalism and the reasons why it would self-destruct and lead to Socialism. Finaly he asked the question “Are Socialism and Democracy are compatible with each other?” (Ob Sozialismus und Demokratie miteinander vereinbar sind?) and his answer was “Yes, marvellously well”. (”Ausgezeichnet”).
This of course raises the opposite question “Are Capitalism and Democracy compatible?” and the answer I leave open.
P.S. Joseph Schumpeter (1883-1950), was a former bankrupt banker from Austria, who emigrated to the USA, became a Harvard professor, wrote “Business Cycles” in 1939, and is one of the USA’s favourite economists. His dire prediction about the fate of Capitalism fits today’s state of the US economy perfectly. Perhaps the time has arrived for
Posted by: J.J. | September 8th, 2008 at 4:00 pm | Report this commentthe USA to adopt the German model, the Social Market Economy?
The German media forecasted that shareholders won’t get such a bad deal as anticipated, but that a dividend might not be paid.
Posted by: J.J. | September 8th, 2008 at 4:59 pm | Report this commentIt now seems non-US investors will get special treatment. To alleviate the pain for US shareholders, and when dividend payment is resumed, make the dividends free of tax for US investors! This is what happened in a case in Germany, but the situation was different. In order to make the privatizatiojn of Deutsche Post more attractive to potential shareholders, the dividend was, and still is, paid out gross, tax free - and it is therefore tax-free also to German shareholders.