Since the boom turned to bust, the government in some ways has given the companies freedom to dig themselves into a bigger hole...and ithas reduced their capital requirements.
So, I'm supposed to appear on a radio show this morning. I need talking points. Things are happening too quickly to keep up with. That's my first point. Some others:
1. For some reason, I am reminded of a Vaudeville scene in which firemen are squirting hoses at the set to try to put out an apparent fire, and management comes out on stage to say, "Don't worry, folks. It's all part of the act." My point is that it's very important at this time for people like Treasury Secretary Paulson and Fed Chairman Bernanke to make it seem like they know what they are doing.
2. It seems as though nobody wants to admit that the FM's are done for. Yet the new proposal on the table to have the government back more of the firms' debt and perhaps buy equity is so radical that I have to assume that there is no returning to the status quo.
3. If you could do it over again from a regulatory perspective, you would want to see the FM's market shares a lot lower and the market shares of other institutions, notably banks, a lot higher. I have to assume that this will be the thrust of policy going forward. It's just not something that is going to happen tomorrow.
4. I used to work at Freddie Mac, in the late 80's and early 90's. Back then, the capital regulations gave the FM's an advantage over banks in holding low-risk mortgages. We understood that, and we stuck to low-risk lending. As times changed, and the market shifted to high-risk loans, it would have been logical for the FM's to say, "This is not our market," and allow their market shares to drop. But top management, at least at Freddie, is pretty green (I'm not sure they could spell "mortgage" when they took over in 2003. When friends of mine described the behavior of the new management team, I decided to sell my Freddie Mac stock. This was at least four years ago.). Between that and government pressure to provide "affordable housing," the FM's decided that they needed to get on the subprime bandwagon rather than stop it.
5. A fundamental debate in economics is between central planning and the spontaneous order of the market. The collapse of the FM's, and of the housing market in general, can be viewed as a failure of central planning. Unfortunately, the dynamics are such that when central planning fails, you typically get more central planning.
Fannie and Freddie have made or guaranteed almost half of all loans to American homeowners. Can it be healthy to have the government control that much lending?
Of course not. But nationalization is healthier than the other options.
He is thinking that if we are going to socialize the risks, then why let private equity-holders keep anything? But if you think that way, then why let the holders of the FM's debt keep everything? Should the taxpayers be happy that they are only bailing out fixed-income investors and not shareholders?
Mallaby writes later,
As long as Fannie and Freddie retain their private/public form, private managers will invent reasons to grow courtesy of public assistance. The best shot at taming them is to bring them into the government. Then, once financial markets have stabilized, the government should shrink the institutions radically and spin them off in pieces, creating maximum space in the mortgage market for smaller private players.
I agree about redistributing mortgage assets to smaller private players. I would have hoped that this process could have occurred gradually, spurred by government regulations that level the playing field between banks and the FM's in terms of holding mortgage assets. But Mallaby may be right. And the proposal that Treasury put together may take us there.