Arnold Kling  

I Need Talking Points on Fannie, Freddie

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Bailed it Shall Be... Good Post on Fannie, Freddie...

The Washington Post writes,


As the housing market boomed in recent years, Fannie and Freddie, like many lenders, took riskier loans. Freddie Mac executives have said they loosened lending standards to avoid losing market share.

This supports my version of events, rather than Paul Krugman's story of the FM's as immaculate victims of the housing bust.

The Post continues,


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.

UPDATE: Sebastian Mallaby writes,


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.


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TRACKBACKS (3 to date)
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The author at Knowledge Problem in a related article titled WSJ: Gerald O'Driscoll on Fannie and Freddie writes:
    Lynne Kiesling I am not sufficiently expert in financial markets to opine on the current state of affairs in mortgages, mortgage-backed securities, banks, and so on. Hearing the current state of financial affairs at the two quasi-public financial insti... [Tracked on July 15, 2008 12:57 PM]
COMMENTS (6 to date)
wintercow20 writes:

Arnold, the WSJ has a long list of historical OpEds it has published on Fannie and Freddie, in addition to simply mentioning this list, you might find a thing or two in there.

Here is the link the link.

saifedean writes:

Arnold,

This 11-year-old article gives some context on the inherently corrupt idea of these two firms: http://slate.msn.com/id/2423/

spencer writes:

Every point you made said that in recent years the FMs have shifted from acting like a government institution to acting like a for profit bank.

Yet you conclude that this shifting to act as a capitalist institution is a failure of central planning.

I would like to see a better defense of this line of reasoning.

Stephen W. Stanton writes:

Good luck getting more than one or two talking points across.

The medium is designed for simple messages supported by anecdotes and snarky criticism of opposing views. Not too many PhD's on talk radio.

Smart, effective people to be sure... But as a guest host, I doubt you'll have time enough to educate people on this complicated topic, then methodically build a case for one way to analyze it.

Gerg writes:

There is an interesting analysis in one of the big papers today - that both the right and left see this as a morality play. Libertarians broadly see this as government messing the market up by interfering, the "left" (very poorly defined, as this group seems to include a lot of the centre) sees it as a failure of regulation.

My view is, they're both right: it is an abomination to have a government subsidize and support specific players and to abdicate any responsibility to regulate same. Creatures of government can only be controlled by government, and if government interferes, it must set limits.

The phrase "privatization of profits and socialization of losses" applies to nothing more than the GSEs.

And while I think the GWB administration is an abomination, particularly in this area, I will give it credit for trying to set some limits for Fannie and Freddie. That's not the same as actually doing it, setting priorities, making compromises to get the best solution, and actually being competent, but they did speak about this frequently.

John Thacker writes:

Every point you made said that in recent years the FMs have shifted from acting like a government institution to acting like a for profit bank.

Yet you conclude that this shifting to act as a capitalist institution is a failure of central planning.

They have always been for profit. They've been for profit institutions existing on the basis of special freedom from regulations that other lenders face (and implicit government guarantees) theoretically in exchange for fulfilling various government targets and requests.

In recent years, despite the push from both recent Administrations and some Congressmen (notably the former Republican House chairman of one relevant committee), the government targets and urgings have all shied away from increasing regulation or forcing Freddie and Fannie to actually make good loans; instead, Congress has been content to be nice to them while insisting that Fannie and Freddie do even more to make housing "affordable"-- the latter has meant subprime loans.

In part this is due to the spectacularly good lobbying effort of the FMs; in part this is because Democrats in Congress who might be eager to regulate wholly private institutions have been unusually hands-off towards the quasi-public Freddie and Fannie.

Congress repeatedly rejected Administration attempts to make Freddie and Fannie play by the rules, insisting that their roles were to encourage homeownership as much as possible. Indeed, the recent housing bill calls on Freddie and Fannie to make even more loans to people who would otherwise not be able to obtain them; something generally called subprime.

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