Fanny Packs
The latest financial debacles hitting Wall Street necessitate two questions. First, what caused the mess? Second, what should be done (and are the recent actions to correct it the right thing to do)? You’ll find no shortage of commentary attempting to answer both questions, and much of it will be far more insightful than this post here. But I would like to add some historical perspective which occasionally gets lost in the shuffle.
Fannie Mae was created as a full-fledged government agency in 1938 at the height of FDR’s New Deal in order to, among other things, assist banks in providing mortgage loans to lower and middle class families. With Fannie Mae, banks had the backing of the federal government in making risky loans that, in a free market, might never be made.
Of course, guaranteeing debt put a strain on the federal government’s balance sheet and so in 1968 it spun the company off as a “private” entity, though the President still appointed 5 of the board’s 18 members. Moreover, Fannie Mae was exempt from state and local taxes, exempt from SEC filing requirements, and FDIC regulations governing the solvency of financial institutions (particularly the capital/asset ratio) were relaxed. Equally important, it had a line of credit with the Treasury and investors long believed the government would back Fannie Mae’s securities in a time of crisis (oh how right they were).
But this so-called “private” company still had a monopoly on the market, and so Freddie Mac was created as its twin to provide some modicum of competition, though they continued to act like twins do – reinforcing the other’s efforts wherever that may be. Fannie Mae and Freddie Mac, once small government programs, together now own or guarantee nearly half of all home loans in the U.S.
Reading some liberal blogs over the past few weeks, one could easily get the impression that Fannie Mae and Freddie Mac are free market entities run amok in a sort of Adam Smith wonderland. But clearly these behemoths are creatures of the federal government, implicitly backed by the government and encouraged to take risks few other truly free market enterprises would take.
While other truly private entities may have crashed and burned years ago from foolish and/or overly risky business ventures (in this case, bad loans), Fannie Mae and Freddie Mac were insulated in an unholy alliance of private profit and government power. Wall Street Journal Editorial Page Editor Paul Gigot summed it up well when he wrote, “The abiding lesson here is what happens when you combine private profit with government power. You create political monsters that are protected both by journalists on the left and pseudo-capitalists on Wall Street, by liberal Democrats and country-club Republicans.”
Eventually though the bubble was bound to burst, and given the size of these two dominoes, they weren’t going down alone. Now that we’re in the mess I don’t claim to know the way out, though I’m probably persuaded most by Tyler Cowen’s position that leaving everything to burn is simply not feasible. Regardless of the solution, we should avoid a similar mistake in the future. I’m just not confident we’re learning the right lessons from its history.
4 Responses to “Fanny Packs”
Maybe the question should be what caused the mess before we start asking who caused it.
A lot about this crisis is way over my head, but I do know it didn’t come out of nowhere. I’ve been aware of warnings for well over a year by various analysts who had been eerily comparing our housing/credit bubbles to the 1980’s era bubbles in Japan. Japan’s property and stock market bubbles burst in the early ’90s and their economy is still struggling to get back.
Here’s a prescient March 2008 op-ed in the NY Times from one of those analysts, Stephen Roach, former chief economist of Morgan Stanley, now chairman of its Asian operations. Roach thinks our U.S. economic crisis is rooted in sustained over-consumption (ie: shifting from income to asset-based saving).
In the op-ed he warns against forestalling “the endgame of post-bubble adjustments. Government aid is being aimed, mistakenly, at maintaining unsustainably high rates of personal consumption. Yet that’s precisely what got the United States into this mess in the first place -Â pushing down the savings rate, fostering a huge trade deficit and stretching consumers to take on an untenable amount of debt.”
He proposes instead: ‘A more effective strategy would be to try to tilt the economy away from consumption and toward exports and long-needed investments in infrastructure.”
He adds a caution: “That’s not to say Washington shouldn’t help the innocent victims of the bubble’s aftermath – especially lower and middle-income families. But the emphasis should be on providing income support for those who have been blindsided by this credit crisis rather than on rekindling excess spending by overextended consumers.”
A note on Freddie Mac and Fannie Mae, taxpayers. Here’s their charter:
the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation have an affirmative obligation to facilitate the financing of affordable housing for low- and moderate-income families in a manner consistent with their overall public purposes, while maintaining a strong financial condition and a reasonable economic return.
In 2006, Tishman Speyer and BlackRock Realty purchased a large residential apartment complex in NYC from Metropolitan Life for $5.4 billion, in what is considered the most ever paid for a single residential property. At the time, the purchase was considered an extremely rich, top-of-the-market transaction. Barron’s thought the debt was way too much (based on too agressive income projections). A large chunk of that debt is held by Fannie Mae and Freddie Mac, despite a charter that states that are required to make housing more affordable, not to bet $$$ on risky, hugely expensive projects that require rents to triple to break even.
I believe that the most appropriate thing that could be done is to dismantle them into smaller organizations and to regulate the system in a way that prevents it from becoming hyperdominated by overly large organizations.
This regulates a system more than I would like to do so in theory, and it caps out the top of the system through losses in efficiency gained by scale, but whenever a company gets “too large to fail” then we are in affect practicing social capitalism. The risk is borne by the taxpayers, while the return is wholly given unto the company. That’s a ridiculous imbalance.
Oops. here’s the link to the op-ed by Stephen Roach in the NY Times: http://www.nytimes.com/2008/03/05/opinion/05roach.html?_r=1&ref=opinion&oref=slogin
We’re about to see the definition of a boondoggle come out of capital hill.