From what I glean in my own research, The New York Times has it exactly wrong. Many leading economists, both Democrat and Republican, think that the cause of the mortgage meltdown was explicitly due to involvement of the government with Fannie and Freddie. If the government had not implicitly backed these two institutions, the risk levels for investment would have been higher and the market would have acted more appropriately. With the government backing them, the risk was much lower and therefore Fannie & Freddie, and the lenders who sell its mortgages to them, could take unreasonable risks in hopes of a profit. In this way, the government's involvement actually was a primary contributor to the meltdown and instead of stepping up government involvement, it should be reducing it. Robert Reich, in Newsweek, calls this "the worst form of socialized capitalism - private gains combined with public losses"
Now here is my question, what actually happens if Fannie and Freddie go under?? I know every article says they are "too big to fail" but what would actually happen?
The press implies that everyone would lose their house and we would go into a deep depression. Great. But HOW would this happen? I want to know. I am a homeowner and if my mortgage company goes out of business, whom would I pay? Who does Fannie and Freddie owe money to and how would their failure to pay their lenders affect me and my ability to live in my house?
My suspicious hunch is that the $25B housing bill is not to keep me in my house. It is instead intended to keep the real estate business operating. Without Fannie and Freddie to buy up all the mortgages, construction, lending, real estate services, city tax bases, commercial services, and many other prfessions would be adversely affected because it would be harder to get a mortgage. If you can not get a mortgage, then there is no need to buy or build a new house. It has broad sweeping implications for people in many classes.
So, the $25B appears to be a social welfare program to keep the economy afloat. I am not well-versed enough to say either way whether this is the smartest approach or not. However, historically, the government's involvement appears to have been a prime contributor to this particular popping bubble. Without its involvement, lenders, which sell approx. 50% of their mortgages to Fannie and Freddie while keeping the lucrative transaction fees, would have been more selective in its lending if Fannie and Freddie would have been more selective in its approach. Unfortunately, with the government backing, Fannie and Freddie could take unreasonable risks because they only had upside; the downside would be paid for by the government, and by extension, the taxpayers.
I suppose that all of this can be correlated to the same situation in Iraq. The government has made a mess and the $25B is to clean it up. While a much cheaper price than Iraq ($1T), the $25B investment is only worth it if meaningful reform to the system is implemented to re-introduce the risk of the market forces and eliminate the safety net provided to private corporations by the government. Without the reform, the band-aid just adds debt to our credit card and at some point the bill will come due again at a much higher price.
The Atlantic's Megan McArdle has a great summary of other commentary on the topic. Some notable quotes:
- Megan McArdle: "Because they are government sponsored, the government let them get away with practices that would never fly in the private market."
- Arnold King: "Unfortunately, the dynamics are such that when central planning fails, you typically get more central planning."
- Steven Bainbridge: "Want a worst case scenario? The government takes over Fannie and Freddie."
- Clive Crook: "One way to think of it is this: take the US national debt of roughly $9,000bn and add $5,000bn."
9/18/2008 UPDATE: OMG... "Wall Street rallied in a stunning late-session turnaround Thursday, shooting higher and hurtling the Dow Jones industrials up 400 points following a report that the federal government might create an entity to absorb banks' bad debt... Wall Street hoped a huge federal intervention could help financial institutions jettison bad mortgage debt and stop the drain on capital that has already taken down companies including Bear Stearns Cos. and Lehman Brothers Holdings Inc... Congress established the RTC in 1989 to buy $394 billion worth of real estate, mortgages and other assets of hundreds of failed savings-and-loan institutions. The corporation operated for several years disposing of the associations' assets, and then went out of business." (source: Tim Paradis, AP Business Writer, "Stocks surge on report of entity for bad debt"). This is just stunning how much executive authority the Fed and Treasury have employed over the past few months. These moves seemed, I thought, designed to create a soft landing, but I fear they are intending to keep the Hindenburg in the air. YIKES
9/22/2008 UPDATE: The projected tab for the aforementioned bailout agency is up to $700B. It is not clear if that is in addition to or includes the $314B already in play. If so, we are now at the price of Iraq at $1T. Fortunately, the deal is not yet approved and the congress is actually going to debate it. This is good news. Regardless of where we end up, we need to debate it. As they say, 'haste makes waste' and 'slow is fast'.
9/29/08 UPDATE: The bailout bill just failed. The dow is down 777 and the Nasdaq is down 200. Mayhem. No one is sure what the result might be. I am optimistic.
9/30/08 UPDATE: I continue to hear that if we do not enact the bailout bill, the credit markets will freeze up and hurt the ability for middle-class americans to buy homes and for small businesses to secure loans. This is a talking point intended to sway voters. It is probably even valid and points out an unfortunate reality for the average person (one unrealized at the start of this original post's string). But when I listen to these types of statements, I actually hear them saying that if we do not enact the bailout bill, we will not continue to be able to accrue debt beyond our means. As one who plummetted into debt during college, without a real understanding of debt, I have spent the last 10 years running away from it and clearing up as much debt as I can. I have no credit card debt. I have no student loan debt. And I spend every day thinking about how fast I can pay off my mortgage debt. Financial freedom is without debt. Borrowing can help you afford more, but if everyone borrows, that just leads to inflation. My big issue is not with Wall Street or homeowner relief or any of the other positioning points; my issue is that there is not recognition that debt in excess of what one can pay back is wrong, perhaps immoral. Worse, incurring debt in excess of what one can pay and forcing payment with other people's money is immoral, perhaps evil. My optimism with the failing bill yesterday is not because I want recession. It is based on the fact that I am hopeful that the public's recognition of (awakening to?) debt's evils may actually lead us back to true financial freedom.
