Fanny and Freddie Got Fingered

by Rob Horning

14 July 2008


Okay, that entry title makes no sense for a post about the impending Freddie Mac/Fannie Mae bailout, but I just wanted to make a pun referencing the funniest movie of the 1990s.

Freddie Mac and Fannie Mae are in the business of guaranteeing residential mortgages, and not an inconsiderable amount of them—more than half, as economist Jared Bernstein notes here. Freddie and Fannie masquerade as independent companies, but investors have always assumed that they are really government agencies and therefore can never go broke. If a spate of mortgages they had guaranteed went bad, taxpayer money would simply be requisitioned to allow the firms to continue operating, since they clearly don’t have the capital on hand to deal with any significant problems. The wisdom of that assumption is now being put to the test, as Fannie and Freddie are spirialing into oblivion.

As mortgages became more and more subprime, they chose to keep up their market share, as Tanta at Calculated Risk details in this comprehensive post. Because of restrictions in their charters, they managed to avoid the worst of the housing bubble’s excesses, but, as Tanta argues, they therefore missed the opportunity to use their clout to impose some discipline on the subprime business, and instead it remained the wild west of financing, a place full of dupes, dishonest brokers, and fat profits to reap—as long as housing prices continued rising. That didn’t happen, as many housing bubble skeptics including Dean Baker and Nouriel Roubini had predicted at the time. To ease problems the credit crunch brought to the private-lending market, legislators pushed to expand Fannie and Freddie’s operations, a idea that investors are now seeming to recognize is a pretty bad one, likely to make their loan portfolios—already threatened by sinking home prices everywhere—become even worse.

With the companies’  insolvency looming, the government has to do something (without them, buying and selling houses in America could become well nigh impossible), but the Republicans in charge are loath to admit the necessity of nationalizing them, nor are they eager to stick it to Wall Street by letting all of Fannie and Freddie’s investors burn. So Treasury secretary Hank Paulson, confronted by a kind of ideological zugzwang, tried to gain a tempo by making an ambiguous speech (admirably parsed here by Felix Salmon). And that’s where things stand currently.

At the FT site, Willem Buiter has the best explanation of what’s wrong with all of this: it’s “dishonest socialism”:

There are many forms of socialism. The version practiced in the US is the most deceitful one I know. An honest, courageous socialist government would say: this is a worthwhile social purpose (financing home ownership, helping my friends on Wall Street); therefore I am going to subsidize it; and here are the additional taxes (or cuts in other public spending) to finance it.
Instead the dishonest, spineless socialist policy makers in successive Democratic and Republican administrations have systematically tried to hide both the subsidies and size and distribution of the incremental fiscal burden associated with the provision of these subsidies, behind an endless array of opaque arrangements and institutions. Off-balance-sheet vehicles and off-budget financing were the bread and butter of the US federal government long before they became popular in Wall Street and the City of London.
The abuse of the Fed as a quasi-fiscal agent of the federal government in the rescue of Bear Stearns is without precedent, and quite possibly without legal justification. The creation of the Delaware SPV that houses $30 billion worth of the most toxic waste from the Bear Stearns balance sheet (with only $1 billion of JP Morgan money standing between the tax payer and the likely losses on the $29 billion committed by the Fed to fund the SPV on a non-recourse basis) is the clearest example of quasi-fiscal obfuscation I have come across in an advanced industrial country. The decision by the Fed to ‘invite’ the primary dealers and their clearers to collude in the (over) pricing of illiquid collateral offered by the primary dealers to the Fed at the newly created TSLF and PDCF (by the Fed accepting the pricing/valuation by the clearers of the illiquid collateral) is another example of the abuse of the Fed as a vehicle for channeling taxpayer-financed subsidies to the primary dealers. This form of socialism for the rich is therefore well-established.

This is how oligarchs prefer the economy to operate: Privatize the gains, socialize the risk. And it seems to me that the obfuscation brought on by the sacredness attributed to homeownership—that anything is excusable as long as it helps “families” experience the indelible blessing of owning property—is what enables it.

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