Fannie & Freddie's nationalization: Smart economics or bad politics?
Last year, Fannie Mae and Freddie Mac owned or guaranteed nearly half of America’s $12 trillion in mortgages. Fannie and Freddie were (like many financial institutions) severely under-capitalized, and they had moved a bit away — under political pressure — from their traditional role of lending only reasonable amounts to credit-worthy borrowers (“conforming loans” conform to Fannie/Freddie standards) but remained far more responsible than most lenders during the housing bubble.
Further, Fannie & Freddie had profited handsomely and undeservedly for decades on their ability to borrow at very low interest rates due to their perceived U.S. government backing. (The market assumed that if Fannie and Freddie ever got in trouble, Uncle Sam would bail them out.) They raked in immense unearned “economic rents” thanks to their implicit government subsidy. And they spread some of those rents around to favored politicians (Democrats and Republicans alike) and their allies. Fannie and Freddie gave many Washington insiders cushy, high-paying jobs.
This created widespread jealousy. Wall Street envied those rents. And non-insiders coveted those jobs. So, when the economy began tanking, Fannie and Freddie’s many enemies attacked. Republicans had another reason to attack: Seeking to pin the blame for the recession on Fannie and Freddie rather than its true primary culprits: ratings agencies that gave “AAA” ratings to packages of subprime mortgages, “hot potato” lending — lending to anyone and everyone, even with no-money-down “liar loans,” knowing you could pocket the transaction fee and pass the risk to foolish investors — and Wall Street’s casino atmosphere following two decades of intense deregulation (non-regulation). Deregulation was a cornerstone of conservative free market ideology, but its passage was aided-and-abetted by Democrats. A majority of House and Senate Democrats approved the atrocious Gramm-Leach-Bliley Financial Services Modernization Act, and President Clinton signed it into law.
Bethany McLean, the reporter who broke the Enron story, offers a detailed look at Fannie and Freddie’s nationalization. It’s an interesting read, suggesting the decision to nationalize had more to do with politics than economics and that their nationalization may have scared investors and exacerbated the financial crisis:
Thus far the government has put not a dime into Fannie and only $13.8 billion into Freddie—which is a drop in the bucket compared to the taxpayer dollars that have gone to some other firms, such as the $45 billion Hank Paulson has handed Citigroup. In this alternative narrative, it was Paulson’s rash action of taking over Fannie and Freddie that helped cause the financial meltdown. As famous money manager Bill Miller, the chief investment officer of Legg Mason Capital Management, wrote in a recent letter to his investors: “When the government pre-emptively seized [Fannie and Freddie] not because they needed capital and could not get it, but because the government believed they would run out in the future, then shareholders of every other institution that needed or was perceived to need capital did the only rational thing they could do—sell, in case the government decided to pre-emptively wipe them out as well.”
In truth, Fannie was a company with extraordinarily powerful enemies. They spanned the decades, the two parties, and the ideological spectrum, from Reagan budget director David Stockman to Clinton Treasury secretary Larry Summers to President George W. Bush, and from Ralph Nader to former Federal Reserve chairman Alan Greenspan. These enemies, who detested the privileges Fannie got from its congressional charter, had long wanted to drastically curtail the company—or kill it outright.
Posted by James on Thursday, February 05, 2009