Fannie, Freddie, and Repeating Economic History
The conventional opinions on the Fannie and Freddie bailout are not terribly broad. From the Left, we hear recycled market-failure arguments, whereas from the Right we hear that the bailout is a necessary evil to be endured until the economy and the housing market rebounds in a few years, at which time--mirabile dictu!--real free market reforms can be implemented by a future congress supposedly more enlightened than the present one.
This is, of course, a con to deflect blame and pacify an otherwise enraged public at least until November 5, 2008. But then what? Here are a couple of scenarios that I see as likely.
The best-case scenario is for Fannie and Freddie to be allowed to chug along in some form for a couple more years, at the expense of higher inflation and an even weaker dollar (if that is even possible). Bernanke's term is up on 2010, and the next president will then appoint a Volcker-like figure who will remove not only this liquidity from the economy, but also much of the already significant liquidity of the Greenspan-Bernanke Feds. (If Obama is elected, he may even appoint Volcker himself.) This Fed chairman will be reviled--the ultimate skunk at the garden party--but he will serve the purpose of clearing the deck for the political class that trashed it through the 1990s and 2000s. Once those dollars are removed, then the Fed can repeat the mistakes of the last 20 years. It will be Open Market Operations as usual.
That is my best case scenario (among likely scenarios). The worst-case is that the bailout will not allow Fannie and Freddie to simply chug along, and the US and global economies continue to atrophy. The result will be a future Bretton Woods-like meeting that announces the end of the implicit international dollar standard on the basis that it proved insufficiently liquid and while also being incompatible with the speed of modern capital flows, thus requiring the creation of a new currency that will be global, issued by a world central bank, and legal tender. This is the scenario currently called for by Robert Mundell.
None of these scenarios are especially encouraging. Fannie and Freddie need to fail (to say nothing of many badly-run banks), and the short-run political and economic upheavals welcomed as necessary precursors to true free-market reforms and the emergence of a long-hindered liberal international order. That they are not being allowed to fail means that these reforms are even less likely. What is happening now reflects the situation in Japan around 1990, when its over-inflated banking system busted and the response was to print as much yen as necessary, resulting in a prolonged and painful recovery. We are following the same path, thus proving that those ignorant of economic history are doomed to repeat it.
Comments (8)
Theforgottenman
Can someone explain how Freddie and Fanie Mae work? They back certain home loans (like 700 billion?) and what would happen if we let them fail? Thanks.
Published: September 10, 2008 4:34 PM
Rationalitate
It's sad that I haven't heard anywhere – not even from the Mises Institute – much about Freddie and Fannie's role in CREATING the subprime mortgage crisis that eventually brought them down. Congress and HUD put pressure on them to make more subprime loans, and they essentially created the market that the private sector would then be forced by the laws of competition to invest in. The biggest failure here isn't that the US is bailing them out, but that they were forced into making these loans in the first place.
Published: September 10, 2008 6:44 PM
YerMawm
Theforgotten* -
As I understand it FNM/FRE buy mortgages from lenders who make the loans (ie. Countrywide, WaMu, etc). Next they will do one of the following:
A) bundle these loans up into securities, and sell them to different investors like Citigroup, Bear Stearns, Lehman, Russia, China, hedge funds, etc. This generates revenue for FNM/FRE to buy and repackage more loans from the lenders.
B) Keep the loans on their books (the reasons/criteria behind this I am not sure of...anyone know?)
Buy buying these loans from the lenders this action frees up capital at the lending institutions (The Countrywides, and WaMUs) to be loaned to other home borrowers. Lenders have to keep a certain amount of deposits on hand in proportion to the loans on their books. Once they reach this cap they must either:
A) Stop lending
B) Take in more deposits.
C) Sell their loans to somebody
Since the lenders sell these loans no strings attached, to FNM/FRE they have no interest in ensuring the loans can be paid.
The problem is FNM/FRE are currently responsible for $5 Trillion in mortgages, which we the taxpayers just guaranteed thanks to Bazooka-Boy Paulson. Did we in our paragon of democracy, which we want to spread to the 4 corners of the earth, get a say how our tax dollars were just spent???? Nope
Did I miss anything? I'm sure there are some good links on the topic
Published: September 10, 2008 7:38 PM
YerMawm
Oops....if they failed??? Buy beer and bullets.
Well housing would further plummet as could the dollar. Interest rates would probably climb...I think.
Check out Peter Schiff's "Crash Proof" for some good insights.
Anybody, please correct me if I am wrong.
Published: September 10, 2008 7:55 PM
Rationalitate
Something else important about them: they ARE the mortgage market. Before all this, they had their hand in about half of all mortgages, and recently they've handled about 70% of all new mortgages. This is all mortgages, not just subprimes.
Published: September 10, 2008 8:33 PM
Matthew
Everyone is perfectly willing to blast Bernanke for "inflating" but that's not what the record shows. Take a look at the monetary base. Its growth is within a normal range, historically speaking. He has so far avoided whatever temptations might exist to print like crazy to "get us out of this."
I'm not saying this to defend Bernanke or to defend the Federal Reserve. I think the Fed is awful and behind the whole mess. I'm saying it because calling for another Volcker is not as simple as the solution is.
Published: September 11, 2008 9:28 AM
YerMawm
Yeah a new Fed chairman, or strategy is not the solution. I don't blame Benny at all. Eventually he will have to start the presses.
Does anybody else find it scary the efforts behind promoting FHA backed Reverse mortgages? Has nothing been learned here?
Watch for PBCG, and FHA to come crawling to congress for more money
Published: September 11, 2008 2:15 PM
gene berman
The process of repairing currency/banking crises seems merely to guarantee that another, even larger, will occur at some time in the future. Eventually (and I do not propose to predict either time or nature), that suggests a crisis embracing all the currencies and banking systems of the world (recognizing that not a single national currency is convertible to anything resembling a money commodity).
Given the speed of modern communication, the potential exists for a flight out of currencies resembling a "run" on a bank--circling the globe in all directions and within only a few hours and with no possibility of "dealing" with the crisis by any other method than martial law in every jurisdiction.
The "powers that be"--all of them--are engaged in a type of "brinkmanship" on a truly staggering scale. If they understand this, their actions (past and present) are both negligent and criminal. If they don't understand--that's even worse.
Published: September 13, 2008 11:02 AM