Fannie's and Freddie's Fates No Surprise to Good Economists

by Don Boudreaux on September 22, 2008

in Current Affairs, Financial Markets, Reality Is Not Optional, Regulation

Monday-morning quarterbacking is as easy as it is self-indulgently gratifying.  Forward-looking perceptiveness is much more difficult and, hence, much more impressive.

In 2001, Jay Cochran (then with the Mercatus Center at George Mason University, and a GMU Econ PhD) and Catherine England (former Senior Policy Analyst at the Cato Institute) co-wrote this paper predicting trouble with Fannie Mae and Freddie Mac.  In a 2001 interview about the paper, Jay said the following about the special privileges Congress granted these government-sponsored enterprises (GSEs) :

These privileges do more than just give the GSEs a funding cost
advantage, they also reinforce the perception of a federal guarantee on
GSE debt obligations.  In order to avoid a federal bailout like the one
we saw with the savings and loan industry, policymakers may want to
consider a variety of alternatives, including privatization of one or
more of the GSEs.

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{ 40 comments }

T L Holaday September 22, 2008 at 7:51 am

It is good to see forward-looking perceptiveness about the financial climate praised here.

Forward-looking perceptiveness about the meteorological climate earns no praise here for Al Gore.

Methinks September 22, 2008 at 8:52 am

I guess we'd better get used to it. The entire financial system is now a GSE.

vidyohs September 22, 2008 at 9:14 am

Ahhhh, so there is a direct correlation between the federal climate and the meteorological climate.

Who knew that there was someone out there that desired praise for the Goreacal?

muirgeo September 22, 2008 at 9:19 am

From the article "….the Gramm-Leach-Bliley Financial Services Modernization Act in 1999 significantly changed the activities of the FHLBs and the way in which they are regulated."

Clinton threatened to veto the bill but the Republican lead Senate had established a veto-proof majority.

From Thomas Palley Scapegoating Regulation

"Yet the reality is far more complex, and economic conservatives will not roll-over and surrender just because of a financial crisis. Instead, if history is a guide, they will blame regulation for the crisis. That was Milton Friedman’s modus operandi when he launched the modern era of deregulation and animus to government with his false claim that the Fed caused the Great Depression."

"Moreover, the roots of the crisis lie in the sub-prime market. That is where “no doc” and “zero down” mortgages proliferated, where loan originations exploded in volume, where losses started, and where the bulk of losses have been so far. Yet, Fannie and Freddie are prevented from financing such mortgage products by their charters.

These facts should make clear that Fannie and Freddie did not cause the crisis. Instead, it was driven by loose and negligent lending by banks and Wall Street. That behavior was due to lack of regulatory oversight, combined with a failed incentive system that rewards management and mortgage brokers for pushing loans rather than prudent lending."

Matt September 22, 2008 at 9:35 am

Privatizing seemingly would not have made a difference–private companies were still bailed out.

And muirgeo, out of respect for our blog host who asked me not to, I will offer no gratuitous insults or name calling. But I really want to. Really. Like a lot.

Hammer September 22, 2008 at 9:36 am

So, just what about the weather did Al Gore successfully predict? So far as I can tell, there is no particular changes that were foreseen, or even proven to be relevant to the models they cite. Of course, we are having an unseasonably cool and pleasant late summer/early fall here in the north east, so we are not so worried about "warming".

Don Mynack September 22, 2008 at 10:09 am

FWIW – I've seen this all over the place, but those of you who don't normally follow Libertarian websites, here's Ron Paul trying to introduce legislation in 2003 to completely privatize Fannie and Freddie. BTW – the bill died in the house.

http://www.lewrockwell.com/paul/paul128.html

The same text is on his official website but I couldn't find the link.

Randy September 22, 2008 at 10:27 am

This whole situation reminds of the saying that every crisis is an opportunity (or words to that effect). The opportunity here seems to be a chance to get private lenders out of the government's business. Go ahead. Regulate away. But do it in such a way that no private lender would ever touch the sub-prime market again. Turn sub-prime entirely over to government. Leave them with no one to blame.

Sam Grove September 22, 2008 at 11:30 am

While progressive/liberals like to holler about "deregulation", any scenario where businessmen are able to secure rules changes that they like, this is not "deregulation". That such happens is a systemic problem of a regulatory system.

Milton Friedman also advised restraint in managing the money supply via the FED and the Treasury. He eventually concluded that politicians would not follow such sage advise and decided that maybe a monopoly credit institution wasn't such a good idea after all.

The point? What Friedman advised isn't necessarily what politicians did.

Sam Grove September 22, 2008 at 11:44 am
Babinich September 22, 2008 at 12:18 pm

muirgeo says:

"These facts should make clear that Fannie and Freddie did not cause the crisis. Instead, it was driven by loose and negligent lending by banks and Wall Street."

Don't be too sure…

In 2005 a prescient Fannie and Freddie reform bill was passed by the Senate Banking Committee. The bill gave a regulator the right to crack down on Fannie and Freddie requiring the two GSE's to eliminate their investments in risky assets.

Ask yourself who killed the bill and why?

muirgeo September 22, 2008 at 12:38 pm

Ask yourself who killed the bill and why?

Posted by: Babinich

What you need to do is put up the bill number then we can read the transcripts of the debate about the bill.

When I do this I consistently find misrepresentations of what the bill was and why some one voted the way they did.

All week I've been hearing about how Clinton signed the bill to kill Glass Steagall. Of course when I look into it I find he threatened to veto it but the Senate had a veto proof majority.

BoscoH September 22, 2008 at 1:07 pm

It is amusing to see progressives like George try to pin this on deregulation and who signed what bill. We had a housing price bubble, fueled by lots of things. Near the end, we have two GSEs whose purpose in life is to make housing more affordable needing to be bailed out. Can we at least agree that the attempt to make housing more affordable failed miserably? Whether or not it was an (or the) ultimate cause of this mess, can we at east admit that we shouldn't try it again?

Oil Shock September 22, 2008 at 1:24 pm

Prof Frank Shostak discredits the too big to fail myth.

Where as, Keynesians in drag, pseudo "Free-market" pimps keeps pimping for a bailout.

Oil Shock September 22, 2008 at 1:24 pm

When was the last time Fannie filed a proper quarterly report?

Sam Grove September 22, 2008 at 1:39 pm

This free market advocate completely opposes the bailouts.

Government GSE's, an SEC, corporate subsidies, protectionism, etc. are NOT free market.

Oil Shock September 22, 2008 at 1:54 pm
Martin Brock September 22, 2008 at 2:16 pm

Who knew that there was someone out there that desired praise for the Goreacal?

Reportedly, that's Henry Paulson.

http://cei.org/gencon/003,05349.cfm

Sam Grove September 22, 2008 at 2:17 pm

Regulation indeed created the current mess

That's not sufficiently descriptive.

Regulation created the incentives that brought on this mess. Alas, human nature is not to be thwarted.

If I may quote myself:

When government creates bureaucracy to regulate business, the incentive is created for business to influence that bureaucracy, either directly, or via influence on legislators.

It's not so simple as blaming 'the government' as much as discerning the systemic flaws in regulatory systems.

It's similar to drug prohibition creating profit incentives for drug distributors to corrupt enforcement bureaucracy.

Here's a question: Given the fact of drug prohibition, how do you eliminate drug criminality?

You can't

Given the existence of business regulation, how to you eliminate business's influence on the regulatory system?

You can't.

A system of political power creates an oligarchy. Businesspeople quickly learn that it is better to join the oligarchy than to remain outside of it.

What can we the people do about it?

Keeping government out of business will keep business out of government.

That's the only way…as I see it.

Oil Shock September 22, 2008 at 2:24 pm

This is a quote from "America's Great Depression" by Murray Rothbard…( from mises blog )

As early as mid-July, Hoover returned to a favorite theme: attacking short-selling, this time the wheat market. The short-selling speculators were denounced for depressing prices and destroying confidence; their unpatriotic "intent is to take a profit from the losses of other people"–a curious charge, since for every short seller there is necessarily a long buyer speculating on a rise. When the crisis came in the fall, the Stock Exchange authorities, undoubtedly influenced by Hoover's long-standing campaign against such sales, restricted short selling. These restrictions helped drive stock prices lower than they would have been otherwise, since the short-seller's profit-taking is one of the main supports for stock prices during a decline. As soon as the crisis struck in the fall, Hoover reverted to his favorite technique of holding conferences. On September 15, he laid plans for a Conference on Home Building and Home Ownership to be held in December, to promote the widening of home ownership and to lower interest rates on second mortgages. The resolutions of the December conference originated many of the key features of later New Deal housing policy, including heavy long-term credit at low rates of interest and government aid to blighted, low-income housing.

Chapter 10 – 1931: The tragic year

Sam Grove September 22, 2008 at 2:39 pm

If I could stand it, I would go through muirgeo's many posts to show how he blames ecnomic problems on the free market, yet at other times claims that free markets have never, and could never, exist.

maximus September 22, 2008 at 3:42 pm

"If I could stand it, I would go through muirgeo's many posts"-Sam Grove

Sam if you do that, you will find yourself morphed into Col Kurtz of Apocolypse Now fame,locked in a dark room unable to say anything but "the horror,the horror".

Dano September 22, 2008 at 8:40 pm

Muirgeo wrote:

"All week I've been hearing about how Clinton signed the bill to kill Glass Steagall. Of course when I look into it I find he threatened to veto it but the Senate had a veto proof majority."

Two points:
1. Threatening a veto is not the same as vetoing a bill. If he was really opposed to the bill, the principled stand would be to veto it and make the Senate override the veto.

2. From what source did you get that the Republicans had a veto-proof majority? I just checked. After both the 1996 and 1998 elections the breakdown was 55 Republicans and 45 Democrats. According to the Senate webpage, 2/3 of each house need to vote in favor of overriding the veto. 2/3 of 100 is 67, which is more than 55.

Also, the article you linked to in the first post says the threatened veto was over the weakening of the Cumminity Reinvestment Act. My now retired Democratic Congressman, who served on the banking committee, privately admits that the CRA contributed to the subprime problem by pressuring financial institutions to make mortgage loans to, well, everybody.

Babinich September 22, 2008 at 9:36 pm
Dano September 22, 2008 at 10:11 pm

"was over the weakening of the Cumminity Reinvestment Act. "

It should be … the Community ….

Ouch. I thought I proofread it before I posted. Sorry.

Sam Grove September 23, 2008 at 12:07 am

Hmmm, cumminism.

Is that cummin as in "Y'all cummin and have a sit."
or as in: I'm cummin!

muirgeo September 23, 2008 at 1:34 am

Babinich

Of the GSE's Chuck Hagel the author of the bill says;

There is no doubt that our housing government sponsored enterprises GSEs, have been successful in carrying out their mission of providing liquidity for the housing market. The market has remained strong through tough economic times, and homeownership in this country is at an all-time high.

The bill died in committee (Republican majority) so it was never voted on by Democrats and I can find no statements by them on the bill.

It looks like this is a bill the Republicans were able to come up with that makes McCain look like a reformer and a regulator. That's apparently all they could find and those reformer republicans couldn't even get it out of their committee.

This is a non story promoted by the Sean Hannnity idiots of the world because they've got nothing.

Their party has caused multiple systemic governmental crashes that have re-verberated across our country and cost tax payers far more then any supposed tax costs they've ever offered.

muirgeo September 23, 2008 at 1:43 am

Hey all,

Right now you have Emperor Paulson and King George asking for a $800,000,000,000 check with no strings attached. When Clinton was in office your stocks rose plenty to make up any increases in taxes you paid.

You wanna be dumbasses and vote for more of the same then have at it. The economy always does better with Democratic presidents and Great Depressions and loss of social liberties regularly happen after too long of rule by Republicans. That's the facts and those are you only choices. The rest of the world understands this why can't you.

muirgeo September 23, 2008 at 1:53 am

Babinich,

http://www.commondreams.org/headline/2008/09/22-3

Here's a fact for you. Senator McCains Campaign FRICKING Manager was paid $30,000 a month for nearly 5 years to lobby for Fannie and Freddie AGAINST stronger regulations.

Fannie and Freddie failed because they had been privatized just like you all wanted to do with social security.

One thing I can agree on is never allow these damn government /private hybrid enterprises to exist. They are also bound to fail from conflicts of interest but they are what the Republicans love because they love raiding government funds for all their friends.

Hans Luftner September 23, 2008 at 3:16 am

George, I don't know what makes you think we're all a bunch of Republicans who support what Republicans support & love Republicans & want to vote Republican all the time. Maybe if you would, just one time, read what other people post, maybe you can add something useful to this discussion.

We tend to support free markets. Republicans don't. We understand that. You don't. Until you learn that, you won't learn anything.

You get all bent out of shape if somebody calls you a marxist, but you sit there & attribute beliefs to us that we don't advocate. Think about that. You won't. You'll just react emotionally to it.

Babinich September 23, 2008 at 5:52 am

muigeo says:

"Babinich,

http://www.commondreams.org/headline/2008/09/22-3

Here's a fact for you. Senator McCains Campaign FRICKING Manager was paid $30,000 a month for nearly 5 years to lobby for Fannie and Freddie AGAINST stronger regulations. "

Please do not go down the party road. These specific GSEs have democratic hand prints all over them.

The Bush administration proposed stepped-up oversight of Fannie Mae and Freddie Mac back in 2003.

Rep. Michael Oxley (R., Ohio) and Sen. Richard Shelby (R., Ala.), chairmen of the congressional committees that oversee the companies, promised to write up legislation along the lines the Bush administration outlined.

McCain is by no means perfect, but who has more credibility on Fannie and Freddie? The one who offers legislation against it or the one that is enriched by contributions from this chimera?

McCain (actually working in the Senate body)
http://thomas.loc.gov/cgi-bin/query/D?r109:16:./temp/~r109ouZsPl::

Obama ("benefiting" from his position in the Senate)
http://www.propublica.org/article/fannie-freddie-gave-big-support-to-obama-mccain-910/

Sam Grove September 23, 2008 at 10:20 am

Show of hands. Any regulars here support McCain?

Muirgeo, do you possess any critical thinking skills at all.

If so, please reveal them.

Sam Grove September 23, 2008 at 10:23 am

I'm seriously considering not voting for a presidential candidate this year.

I typically vote libertarian, but, at this time, I don't think I can actually cast a vote for Barr.

Oil Shock September 23, 2008 at 11:34 am

I won't cast my vote for McCain. I wont be voting.

Hans Luftner September 23, 2008 at 1:38 pm

I'm going to vote for the guy I want to be president. So I won't be voting either. There'll be no blood on my hands this time, & I'll be free to complain about whomever wins.

brotio September 24, 2008 at 12:21 am

Because I think we must leave Iraq as victors and not from helicopters on top of the US Embassy, I have no choice but to vote for McCain. Obama intends to surrender Iraq.

The fact that Obama and Muirduck agree that the government should run health care is another good reason to vote for the only other candidate who has a chance of winning.

The fact that Muirduck is an Obama supporter is reason enough. Socialist birds of a feather, and all that.

brotio September 24, 2008 at 12:53 am

Oh yeah, on the gun topic :)

I just read about Ruger's Mini-6.8. I would like something with more power than a .223 for a "Shit Hits the Fan" gun, and I don't like the way AK's shoulder (especially because I shoot left-handed), so I'm really intrigued by the new Ruger.

The Mini might be as indestructible as an AK, and they fit me much better (I already own a Mini-14).

Hans Luftner September 24, 2008 at 2:26 am

and not from helicopters on top of the US Embassy

I personally like the helicopter idea, but Obama won't give up Iraq either. I also wouldn't put it past McCain to nationalize health care. He's already admitted he knows nothing about economics.

Part of me hopes Obama will win just so I can see my leftist friends & co-workers rationalize all the "change" that Obama never actually gets around to implementing. But I still won't vote for him.

Babinich September 24, 2008 at 5:53 am

To me McCain is the lesser of two evils.

I'd rather have McCain nominating SCOTUS members than Obama nominating persons for SCOTUS.

Sam Grove September 24, 2008 at 9:07 pm

Voting for the lesser of the two evils presented to us will result in minimal change.

The oligarchy has you by your fear of the other guy.

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