Fannie and Freddie, as Predicted
A reprise of what I wrote August 25: Any day now -- perhaps any hour -- the plug will be pulled on Fannie Mae and Freddie Mac, and a massive government bailout will ensue. Together, they'll become the largest government-owned entities in American history, and, once again, taxpayers will pay the bill, which could come to $25 billion or more.
One question is how did we ever get to this? The Savings and Loan Bailout of the late 1980s should have taught us that when government guarantees the downside of risks and private investors reap the upside gains, there's hell to pay. The risks Fannie and Freddie took on weren't officially guaranteed by the government -- that is, by you and me -- but investors assumed they were. And so did Fannie's and Freddie's executives, who reaped a bonanza with bonuses in the tens of millions each year.
Apologists will say that Fannie and Freddie exist to make housing loans to low-income Americans, so it was inevitable that the two giants would get caught in the quagmire of the housing burst. But the fact is, Fannie and Freddie -- and the executives who ran them and still run them -- have been out to maximize profits. Period. Just the same as every other mortgage and investment bank. High-risk sub-prime loans offered a higher rate of return, so Fannie and Freddie went into them big time. And because of the implicit government guarantee, Fannie and Freddie could take on even more risks and make even more money. Until now.
It's another case of socialized capitalism, folks. The largest, yet. Along with making lots of money for investors and their executives, Fannie and Freddie corrupted our political process. They blocked any attempt to reign in the risks. Their lobbyists were and are the most sophisticated and among the most ubiquitous in Washington.
What to do now? Hope that, like the S&L fiasco, taxpayers can get back a fair portion of our dollars. But unlike the S&L fiasco, this time we should make sure we bury socialized capitalism for good.
One question is how did we ever get to this? The Savings and Loan Bailout of the late 1980s should have taught us that when government guarantees the downside of risks and private investors reap the upside gains, there's hell to pay. The risks Fannie and Freddie took on weren't officially guaranteed by the government -- that is, by you and me -- but investors assumed they were. And so did Fannie's and Freddie's executives, who reaped a bonanza with bonuses in the tens of millions each year.
Apologists will say that Fannie and Freddie exist to make housing loans to low-income Americans, so it was inevitable that the two giants would get caught in the quagmire of the housing burst. But the fact is, Fannie and Freddie -- and the executives who ran them and still run them -- have been out to maximize profits. Period. Just the same as every other mortgage and investment bank. High-risk sub-prime loans offered a higher rate of return, so Fannie and Freddie went into them big time. And because of the implicit government guarantee, Fannie and Freddie could take on even more risks and make even more money. Until now.
It's another case of socialized capitalism, folks. The largest, yet. Along with making lots of money for investors and their executives, Fannie and Freddie corrupted our political process. They blocked any attempt to reign in the risks. Their lobbyists were and are the most sophisticated and among the most ubiquitous in Washington.
What to do now? Hope that, like the S&L fiasco, taxpayers can get back a fair portion of our dollars. But unlike the S&L fiasco, this time we should make sure we bury socialized capitalism for good.
posted by Robert Reich | 3:09 PM
15 Comments:
**The plan, outlined jointly by the Treasury Department and Federal Housing Finance Agency, also includes a plan for the Treasury to purchase mortgage-backed securities from the firms in the open market, and a lending facility through the Treasury from its general fund held at the Federal Reserve Bank of New York.**
This is huge. This is the federal government taking over the "toxic waste" in a way that will have an impact not just on Freddie and Fannie, but on the whole market. By "buying" mortgage-backed securities instrad of taking them as collateral, the Treasury does two things at the same time:
• it takes off the assets and liabilities off the balance sheet of the two companies in a definitive way (rather than temporarily) and assumes, for sure, the associated risk;
• it sets a price on these securities. This has been the biggest problem to solve the credit crisis: nobody has been willing to set a price on these assets, because of the uncertainty on the real value of the underlying assets (or because everybody could see that they were falling by the day). By setting such a price, thegovernment creates a highly significant precedent - and, in all likelihood, provides a floor to these prices, ie an implicit commitment (or at least the expectation of a commitment) to buy more such securities.
In doing this, the government is boldly trying to call the end of the financial crisis, set a total price to it, and agree to pay the difference if the cost is higher in the end. This, to me, looks like a full governmental guarantee to the whole banking sector. Of course, a lot will depend on where the price is set to purchase these mortgage-backed assets, but this is still a take-over of the toxic waste by taxpayers, at aprice that may or may not (and, frankly, is highly unlikely to) be right.
But it's even worse than that: by providing an additional lending facility on top of that, the government is saying: we're putting our money (well, yours) where our mouth is - providing further liquidity to the companies and, I presume, expecting them, once the toxic waste has been cleared from their books (which can happen now that there is a floor price), to lend to the mortagage markets again.
It's the usual solution of the Greenspan bubble: as soon as one bursts, we blow another one to cover it up and keep the party going a little longer.
Of course, the goal here is simply to create a boost that lasts until November, and given the kind of weaons used, it's likely to succeed in that short term goal. Saving the US economy is another thing, given that its fundamental problem is spending beyond incomes - more debt does not cure that, rather the opposite. The twin movements of growing spending and stagnant incomes have to be brought back together. Boosting spending via debt cannot work this time; incomes have to be raised - and for the right people.
This plan is not about this, it's about bailing out the financiers that played and lost with other people's money, and give them a chance to try again. Par for the course, of course.
"And because of the implicit government guarantee, Fannie and Freddie could take on even more risks and make even more money."
While most everything in economics is abstract and hard for most people to wrap their heads around, this is pretty easy to grasp. Tax payers have in effect, funded a gambling habit.
Maybe you'd like to help out Secretary Paulson & propose a FDIC-like mechanism for the Fed's future bailouts.
It seems inevitable that we are moving away from regulation; maybe it'd even be impossible to put the unregulated, offshore funding genie back into the bottle even if the tide against regulation turned.
So my question is, "how much is it worth for a firm to be too big to fail? How can our government set a fair TBBTF price?"
Seattle Times online states that F & F at least are going to give up their lobbyists. Don't know if it's true. To me, all lobbyists should be banned. I can see a corporation making a clear profit and competing within its own market segment, but why lobby? It's enough to know business cycles and creative destruction exist.
A home is worth the wholesale costs of the building supply and the labor (and it's been inexpensive labor from Mexico). Nothing more.
I proposed people who were pushed into mortgages with balloon clauses should go move in with their fraudsters, and follow it up the chain until some move in with the CEOs. Hank Paulson should be fired. His assets sold on eBay. Then he can be deported and go live with the Chinese if he's helping them realize their investment interests in GSE preferred stock. At least Alan Greenspan has lived long enough to see the bubbles burst.
It's just mind boggling to me that the two morons heading up monthly job creation announcements every month for 7.5 years have never hit their targets, but people think mortgage payments can reset to higher monthly payments. I'm content knowing leaders in the US really are that dumb. Thank heaven I didn't vote for George W Bush and know how to study and retrain in the health sciences.
Dr. Reich,
You may still be underestimating the illusionary, deceptive financial soundness of Freddie and Fannie by your seemingly unrealistically low expected taxpayer bailout cost of $25 Billion.
Can you explain how you arrived at this figure? With over $5 Trillion in outstanding mortgages, Freddie/Fannie and ignoring their heavy investments in derivatives, the Worst but not impossible Scenario could be a 2-4% Mortgage Writedown. So taxpayer cost might well reach a level as high as $100-$200 Billion! There seems to be no transparent published evidence or due diligence oversight analysis that the end to the financial losses for Freddie/Fannie is in sight.
Alll this means more borrowing from China to finance a Deficit next year that will soar far above $500 Billion. This would play havoc with the new administration's Investment Stimulus programs our nation so desperately needs. Hopefully, I'm 100% wrong and you're 100% right that the Freddie/Fannie losses are contained at $25 Billion!
"...this time we should make sure we bury socialized capitalism for good."
If I had posted this quote, most of the regulars around here would have ripped me for such a statement. Luckily it was the good Dr. that said it, and I thank him.
We are becoming communists. The Chinese are selling and privatizing their state owned enterprises (SOE), and the US government is being forced to salvage (buy/finance)large private US enterprises.
What is wrong with the republi-bunkins (Bush/Cheney/McCain/ et al.) ?????
I've been wondering the same thing as Frank T. has stated, why are they tossing the $25bln number around?
I'll raise Frank's estimate. Last week the Gov reported 9% of all mortgages were either late or in default. This number is rising rapidly, and with unemployment going up you can be sure it will get higher. Almost 20% of Americans are now upside down in their mortgages. At what point is there going to be a traffic jam at the local banks when these people decide to just drop off their keys and say good luck?
I'm betting we'll reach 10% foreclosures and the tax payer will get stuck with closer to $400-500 billion.
With declining revenues due to the recession/depression, the $160bln stimulus that failed completely, and the extra costs of these bail-outs, the deficit next year will reach 500-600 billion or more. At what point do foreign governments decide to stop throwing good money after bad down the rat hole, with little chance of regaining their investments, and quit lending the U.S. more money to finance the monster deficits?
And yet America is evenly divided whether we should continue with the same disastrous conservative economic policies that are destroying the country, or whether we should try reasonable thought for a change. It's too bad the 50% of stupid Americans who got us into this mess are about to drag the rest of us down with them.
We're not communists. In communism, the rich *share" their wealth, not take it from the reat of us by force of the government.
This is called fascism.
Donna, you misunderstand: in socialism, the government takes over companies and destroys them through incompetence. In American capitalism, the the government is more efficient: it allows companies to destroy themselves through incompetence, and then the government takes them over.
Seriously, Too Big to Fail? Any company in the Fortune 10. Hewlett-Packard is #11, and I think they'd let it go. IBM is #10, and I think it would be bailed. But knowing government bureaucrats, they'll make a 30-page set of rules that amounts to the same thing.
I posted about this on the other thread.
The government had no choice.
If Fannie and Freddie failed it would have caused a huge, and I mean HUGE financial crisis in the world.
I'm surprised Dr.Reich has not commented on that 'what if".
Dr. Reich,
Knowing the Federal Budget Deficits for 2008 and 2009 will exceed $400 Billion to $500 Billion before any consideration of the ultimate cost of the Fannie/Freddie bailout ... where the Writeoff risk exposure could be as high as 2% to 5%. This would amount to $200 to $500 Billion which must be added to 2009's already expected Deficit of ±$500 Billion. Another risk is the inflationary effect of floating substantial debt issues to finance the cost of the Fannie-Fredddie Writeoffs.
As the world's number one Debtor nation, the US is testing the breakpoint as to how long the rest of the world will be willing to continue diverting their Savings to finance our runaway Debt situation. Investors in our bonds are already demanding much higher returns (as much as a 1% higher interest rate return) despite government guarantees of mortgages.
Putting Fannie and Freddie in conservatorship, which eliminates the middleman shareholder profit element and obscene CEO salaries, should result in cheaper home loans given government's plan to purchase mortgage securities directly.
As for pointing the finger as to who's to blame for this fiasco, this is a waste of time -- except insofar we learn from past mistakes, which we seldom do
But pleasantly for a change, I was impressed to hear that President Bush, as early as 2002, saw the Fannie/Freddie structure with the "Implicit Government Guarantee" as a ticking financial time bomb. He favored and sought much stricter regulations over these companies but his own Republican Congressional party members stopped this effort when they had the majority in Congress. The Democrats finally agreed to more legalregulation authority with their improved power position in Congress as result of 2006 elections.
That legal authority is now the basis of Treasury Secretary Paulson´s no option decision to take total control over these mortgage giants -- given huge exposure in outstanding mortgages and other financial instruments amounting to ±$6 Trillion, or over 60% of our accumulated Nationl Debt now approaching ±$10 Trillion in fiscal year 2008.
Hope the shareholders really lose here to minimize the privatization of profits and socialization of losses disease systemically afflicting and undermining our financial system.
As mentioned earlier, should the
Fannie/Freddie writeoffs soar into the $200 to $500 Billion range, this is going to make it very difficult to raise funds needed for critical Stimulus Investments in Social-Infrastructure, Health Care, Alternate Fuels, Education, etc., etc. Therefore, Investment priorities and scale of same will have to be limited, no matter how many "Pork Barrel Earmark" cuts are made.
Having looked at this Pork Barrel Earmark pot carefully, the most that can be saved here is ±$60 Billion annnually -- very, very Important but hardly a panacea for funding the huge Investments needed in our economy. Another complication is that at least a third of the Earmarks are for Legitimate projects that generate lots of local jobs.
The problems are complex and dangerous if the policy mix and systemic changes are not balanced wisely and cleverly. For we stand in danger fo gettign the 12 year Japanese collapse.
As a side note, David Brooks NY Times article, `Surprise Me Most´ has a few pretty interesting ideas highlighting the need for both Parties to come together to get the Stimulus Changes right for ALL Americans. Realistic, probably not, but some wise words nevertheless.
That's why way back I suggested, for example, covering our vital Human Capital Investment needs (in Education and Worker Retraining) by floating attractively structured `Invest in American Education Bonds´ -- rather than funding this particular Investment requirement by borrowing from China and paying the higher interest rates to them rather than to American investors. This would also increase our economic systems´ Savings level and hence general financial Liquidity to fund necessary Investments over nex 6-8 years -- a Savings level at ZERO in recent years!
Dr. Reich,
Now Lehman's is the next major financial institution facing a severe survival crisis having lost $3.9 Billion in Q3. They must sell off assets to remain in business. Fortunately, a government rescue will not occur here as the market financial angels will pounce on this firesale.
The bottom of the financial debacle is far from sight.
Hold onto your seatbelts everyone and your cash!
Hope the pessimists, including me, are ridiculously wrong that the potential losses in the range of $200-500 Billion are still possible for Fannie and Freddie vs. Dr. Reich's modest loss estimate of $25 Billion.
As a side note, David Brooks NY Times article, `Surprise Me Most´ has a few pretty interesting ideas highlighting the need for both Parties to come together to get the Stimulus Changes right for ALL Americans. Realistic, probably not, but some wise words nevertheless.
[URL="http://www.amer-nejma.com"]Amer[/URL]
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