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Tilting at Windmills

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July 14, 2008
By: Kevin Drum

FREDDIE AND FANNIE....The Washington Post has a pretty good piece today about Fannie Mae and Freddie Mac and how they managed to avoid some much-needed oversight for the past decade or so. But at the risk of tooting our own horn — ah, who am I kidding, I am tooting our horn here — you could have gotten the basic lay of the land four years ago right here in the Washington Monthly:

By the late 1980s, these two entities, which belong to the category known as Government Sponsored Entities (GSEs), were buying up and reselling 30 percent of new mortgages and packaging the mortgages to be sold as securities.

Fannie and Freddie's market share was limited by their ability to attract investment capital. But in 1989, Congress instituted some modest-seeming technical changes that made Freddie and Fannie much more attractive to investors, and able to draw much more capital. The GSEs used the new capital to buy up every mortgage they could, and banks were only too happy to sell off the mortgage paper.

....This shift has had two crucial, if under-appreciated, consequences. First, in little more than a decade, Fannie Mae and Freddie Mac have gone from handling one trillion dollars in mortgages to four trillion, with virtually no changes in oversight. Second, their dominance of the mortgage market has profoundly undermined the discipline that once kept housing prices in check.

Once banks knew they could automatically hand off the mortgages they wrote to Fannie and Freddie with basically no risk, the old incentive system dissolved. "Banks and other mortgage lenders are not watching home prices carefully because they rarely hold onto the mortgage paper they create — they just sell it upstream to mortgage investors," John R. Talbott, a housing researcher at UCLA's Anderson School of Business, has argued. "It is a dangerous situation indeed when neither home buyers nor the institutions that finance them are concerned with the ultimate price being paid for the housing asset."

The piece is called "There Goes the Neighborhood," by Ben Wallace-Wells, and it's still worth reading today. It's about a lot more than just Freddie and Fannie — much to Alan Greenspan's discomfort, I'm sure.

Kevin Drum 12:19 AM Permalink | Trackbacks | Comments (27)

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Comments

Wow, that's a depressing tale.

I've never had any cause to figure out how Freddie Mac and Fannie Mae worked, but, hell, that's a lot of money passing through two institutions. Seems like $81 billion in capital could go really fast.

So the securities they sold, is the guarantee underlying them 100% of losses that comes back to these institutions? Just how much money are we talking about in total possible losses to those holding the paper? How much is still to be uncovered if property prices continue to fall, foreclosures to mount, mortgage markets freeze up? Can this reach some implosion point?

Should we all be buying gold?

Anybody got any answers?

Posted by: on July 14, 2008 at 1:55 AM | PERMALINK

I think I just found out how these anonymous posts go up.

Posted by: notthere on July 14, 2008 at 1:57 AM | PERMALINK

Freddie and Fannie are just a corner of the ponzi scheme that is the US financial system. This weeks' market will show if the ponzi scheme has more life or if we will really start to see a reckoning for the theocratic/fascist anti-society that replaced a once proud secular republic that was America.

Posted by: psychohistorian on July 14, 2008 at 2:10 AM | PERMALINK

"But in 1989, Congress instituted some modest-seeming technical changes that made Freddie and Fannie much more attractive to investors, and able to draw much more capital."

How much you want to bet that former Sen. Phil Gramm has his fingerprints all over these 1989 "modest-seeming technical changes"?

Posted by: The Oracle on July 14, 2008 at 2:31 AM | PERMALINK

To put this in perspective, we need a parody of the song "Frankie and Johnnie:"

"Freddie and Fannie were sweethearts,
In D.C.'s most incestuous way, .... "

Please add to this.

Posted by: Shag from Brookline on July 14, 2008 at 7:12 AM | PERMALINK

This entire issue is difficult for me to wrap my head around...I continue to try and appreciate it when an article or blog makes the attempt to clarify what's happening. For me it boils down to another example of what GREED eventually leads to...and with the deregulation that ST REAGAN is constantly applauded for and other REPUGS continued to pursue (with, I'm sure, happy compliance and assistance from prominent DEMS who benefited along the way) we sheeple went gaily along because it looked like things were going to be great for EVERYONE...more $$ - that couldn't be a bad thing? I seem to remember seeing the fool in the WH constantly commenting on how wonderful it was that more people were being able to buy houses of their own (you know the "merukin" DREAM)...haven't heard that one lately...Of course Fannie and Freddie MUST be bailed out because now it's going to hurt the RICH FOLKS...never mind the little people lying in the road on the way...GO AMERICA!!!!!

Posted by: Dancer on July 14, 2008 at 8:45 AM | PERMALINK

Hey buddy can you spare me a dime?

Posted by: Ron Byers on July 14, 2008 at 9:16 AM | PERMALINK

The disaster is NOT the result of insufficient government oversight.

This disaster is the result of the New Deal-era monstrosities known as Freddie Mac and Fannie Mae.

They are not ordinary private companies. Since they started, they have had access to a guaranteed line of credit originating with the US Treasury. They have had artificially lower borrowing costs than any private lender. Their securities are listed as government securities. Naturally, their ratings have been better than they deserved.

As a direct result of these government-granted special privileges, they have not been required to operate in a fiscally-sound manner. They have not been required by financial realities to maintain a proper balance of equity and risk. The federal government CREATED them for the express purpose of having them operate in a financially UNSOUND manner, enabling them to engage in greater risk than any private lender would.

This is called "easy credit." It causes inflation. It has caused this particular inflationary bubble, which has now burst.

This is also called "fascism" -- the fusion of nominally private business with the government.

When the bad debt of these two FDR-created criminal enterprises are passed onto the backs of the taxpayer, it will become full-fledged socialism. Socializing the losses.

Welcome to the world that FDR built.

Posted by: Magnus on July 14, 2008 at 9:49 AM | PERMALINK

That was a brilliant essay by Benjamin Wallace-Wells. Too bad people like that are not in government now.

Posted by: Bob M on July 14, 2008 at 9:52 AM | PERMALINK

Orwell, "Government" by nature is not the problem. Our particular way of polluting the concept "Government" here in the US by turning it into a massive sty in which greedy scam artists suck on the teat of the American Taxpayer is the problem. "Government" isn't the problem - the people we elect because we Americans simply can't be bothered to get our fat asses off the couch and follow politics because we would rather follow American Idol is the problem.

We, as a country, turn a blind eye to corruption and we keep voting for it at the polls. We got the government we deserve.

And yes, we will sit back and allow health care to be turned into yet another teat for the corrupt to suck taxpayer dollars because we can't be bothered to elect good governance.


Posted by: Art Eclectic on July 14, 2008 at 10:01 AM | PERMALINK

We, as a country, turn a blind eye to corruption and we keep voting for it at the polls. We got the government we deserve.

And yes, we will sit back and allow health care to be turned into yet another teat for the corrupt to suck taxpayer dollars because we can't be bothered to elect good governance.

Let's say that is true -- that people with theoretically good (or even perfect!) intentions start these various government programs to control economic matters. And then, a group of eeeevil, greedy parasites invariably comes along and transforms it into their own personal piggy bank.

Let's say that's all true. It's a cartoonish view of the world, but let's you're right.

Wouldn't it be safer to take away the capacity for such corruption by denying the government the power to control people's economic lives in the first place?

Wouldn't it be prudent to take away the breeding ground in which these parasites thrive?

They are drawn to the unique economic power that only government can give. They smell special governmental privileges from a mile away. It's like leaving sugar all over your kitchen counters and then being surprised you attract vermin.

We are very far gone. The US economy is teetering on the brink of disaster. This inflationary bubble in housing is extremely bad. It will get worse. More bailouts are coming.

But this never would have happened if the US government never had the power to create and sponsor a enterprises with the power to guarantee mortgages, which, after all, primary purpose is to make the lives of bankers easier.

Posted by: Magnus on July 14, 2008 at 10:14 AM | PERMALINK

Magnus, I completely agree. Frankly, I wouldn't even go so far as to say most government programs were started for good or noble purposes. They were started by people; people who are very used to trading "favors" for votes, which is the way things work in Washington. There may have been a noble cause at the beginning, but by the time it comes to the floor for a vote there has been enough horse-trading to waste whatever good was in the original intention.

What I was objecting to is this "it's all the fault of the big, bad gubbermint" mantra chanted by people who want to blame some faceless entity of evil for all the wrongs in the world. We voted for these people and for that, the blame ultimately rests with us.

Posted by: Art Eclectic on July 14, 2008 at 10:27 AM | PERMALINK

The problem began with the Jimmy Carter inflation that led to the S&L meltdown. The days when S&Ls loaned money and collected the payments, like in "It's a Wonderful Life", were gone by 1985. If you want a name, try Fernand St Germain, chair of the House Banking Committee. Guess his party affiliation. The mortgages generated in the past 15 years have been quickly sold to Freddie or Fannie and the mortgage brokers collected their fees and could care less about foreclosure. This was inevitable and the Wall Street Journal had been writing editorials predicting this for years. Both parties contributed.

Posted by: Mike K on July 14, 2008 at 10:37 AM | PERMALINK

Yes, AE, I agree -- pure intentions only exist in fairy tales.

The idea of a "noble cause" behind things like the New Deal (and all of its ugly step-children like Fannie and Freddie) is just propaganda -- insiders who want these programs create a myth that the proposed government program will make everything better. It's all sunshine and daffodils. But in truth, they are simply master advertisers (i.e., liars) -- they take advantage of ordinary people's general good-nature, to appeal to the best instincts in people, and then pervert these sentiments to slide some self-serving piece of legislation through.

If this happened once or twice, I'd say it could be dealt with. The fact that it happens every time leads me to believe that the whole process is a giant sham.

Posted by: Magnus on July 14, 2008 at 10:47 AM | PERMALINK

Why are people surprised? Insolvency and bailouts go hand in hand with our debt-as-currency financial system. Collapse is inevitable. It starts with the small financial operators, spreads to the mid levels, and, today, we are seeing the collapse of Fannie and Freddie. Within a year, you very well may see the insolvency of Citigroup and many other large banks. If you do, then the Federal Reserve and the US Treasury will soon follow.

Posted by: Yancey Ward on July 14, 2008 at 10:48 AM | PERMALINK

Jesus Magnus the level of your lack of understanding and naivete blows my mind. T^he fact that you can even write is an amazement to me. Some where along the line you never bothered to try to think.
You have no clue what's really going on do you. Let me give you one. Don't pontificate about subjects you know so little about that as soon as you open your mouth you leave all doubt as to your ignorance aside.
If you really think we'd all be better off letting the corporate masters run everything because everything they do is so benevelent and efficient just say so.

Posted by: Gandalf on July 14, 2008 at 10:56 AM | PERMALINK

Don't about y'all but I get the distinct impression Nouriel Roubini ain't happy about this latest privatize-the-gains-socialize-the-losses move:

Also, unlike any corporate restructuring plan where current management is replaced - we usually kick the bums out - this plan also bails out the corrupt management of Fannie and Freddie that has spent the last few decades creating a corruption and graft machine that is unrivaled in U.S. history. These sleazebacks who fattened their incomes by the hundreds of millions and used these two institutions and the biggest lobby machine in Washington to corrupt and buy off Congress and any potential critic of the GSEs will remain in charge and continue their scams and gambling for redemption financial schemes. Thank you comrades Paulson and Bernanke for making official this socialism for the Wall Street, the rich and the well connected.

http://www.rgemonitor.com/roubini-monitor/252974/insolvency-of-the-fannie-and-freddie-predicted-here-two-year-ago-what-happens-next-or-how-to-avoid-the-%E2%80%9Cmother-of-all-bailouts
%E2%80%9D/

Which makes two of us.

Posted by: MsNThrope on July 14, 2008 at 11:08 AM | PERMALINK

If you really think we'd all be better off letting the corporate masters run everything because everything they do is so benevelent and efficient just say so.

What on earth are you referring to?

Do you mean the corporations that, RIGHT NOW, are using government-sponsored institutions like Fannie Mae and Freddie Mac to their special benefit? Those corporations? The ones who, now that the economy has been bled dry, are going to get their buddies in that same federal government to bail them out at our expense? Them?

Gee, I wish I had a friend in government who insisted that, no matter how poorly I ran my business, I would never be "allowed to fail."

You'd think that someone with the nickname "Gandalf" would have grasped the central theme of Lord of the Rings -- no one can wield power without being corrupted. We are only safe if the power doesn't exist.

The federal government shouldn't have the power to create companies like Fannie Mae and Freddie Mac, and shouldn't have the power to protect them from the consequences of their own crimes, much less require all of us to pay for it.

(Truth be told, the US government DOESN'T have that power. It was usurped. The government that wields that power now is the US government in name only. It has been illegitimate for a long time.)

Posted by: Magnus on July 14, 2008 at 11:17 AM | PERMALINK

Boy talk about missing the point Magnus. If the power doesn't exist? Why not just say if the sun doesn't exist. Or maybe we should just go back to the good old days when Ward and June Cleaver were all the rage. i'm not so ignorant as to think that having too much power isn't a problem but the fact is unless we go back to the hunter gatherer era we're not going to get rid of it. WE need to learn to deal with it and besides that your whole point is a complete obfuscation to what the real problem is with the whole housing crisis.

Posted by: Gandalf on July 14, 2008 at 12:05 PM | PERMALINK

Wouldn't it be safer to take away the capacity for such corruption by denying the government the power to control people's economic lives in the first place?

Magnus, people still need the goods and services that can't be provided by a classic market. Neither home lending nor health care is, or can be, run under a classic market model. If they could, they would.

The notion of unregulated banking is particularly silly. That is what lead to the great depression in 1929 and has led us to the collapse of IndyMack, Bear Sterns and all the rest of the 90 banks that are in trouble.

By the way I bet those investors who had less than $100,000 in IndyMack are happy as hell for FDIC regulation.

The better solution would be for all of us to pay attention to and participate in its day to day operations.

Shedding our minds of unworkable myths and fairy tells would help as well. People can be corrupted. The way you avoid corruption is to put checks and balances on everybody in a position of power.

One final thought. There are no corporations in nature. Corporations are all, every single one of them, creatures of the government.

Posted by: Ron Byers on July 14, 2008 at 12:19 PM | PERMALINK

One final thought. There are no corporations in nature. Corporations are all, every single one of them, creatures of the government.
Posted by: Ron Byers

Indeed.

Bill Moyers : "Capitalism breeds great inequality that is destructive, unless tempered by an intuition for equality, which is the heart of democracy. When the state becomes the guardian of power and privilege to the neglect of justice for the people who have neither power nor privilege, you can no longer claim to have a representative government."

Posted by: MsNThrope on July 14, 2008 at 12:40 PM | PERMALINK

This bailout of Freddie and Fannie is counterproductive. Another congressional initiative, the Mortgage Bailout, will tax Freddie and Fannie to the tune of $530 million/ YEAR. So Congress wants to bail out an institution and tax it as well? Whats going on? Call your senators/representatives and tell them: Back off the Mortgage Bailout Bill and Back off Bailing out Fannie and Freddie Mac!
http://www.freedomworks.org/newsroom/press_template.php?press_id=2585
Blue Dog House Contact info:
1-866-887-5841
http://www.freedomworks.org/newsroom/press_template.php?press_id=2580

Posted by: Michael on July 14, 2008 at 1:02 PM | PERMALINK

The notion of unregulated banking is particularly silly. That is what lead to the great depression in 1929 and has led us to the collapse of IndyMack, Bear Sterns and all the rest of the 90 banks that are in trouble.

You mean the Great Depression that started 15 years AFTER the U.S. established a central bank by statute, mandated a uniform government-sponsored currency, and promoted the artificial relaxation of credit?

Is that the "unregulated banking" industry you are referring to? Or is that a "classic market"?

I don't know about you, but "central bank" and an army of federal bank regulators is neither a classic market nor "unregulated." You seem to be confused.

Posted by: magnus on July 14, 2008 at 1:33 PM | PERMALINK

Listening to an NPR report on the situation, I heard one expert explain that this whole issue demonstrates a policy of privatizing profits while socializing losses. I.e. -- investors profit in the good times, and the taxpayer pays in the bad. How did things get so utterly twisted?

Posted by: Bobbi on July 14, 2008 at 3:20 PM | PERMALINK

"When the bad debt of these two FDR-created criminal enterprises are passed onto the backs of the taxpayer, it will become full-fledged socialism. Socializing the losses.

Welcome to the world that FDR built."

Posted by: Magnus on July 14, 2008 at 9:49 AM
------------------------------

You claim there's bad debt being passed to the taxpayer. Prove it. Fanny & Freddy are solid -- so say Paulson & Bernanke.

You say, "these two FDR-created criminal enterprises". FDR didn't change the regulations in 1989 during Bush I and you it's on you to prove they're criminal.

Republican propaganda about the risky Fanny & Freddy doesn't tell me they're risky at all. It tells me Bushies are planning to destroy those outfits for fun & profit and they want everyone to think they were wonky before hand. P.R. can do a lot to convince people of what's inevitable, but it doesn't always work -- just ask President Hillary Clinton.

One thing that might surprise some people is to learn that among Fanny & Freddy's largest bond-holders is The Cayman Islands. Let's see now, what are they known for?

These days you can't assume anything that happens is accidental. Always ask, what's in it for the Bush mafia.

Posted by: MarkH on July 14, 2008 at 5:08 PM | PERMALINK

Dear Mr. Drum,
I agree that our elected officials should have known four years ago but our well-lobbied politicians, who have about 75 paid lobbyists telling them what to do, a lot of them being HEDGE FUND DEALERS, who are not even registered as lobbyists. Bailing out Freddie Mac and Fannie Mae isn't going to work. What they should do is nationalize them and then reinstate the GLASS-STEAGALL ACT to get things back under control. Senator Obama's suggestion to TAX THE HEDGE FUND DEALERS is an excellent idea. Then you would find out if the HEDGE FUND DEALERS and those EXOTIC DERIVATIVES that they are circulating are an income or an expense providing the IRS can make up their mind. The Basel II report that I read in Business Week emphasized the fact that they are trying to get some regulations on these EXOTIC DERIVATIVES on a world-wide basis. Also Der Speigle, a German newspaper, said that the International Monetary Fund wants to investigate the U.S. Financial System but that President George W. Bush has blocked it until after he is out of office. Please write another article and remind our politicians who they are susposed to be working for and that is us, the taxpayers. I enjoyed your article.
Yours truly, Disgusted Middleclass Taxpayer, LaVern Isely

Posted by: LaVern Isely on July 26, 2008 at 3:26 PM | PERMALINK

Stye eye treatment another annoying problem were caused the eye.

Posted by: Steven D. Caraway on February 20, 2011 at 12:09 PM | PERMALINK
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