Editore"s Note
Tilting at Windmills

Email Newsletter icon, E-mail Newsletter icon, Email List icon, E-mail List icon Sign up for Free News & Updates

July 17, 2008
By: Kevin Drum

THE PROBLEM WITH HYBRIDS....Fannie Mae and Freddie Mac were examples of institutions known as Government Sponsored Entities, or GSEs. That is, they were neither fish nor fowl, neither fully private nor fully public. Larry Summers writes today that this was a big part of their problem:

When there were business failures it was always the result of their social obligations. Government budget discipline was not appropriate because it was always emphasized that they were "private companies." But market discipline was nearly nonexistent given the general perception — now validated — that their debt was government backed. Little wonder with gains privatized and losses socialized that the enterprises have gambled their way into financial catastrophe.

....It is hard in this world to do well. It is hard to do good. When I hear a claim that an institution is going to do both, I reach for my wallet. You should too.

Is Summers being too skeptical? Is this a general problem, or were Freddie and Fannie one-off failures that were inevitable in a meltdown as spectacular as our recent mortgage bubble/bust? Discuss.

Kevin Drum 11:29 AM Permalink | Trackbacks | Comments (37)

Bookmark and Share
 
Comments

If you have not followed this man's career, he's prone to making sweeping, factfree truthiness remarks about lots of things, just add this statement to the list.

Posted by: The Olive Ridley Crawl on July 17, 2008 at 11:36 AM | PERMALINK

People have spent too much time over-analyzing what happened to mortgage banking. There was nothing wrong with Countrywide, Fannie Mae, Freddie Mac, Etc., etc. until all of them decided that credit worthiness was no longer a criteria for lending. It's that simple.

Posted by: Jeff II on July 17, 2008 at 11:48 AM | PERMALINK

What Jeff II said! It wasn't just GSE's that had problems, so why blame their GSEness, unless you have a political axe to grind?

Posted by: K on July 17, 2008 at 11:59 AM | PERMALINK

were Freddie and Fannie one-off failures that were inevitable in a meltdown as spectacular as our recent mortgage bubble/bust?

Wrong question. The right question is, why were regulations so lax that the real estate bubble allowed to inflate to the point where it could burst so spectacularly?

Posted by: jimBOB on July 17, 2008 at 12:00 PM | PERMALINK

I agree with Summers. Very well put...

Posted by: on July 17, 2008 at 12:07 PM | PERMALINK

Well, that would certainly go a long way toward explaining why the private banks haven't had any trouble with ...

... oh, shit.
.

Posted by: Grand Moff Texan on July 17, 2008 at 12:08 PM | PERMALINK

Fannie and Freddie worked pretty well to increase markets for mortgages until regulations were lifted, which led to making loans to people who lacked credit worthiness and disregarding inflated/fraudulent appraisals of the properties that were supposed to be collateral for the loans. Banks and mortgage compainies took advantage of Fannie and Freddie to purchase their poorly dilligenced loan making practices as a form of corporate welfare, which resulted in a public financed credit bubble.

Posted by: Brojo on July 17, 2008 at 12:14 PM | PERMALINK

Yep, the Fannie/Freddie problems are primarily the result of systemic under-regulation in the mortgage and security markets, not their GSE status. This includes being allowed to underwrite mortgages for more than the national median home price.

However, the kicker was that this under-regulation came during a period of extremely low interest rates. Thanks twice, Easy Al Greenspend.

Posted by: PeakVT on July 17, 2008 at 12:16 PM | PERMALINK

Quasi-private or fully private is a distinction without a difference in the current power structure. Bear Stearns was bailed out only a few steps down the road from where Fannie & Freddie will be.
The key term in Summers' text is "gains privatized and losses socialized," and this applies to any entity of sufficient size and political clout. This is nothing new -- the S&L crisis of the late 80s was just the first round. (I wonder what Neil Bush's net worth is right about now?)
Ironically, Ayn Rand got this part right: Phil Gramm is Wesley Mouch. Too bad there's no John Galt to set it "right" (his world would of course be even worse), because it's your tax dollars (and mine, pitiful though they may be) that are paying for it.

Posted by: smartalek on July 17, 2008 at 12:16 PM | PERMALINK

Rationalization after the fact.

If they were fully public, then they would consume enough of the federal budget that Medicare would be down to 1% of government share.

Kevin wants to rationalize away that fact that the federal legislature cannot manage such a huge proportion of the economy and maintain stability.

We are unstable precisely because Kevin and Larry simply apply rationalization when they get into trouble with government.

Posted by: MattY on July 17, 2008 at 12:23 PM | PERMALINK

He's got a pretty good point. Take another hybrid, for example: Amtrak. If it were just another part of the Department of Transportation, then Congress would be able to fund it with the same sort of earmarking that gets highways built. If it were fully private, then it would spend tons on lobbying, like the airlines and auto companies do, and reap huge returns when Congress builds new rails for it. But since it's stuck in this middle ground, there's no easy constituency, and it continues to limp along with minimal capital.

Posted by: tom veil on July 17, 2008 at 12:29 PM | PERMALINK

People have spent too much time over-analyzing what happened to mortgage banking. There was nothing wrong with Countrywide, Fannie Mae, Freddie Mac, Etc., etc. until all of them decided that credit worthiness was no longer a criteria for lending. It's that simple.

Not just that, by buying up every mortgage in sight, they eliminated the incentive for lenders to ensure that the houses were valued appropriately.

Posted by: dob on July 17, 2008 at 12:31 PM | PERMALINK

So, the only entities exhibiting a 'lack of market discipline' were Fannie Mae and Freddie Mac? Oh, wait, there's also Bear Stearns and IndyMac. But that's all, right? Well, except for Countrywide. And - oh, never mind. I guess it depends on how you define 'market discipline.'

Posted by: cmac on July 17, 2008 at 12:33 PM | PERMALINK

There was nothing wrong with Countrywide, Fannie Mae, Freddie Mac, Etc., etc. until all of them decided that credit worthiness was no longer a criteria for lending. It's that simple.

That actually makes sense. Unlike the bullshit explanation offered by Summers.

Posted by: lobbygow on July 17, 2008 at 12:39 PM | PERMALINK

Summers is right that setups that lead to privatized profits and socialized losses are a setup for major problems. The answer, since the taxpayers are going to be stuck anyway, is to just have institutions like Fannie and Freddie be arms of government. The management then won't be tempted to gamble to improve the rate of return, any profits in boom times would go to pay down the national debt instead of going to stockholders, and since the public already has to pay the losses, no difference there.

Sure, Americans are allergic to the word "socialist". But our current hybrid system is a lot worse.

Posted by: Joe Buck on July 17, 2008 at 12:41 PM | PERMALINK

I was wondering how long it would take the comments section to generate an ad hominim argument aimed at Summers.

First comment! Nice!

Posted by: BTD Greg on July 17, 2008 at 12:43 PM | PERMALINK

He's got a pretty good point. Take another hybrid, for example: Amtrak. Posted by: tom veil

Amtrak is not a hybrid. It is no different than a county bus system or a city subway - none, particularly with Amtrak being a technologically dated system, is expected to make money. They are providing a public service that, at best, breaks even.

There are a lot of numb skulls in Congress that may think it's supposed to make money, but these are the same people who don't want to fund mass transit and have no problem supporting tax credits for oil companies.

Posted by: Jeff II on July 17, 2008 at 12:44 PM | PERMALINK

An interesting take on the whole issue of public/private was in the Washington Post written by Franklin Raines, Clinton's head of OMB who ran Fannie Mae from 1999 - 2004. You can read it at http://www.washingtonpost.com/wp-dyn/content/article/2008/07/15/AR2008071502426.html?hpid=opinionsbox1.

Posted by: Th on July 17, 2008 at 12:53 PM | PERMALINK

Strange that Summers, and nobody else, worried about GSEs during the Clinton Admin. So much for New Democrats, eh?

Fannie WAS originally started as a straight-up in-house federal entity.

And, it's not an ad hominem against Summers if it's true.

Posted by: SocraticGadfly on July 17, 2008 at 12:54 PM | PERMALINK

God what a bunch of sheep. Most of these alleged explainations of the mort situation fall into the category of trying to apply a simple explanation to a complex problem.

Posted by: Gandalf on July 17, 2008 at 1:18 PM | PERMALINK

"The management then won't be tempted to gamble .."

I love this misdirection.

The management are 535 bozos who have never run a company in their lives, and who have the least thought about anybody making money.

The people who this poster wants to manage have managed to deliver 10 trillion in debt for 150 million taxpayers. That is why the housing market cannot maintain itself, managers that this poster seems to trust.

Posted by: Matt on July 17, 2008 at 1:31 PM | PERMALINK

Summers is right. There should be NO Public/Private hybrids. Fanny Mae and Freddie Mac should be combined and fully nationalized into a non-profit public service.

Private corporations will ALWAYS rip off the taxpayer if placed on the tax-support teat. Their entire modus operandi is to maximize profits for the least amount of work/service possible. Thus, they MUST provide less for the same amount of money than a truly public entity must which lacks any profit motive (break even is the aim).

The ONLY time private contractors should be used by the Gov't is for TEMPORARY functions. NEVER EVER for ongoing functions.

Posted by: Praedor Atrebates on July 17, 2008 at 1:39 PM | PERMALINK

While I'm going, the FED should be nationalized as well. The Constitution gives the government the authority to print and distribute money, NOT private profit-seeking banking entities.

Wilson himself was immediately sorry he signed the damn (unconstitutional) law creating the Fed. Thomas Jefferson warned about allowing BANKERS to control the money supply.

The government should FULLY own the Fed, print and dispense money the same way the Fed does but without having to pay interest on its own friggin money (fer christ's sake! The GOVERNMENT owns the money and has full responsibility to print it, so why is the government paying interest on its own money?). Private banks should pay interest on the money borrowed from the fully nationalized Fed, but NOT the government itself.

The end.

Posted by: Praedor Atrebates on July 17, 2008 at 1:46 PM | PERMALINK

While I'm going, the FED should be nationalized as well. Posted by: Praedor Atrebates

Didn't we go through this same exercise not long ago?

The Federal Reserve Bank doesn't need to be "nationalized" as it is already a government institution.

Posted by: Jeff II on July 17, 2008 at 2:12 PM | PERMALINK

were Freddie and Fannie one-off failures that were inevitable in a meltdown as spectacular as our recent mortgage bubble/bust?

Gosh, it would have been okay to drive drunk if only all those pedestrians, other cars and trees hadn't gotten in my way.

Posted by: rea on July 17, 2008 at 2:25 PM | PERMALINK

One of the reasons for Fannie Mae and Freddie Mac was oversight. They were supposed to be backing for good loans and on the lookout for risky loans, keeping the lending institutions in line. Then a little deregulation, chances to get people in homes with little regard to their ability to pay since the loan was going to other parties, and Freddie and Fannie are in trouble, like the rest of the mortgage industry. And then they come running to the government for more money.

Posted by: taxpayer on July 17, 2008 at 2:28 PM | PERMALINK

Praedor Atrebates, if the federal reserve bank is unconstitutional, it's hard to escape the conclusion that the first Bank of the United States, chartered in 1791, was unconstitutional as well. No offense, but I always distrust people who think they know more about the Constitution than George Washington or Alexander Hamilton. Note that the founders had before them the example of the Bank of England, chartered 1694 . . .

Posted by: rea on July 17, 2008 at 2:41 PM | PERMALINK

larry summers is a busy beaver since he left harvard

a little history from wikipedia

http://en.wikipedia.org/wiki/Government_sponsored_enterprise

The government sponsored enterprises (GSEs) are a group of financial services corporations created by the United States Congress. Their function is to enhance the flow of credit to targeted sectors of the economy and to make those segments of the capital market more efficient and transparent. The desired effect of the GSEs is to enhance the availability and reduce the cost of credit to the targeted borrowing sectors: agriculture, home finance and education.[citation needed] Congress created the first GSE in 1916 with the creation of the Farm Credit System; it initiated GSEs in the home finance segment of the economy with the creation of the Federal Home Loan Banks in 1932; and it targeted education when it chartered Sallie Mae in 1972 (although Congress allowed Sallie Mae to relinquish its government sponsorship and become a fully private institution via legislation in 1995). The residential mortgage borrowing segment is by far the largest of the borrowing segments in which the GSEs operate. Together, the three mortgage finance GSEs (Fannie Mae, Freddie Mac and the 12 Federal Home Loan Banks) have several trillion dollars of on-balance sheet assets.[citation needed]

Business
The GSEs have created a secondary market in these loans through securitization so that the primary market debt issues can be bought and—most importantly—traded by investors. Demand for debt securities drives up their trading price, which lowers their interest rates. Proponents say that this secondary market in consumer loans gives household borrowers cheap fixed rate loans (low fixed rates on long term loans), removes credit risk from banks' balance sheets and provides standardized instruments (securitized securities) for investors.[

"the market" loved sub-prime mortgages to death and now "it" have soured on mortgages altogether

the sub-prime crisis was created by private money - not freddie/fannie mac money (they may have gotten into subprime at the tail end)


Posted by: jamzo on July 17, 2008 at 4:00 PM | PERMALINK

I hate to go all empirical, but the semi-private status of the GSE's has been there since 1968, when they were offloaded to hide the cost of the Vietnam War. So they're been ok for nearly 40 years. If their status is the only problem, why didn't it happen a lot sooner?

So without raising any ad hominem points, the argument is defective.

But it is similar to the flippant ashattery we saw in the World Bank memo and his pontifications on faculty positions for women in the sciences.

Posted by: Roger Bigod on July 17, 2008 at 4:04 PM | PERMALINK

Jeff II:

You are wrong on a couple of counts. First, FNMA and FHLMC didn't fund Alt-A and subprime mortgages the way Countrywide did. They only funded "conforming" loans, which meant they had to adhere to conventional mortgage underwriting requirements (i.e. at least 80% LTV, evidence of repayment ability, etc.) Countrywide clearly lent money on a shoestring and a song. They would surely have landed in bankruptcy, if Bank of America hadn't decided to buy their mistake, since they had already purchased a lot of the worthless paper Countrywide originated. Where FNMA and FHLMC got into trouble is in paying massive, private market salaries and bonuses in an essentially govt.-run enterprise (i.e. capitalist returns in a socialist company). Your second error is in calling the Fed a governmental institution - that is not true. It is a quasi-governmental enterprise that receives no taxpayer money whatsoever. Technically, the Fed is the fiscal agent for the U.S. Treasury. Big difference.

TCD

Posted by: The Conservative Deflator on July 17, 2008 at 4:08 PM | PERMALINK

I think Larry is also the author of a memorable aphorism which fits with his observation here: no one ever washes a rented car.

Posted by: Ish on July 17, 2008 at 4:14 PM | PERMALINK

Jeff II: You are wrong on a couple of counts. First, FNMA and FHLMC didn't fund Alt-A and subprime mortgages the way Countrywide did. They only funded "conforming" loans, which meant they had to adhere to conventional mortgage underwriting requirements (i.e. at least 80% LTV, evidence of repayment ability, etc.). . . Where FNMA and FHLMC got into trouble is in paying massive, private market salaries and bonuses in an essentially govt.-run enterprise (i.e. capitalist returns in a socialist company). Posted by: The Conservative Deflator

Where did you get this idea? If this were the case, then they wouldn't be in trouble. Conforming mortgages aren't the ones defaulting these days. Furthermore, two financial institution of that size do not go into arrears simply by paying their executives too much unless they were on the verge of insolvency to begin with.

They are, like everyone else in mortgage banking, holding a lot of bad paper on loans that they guaranteed, as is their mandate.

* * * * *

The two companies, which bought securities backed by risky subprime mortgages when the housing market was booming, have watched those bets unravel in the past few months as the housing market buckled under credit crisis pressures.

http://money.cnn.com/2008/07/07/real_estate/fannie_freddie/index.htm?postversion=2008070718

Also see.

http://www.econbrowser.com/archives/2008/07/fannie_mae_and.html

http://www.iht.com/articles/2007/07/30/business/bxprime-web.php

* * * * *

Finally, the Federal Reserve system was established by Congress in 1913. The Chairman of the Federal Reserve Bank is appointed by and serves at the discretion of the president. I don't think that's the case with Citibank or the Bank of America, two examples of private banks.

Posted by: Jeff II on July 17, 2008 at 4:44 PM | PERMALINK

Besides the expected undertone of cynicism, the rented car observation is, on closer examination, kind of dumb. Nobody sweeps the floor in a hotel room they've rented or washes their dishes in a restaurant. So?

Posted by: Roger Bigod on July 17, 2008 at 5:24 PM | PERMALINK

Isn't there a law or vehicle whereby taxpayers can go after the millions in obscene salaries and bonuses the Fannie/Freddie managers paid themselves?

Posted by: hollywood on July 17, 2008 at 8:03 PM | PERMALINK

Isn't there a law or vehicle whereby taxpayers can go after the millions in obscene salaries and bonuses the Fannie/Freddie managers paid themselves?
Posted by: hollywood

Yes. That would be through Congress. However, it's much too busy doing nothing right now to take it's oversight duties responsibly, like letting Rove get away with ignoring subpoenas though he's no longer in government.

Enough already. Arrest that motherfucker's ass and set him down in that chair.

Posted by: Jeff II on July 17, 2008 at 8:25 PM | PERMALINK

I'm with you, Jeff. Arrest both that motherfucker's asses and set them down. But apparently, we are going to be treated to some sort of Pelosi "abuses" show with no consequences for anyone.

Posted by: hollywood on July 17, 2008 at 8:29 PM | PERMALINK

it's much too busy doing nothing right now to take it's oversight duties responsibly, like letting Rove get away with ignoring subpoenas though he's no longer in government.
癌症But apparently, we are going to be treated to some sort of Pelosi "abuses" show with no consequences for anyone.

Posted by: xinyaow on July 18, 2008 at 5:08 AM | PERMALINK
Post a comment









Remember personal info?










 

 

Read Jonathan Rowe remembrance and articles
Email Newsletter icon, E-mail Newsletter icon, Email List icon, E-mail List icon Sign up for Free News & Updates

Advertise in WM



buy from Amazon and
support the Monthly