Tuesday, 15 July 2008

Why you shouldn't give a Fannie Mae

Contrary to popular economic wisdom, the collapse of the appallingly named American welfare lenders 'Fannie Mae' and 'Freddie Mac' would not be a disaster to be measured against the Vandals' sacking of Rome, as some breathlessly illiterate commentators suggest.

These two government-created behemoths "own" ninety percent of America's "secondary" mortgage market -- in other words, cheap credit doled out to make up the difference between what house-buyers wanted, and what they could really afford. This is the junk mortgage market primarily responsible for creating the housing bubble with the money pumped out by the Federal Reserve's printing presses, which have been running hot for a decade.

Without all this extra credit, created by 'The Fed' out of thin air, and without these two bloated bureaucracies, created way back in the thirties by Franklin Roosevelt's 'New Deal' panjandrum, the housing bubble would likely never have happened as it did.

The counterfeit capital doled out through Fannie Mae (the Federal National Mortgage Association) and the Federal Home Mortgage Corporation (Freddie Mac) amounts to middle class welfare for house-buyers . The delusion of inflationism -- the process by which prosperity is 'assured' by expanding the money supply while strangling production -- allowed everyone to believe this was sustainable.

It isn't. The $5 trillion bubble is about to burst. The real disaster, as Lew Rockwell points out, is not the bursting but the politicians who want to bail out the bubble with even more printed money -- as if the salve of ever more printed money will be able to turn stones into bread, or bubble into balm:

Here is John McCain:
"Those institutions, Fannie and Freddie, have been responsible for millions of Americans to be able to own their own homes, and they will not fail, we will not allow them to fail … we will do what's necessary to make sure that they continue that function."
Not a single Democrat disagrees.
As with the S&L fiasco from years ago, the case of the housing bust followed by the trillions in taxpayer liabilities for the disaster will again be cited as a case of "the shock doctrine" and "disaster capitalism" in which the elites make fantastic amounts of money at the expense of the little guy. The critique will be mostly solid but for the one most important point: this kind of fiasco would not happen in a free market. It happens because government, through credit creation and guarantees, makes it possible.

It was not capitalism that created this mess, it was the vial of government poison that everyone has been drinking. Time to go cold turkey, not to keep brewing more.

UPDATE: The bailout of Freddie and Fannie has got investor Jim Rogers outraged.

The U.S. economy is in a recession, possibly the worst since World War II, Rogers said. "They're ruining what has been one of the greatest economies in the world,'' Rogers said. Bernanke and Paulson "are bailing out their friends on Wall Street but there are 300 million Americans that are going to have to pay for this, and 6 billion people in the world who are going to have to pay for it.''

See him explain it all in his usual colourful fashion at the Mises Blog.


  1. As one commentator said, of this and the previous bail out of Bear Sterns, it is simply socialism for the rich.

    The West is unfortunately largely run by ignorant, meddling fools, hence the precariousness of our freedoms into the future.

    Mark Hubbard

  2. Most of what you say is mostly correct, certainly the cheap credit available over the last decade is the fuel which has created the present situation. Greenspan will be judged very unkindly by history. But now that we are here the answer isn't to allow financial instos to just fall over. Bernanke's response with bear stearnsw as the best way out - essentially guarantee the debt obligations of bear stearns, but punish the equity holders. The same thing is happening with freddie and fannie. Equity owners will end up with pretty much nothing but holders of debt will have principal mostly underwritten. The ramifications for the wider economy if a major financial insto goes down is the complete lock up of debt markets and then well see recession for real.

    Its all very well to argue one form of strict economic orthodoxy but thats not how we got here so the solution has to reflect that. Yes bank and brokerage balnace sheets are way too levered, yes there's an asset quality hidden on everyone's balance sheet, but using shock therapy isnt the right cure right now. The otc exposures between banks and financials are so large, so complex, that if one player defaults the fallout is very very ugly.

    And its not clear you know this from your post but FHLMC and FNMA are both privately owned, NYSE listed corporations. They have an implicit debt guarantee from the US government providing that the mortgages they originate meet certain criteria (ie are "conforming loans"). Conforming loans must meet criteria including applicant credit score, loan size (maximum related to average area house price) etc. They arent a sub prime originator (although potentially a lot of their loans may migrate toward that category), and FNMA/FHLMC use securitisation to shift most of the credit risk they take to external investors.

    This whole credit crunch is actually the correct response to years of unfettered money suply growth and resultant overleverage. The trick - which I think Bernanke is doing well - is to deflate the bubble and remove excesses in a manner which damages the economy as little as is possible. Tipping financials into bankruptcy just converts a liquidity problem into an asset value destruction. Trust me, as a distressed debt investor we'll make far more money out of unfettered bankruptcies with resultant slashed price asset sales than we will out of a controlled write down of balnace sheets.

  3. Hi GoMango, you said, "And its not clear you know this from your post but FHLMC and FNMA are both privately owned..."

    Yes, I'm aware that both FHLMC and FNMA are nominally privately owned ... but as this Wall Street Journal retrospective shows the GSE's are essentially public entities, and their problems aren't a surprise to anyone.

    You also say, GoMango, that "now that we are here the answer isn't to allow financial instos to just fall over."

    I don't agree. I don't agree at all.

    You're aware, I'm sure, of the moral hazard problem created, so I won't belabour that.

    You must be aware they're bailed out with even more created credit, so there's surely no real need to belabour that.

    So, as a commenter at the Mises Blog says, Let's get real for a moment: If Fannie and her fascist brother were indeed to "fail," what would actually happen? Those resources, the "mortgages", would be sold at a discount, to people with better use for those resources.

    No one would die, and recovery would be possible.

    The malinvestment would be gone, to fertilise productive activity, instead of being left to linger on like some malevolent zombie chained up in the basement consuming your seed corn.

    [WARNING: Mixed metaphor alert!]


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