Tuesday, September 09, 2008

GSE Excess: Privatizing Profits, Socializing Losses

From the Executive Summary of The Cato Institute's Briefing Paper "Freddie Mac and Fannie Mae: An Exit Strategy for the Taxpayer," by economist/blogger Arnold Kling:

The Fannie Mae-Freddie Mac crisis may have been the most avoidable financial crisis in history. Economists have long complained that the risks posed by the government-sponsored enterprises were large relative to any social benefits.

We now realize that the overall policy of promoting home ownership was carried to excess. Even taking as given the goal of expanding home ownership, the public policy case for subsidizing mortgage finance was weak. The case for using the GSEs as a vehicle to subsidize mortgage finance was weaker still. The GSE structure serves to privatize profits and socialize losses. And even if one thought that home ownership was worth encouraging, mortgage debt was worth subsidizing, and the GSE structure was viable, allowing the GSEs to assume a dominant role in mortgage finance was a mistake. The larger they grew, the more precarious our financial markets became.

MP: I think the sentence in bold above says it all.


At 9/09/2008 9:51 AM, Anonymous Anonymous said...

Having said all that, I think their nationalization is good news if the final goal is to spin them off eventually as 5 or 6 completely private entities with no government backing.

The best thing I read about their nationalization is that their lobbying arms have been completely eliminated. Which means that returning to the status quo will probably not happen.

At 9/09/2008 2:50 PM, Anonymous Anonymous said...

Nice to see Mudd & Syron are also gone and that the portfolio will be downsized 10% per annum starting in 2010.

Unfortunately, Fannie & Freddie have lots of friends like Barney Frank (D). Judging by the past action (or rather total inaction) on the accounting irregularities, these folks will stall until the crisis is over.

At 9/09/2008 3:33 PM, Anonymous Anonymous said...

The GSE structure serves to privatize profits and socialize losses

You don't know very much about the GSE structure, do you Carpe Diem?

The GSE equity holders (common and preferred), primarily U.S. mutual funds and banks, were effectively wiped out, but the GSE bondholders, primarily, China weren't.

The Chinese agency et.al. bondholders privatized the gains, the U.S. Treasury socialized those losses.

Welcome to the USSAC, the United States Socialized America for China.

As a libertarian free market economist, you ought to be pissing in your trousers.


...that the portfolio will be downsized 10% per annum starting in 2010.

Apart from the fact that the GSE's were crammed with toxic waste since the credit crunch began (something that Carpe Diem does not admit), for about a year now, who else is going to provide the over-leveraged, under-employed, under-earning American consumer with a mortgage.

And if you think that Allison and Moffett will not make more money than Mudd and Syron, I have a bridge to nowhere available for your purchase.

At 9/10/2008 10:43 PM, Blogger Voice of Reason said...

Where is the accountability? We had a fit about Enron and every other corporate accounting scandal but when it comes to FRED and FANNIE the government turns the other cheek. Mr Frank and Mr Dodds should be investigated to the full extentas Mr Ley and his colleagues were. It really is both amazing and outrageous.

It's much easier to turn the attention on the Chinese than it is to deal with the truth Mr anonymous. Government officials who supposedly overlook these entities happened to turn a blind eye to the total debauchery of income statements. They failed and should be held accountable!

At 9/14/2008 3:52 PM, Blogger Kevin Lamson said...

Six months after U. S. regulators hoped a bailout of Bear Stearns Cos. would help put an end to the credit crisis, the worst could be yet to come as fresh fears about the viability of financial firms are rocking Wall Street. Now, Lehman Brothers, until recently the fourth-largest securities firm on Wall Street just ahead of Bear Stearns, is facing the same fate.
In order to stave off a loss of faith in U.S financial institutions the U.S. Government decided in underwrite a sale of Bear Stearns to JP. Morgan. A conservative estimate of the cost of this bail out was thirty billion dollars $30,000,000,000,00. This was promoted by the Bush Administration, the Federal Reserve and the U.S. Treasury as necessary because a “collapse of Bear Stearns” would “stager the financial markets” and “undercut confidence in the U.S. Financial System”.
However since the Bear Stearn’s bailout, the “financial markets” have continued to falter and both international and domestic confidence in U.S Financial System have continued to decline. And for good reason. For at least the past eight years U.S. Financial Institutions such as Banks and Investment Banks, and U.S. GSE’s like Fannie Mae and Freddie Mac have flipped trillions of dollars of bonds into the International Financial markets. These bonds were purportedly backed debts owed by millions of American homeowners and secured by mortgages against their homes. Many of these so-called “mortgage loans” were made to American’s who would not, because they could not, repay these loans. Because they simply did not have the financial capacity to repay the loans. Thus millions of these unqualified American borrowers have defaulted on their loans and millions more will. These loan defaults result in a foreclosure of the mortgage which secures the debt, which in turn results in the bond holders, through a trust, ending up owning an interest in real estate in place of holding an performing loan. The GSE’s, Banks and Investment Banks that sold or hold these bonds are in DEEP trouble. Because the income stream that was supposed to come from monthly instalment’s being made by American’ borrowers is simply not flowing in as promised. And the property that was supposed to secure the repayment of the loans are now selling for 30% to 80% of the amount secured. Couple this with the holding and foreclosure expense in taking back the property and in some cases the actual principal back to the bond holders might is significantly less than what the initial bond holder paid for the bond. In other words the actual asset value backing these bonds could be 40% to 90% less tan the bond holder invested. In cases where lenders made so-called home-equity loans and taken second or third mortgage positions the value of the security is ZERO. Many of these home equity loans have been written off completely because the property has no equity left after being foreclosed by a first mortgage lender.
No one seems to want to audit these mortgage backed security trusts to determine which loans are good, vs. which ones are in default, underwater, foreclosed and or written off etc. This of course means that investors who purchased these bonds are left holding a security of questionable value. So the actual value of these bonds remains a secret. Thus we have trillions of dollars of bonds being held by investors around the world where no one really knows the actual value. In this writer’s opinion this is what creates an investor confidence problem in the Financial Markets and the U.S. Financial System.
In place of determining what these bonds are really worth, the U.S. Government decided to step in and blindly guarantee a 30 billion dollar bail out of Bear Stearn’s using the full faith a credit, ie. tax payer money, to guarantee the “bad paper” held by Bear Stearns. Our Government took this action on the premise that a “collapse of Bear Stearns” would “stager the financial markets” and “undercut confidence in the “U.S. Financial System”. As can be seen from events over the last three months this Bear Stearn’s bailout and Guarantee by our government did nothing much to reassure investor confidence in the bailout U.S. Financial System.
Over the past week alone, the United States' two main mortgage-finance firms -- Fannie Mae and Freddie Mac, in place of filing in bankruptcy, were put into a “conservatorship” under government, while Lehman Brothers Holdings Inc. was being pushed by the Government into a possible take over by a rival, and probably foreign, bank in place of being forced into bankruptcy. A Bankruptcy proceeding by design would of course require a complete accounting of these firms assets to determine te value of assets vs. the liabilites = how much creditor claims, including bond holders, are really worth. Heaven forbid anyone knowing what their bond is really worth!
Even though Fannie Mae, Freddie Mac, and Lehman Bros, have escaped having to expose the true value of their respective assets by filing bankrutpcy, their shareholder’s have already lost hundreds of billions of dollars, despite being repeatedly assured by management in press release after press release that everything was OK. The U.S. Government along with the management of these once prestigious firms went so far as attacking anyone who was publically warning people that these entities might acutally be insolvent or on the edge of insolvancy.
The stocks of other U. S. financial firms, including savings and loan giant Washington Mutual, Wall Street investment bank Merrill Lynch & Co. and insurance behemoth American International Group Inc. (AIG) have been whipsawed this week as investors fret about further dominoes to fall.
The immediate challenge for the Bush administration is resolving the fate of Lehman Brothers. It was again reported that “Global fears intensified over the weekend that Lehman's collapse would “stagger markets” and “undercut confidence in the U.S. financial system”. Will the U.S Government once again try to calm “Global fears” by forcing a U.S Investment Bank to sell its good operations and assets to a rival bank while the U.S. Government puts its tax payers on the hook for taking the bad assets? This continued scheme of privatizing profits while socializing losses to ensure “Global confidence in the U.S. Financial System” is in this writers view short sited and doomed to fail, costing U.S. Taxpayers billions if not trillions of dollars. I mean really who in their right mind would guaranty a debt owed by someone else that was already in default and where the asset backing the debt was of questionable value? The answer appears to be no one will do this other than the good old U.S. Government. The only unanswered questions are; 1) how much will the U.S. Government ultimately lose by gambling tax payer money to bailout all these U.S. Financial Institutions and; 2) How much can the U.S. Treasury borrow from the Federal Reserve to finance the losses it takes from these bailouts?
Your considered opinions and thoughtful comments are invited.


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