by hilzoy
The NYT:
“Alarmed by the sharply eroding confidence in the nation’s two largest mortgage finance companies, the Bush administration on Sunday asked Congress to approve a sweeping rescue package that would give officials the power to inject billions of federal dollars into the beleaguered companies through investments and loans.
In a separate announcement, the Federal Reserve said that it would make one of its short-term lending programs available to the two companies, Fannie Mae and Freddie Mac. The Fed said that it had made its decision “to promote the availability of home mortgage credit during a period of stress in financial markets.”
An official said the Fed’s decision to permit the companies to borrow from its so-called discount window was approved at the request of the Treasury, but that it was temporary and would probably end once Congress approved Treasury’s plan. Some officials briefed on the plan said Congress could be asked to extend the total line of credit to the institutions to $300 billion.”
Good. I’m glad the government stepped in. That said, I agree with Dean Baker that it should have stepped in with conditions:
“Apparently the government is going to hand Fannie and Freddie bucket loads of taxpayer dollars, no questions asked. The NYT reports that they will be given access to $300 billion of government loans at below market interest.
That’s nice. Shareholders who would have lost all their money if matters were left to the market, may instead walk away with billions of dollars. Similarly, the top executives of these companies, who earn salaries in the millions and tens of millions of dollars, will keep collecting their paychecks.
We should all be thankful that the government intervened. After all really rich people and investment fund managers can’t be expected to be able to handle their investments on their own. They need the helping hand of the government when they really screw up.
Similarly, we don’t want the fate of highly paid executives to be left to market. If this happened, some might lose their vacation homes and private jets.
Some people say that we had to hand tens of billions of dollars to the country’s richest people to prevent a financial collapse. This is simply not true.
We had to keep Fannie and Freddie in business, but we could have done this by putting conditions on the bailout. The government uses conditions all the time when it offers help to low and moderate income people. Unemployment insurance, TANF, food stamps, and even student loans come with all sorts of conditions.It is only when it comes to giving money to extremely rich people that we find it impossible to impose conditions. Again, we could have told Fannie and Freddie that no executives will get more than $2 million a year in total compensation. We could have told their shareholders that they are out of luck, because that is what is supposed to happen when you invest in a bankrupt company.
Instead, we told the people who work as truck drivers, school teachers, and fire fighters that they will have to pay more in taxes to help some of the richest people in the country escape the consequences of their own stupidity. While kicking the poor is always fun for politicians, neither the Bush administration nor Congress are prepared to tell the very rich that they are on their own.”
There are two reasons to take steps that both prevent Fannie and Freddie from going under and make shareholders and executives take serious hits. The first is that this is the only way to avoid moral hazard: people’s tendency to take unnecessary and stupid risks when they are not going to wind up paying for them. If shareholders actually lose their money, and executives have to be content with — sniff! — two million a year, that might just do the trick. (Note: I’d be fine restricting compensation limits to people who are presently on board, not new hires. It’s the people who got us into this who need to pay some sort of price, so that the next time around, people might think twice. I’m also open to the idea that Baker’s particular suggestions are wrong. It’s the principle of holding investors and executives accountable that I care about, not any one particular idea about how best to do this.)
The second is basic fairness. One of the things that really bothered me about the FISA bill was the fact that so many people who don’t think twice about the fate of ordinary people under our criminal justice system were suddenly horrified at the thought that those poor telecoms, with their in-house lawyers, might be responsible for knowing what the law is, and, if in doubt, erring on the side of caution. A kid who acts as a lookout for a robbery that goes bad can be charged as an adult with felony murder, whether or not he had any idea that the law makes this possible. If he participated because he didn’t want to say no to the bigger guys with guns, that might or might not get him off the hook, depending on whether his court-appointed lawyer had too many other cases to notice, whether the judge was paying attention, whether the jury didn’t believe him because they thought he wore the wrong kinds of clothes (aka ‘looked like a gangbanger’), and so forth. In this way, a kid who has no previous record of violence, who committed no act of violence on this particular occasion, and whose offense was having failed, on one occasion, to stand up to people who actually were violent, and who lived in his neighborhood and knew his name, can be sentenced to decades in prison.
Yet, oddly, most of the people who were sticking up for the telecoms do not have a history of caring about this sort of thing. Stranger still, the people who thought it was fine for Scooter Libby’s sentence to be commuted rarely get exercised about kids like this. In fact, many of them regularly go on about how important it is to get tough on crime. And yet there they were, talking as though the fact that Scooter Libby thought he was acting in the nation’s interests, and the telecoms were scared to stand up to the people who give them contracts, was enough to let them off the hook.
News Flash: A lot of people who break the law think that they have some reason for doing so. Sometimes those reasons are pretty comprehensible: a kid who deals crack because he wants to buy his kid sister some clothes that don’t have holes in them, for instance, or because someone in his family has to buy groceries. But we normally think that this should not get you off the hook. Unless, of course, you happen to be a major corporation or a well-connected Washington insider. Then, of course, everything is different.
Same here: when families are losing their homes — families they don’t know, at any rate — some people are happy to say: well, that’s the price they pay for financial irresponsibility. Admittedly, some of the people who will lose everything might have been eighty year olds with mortgages that were almost paid off before that nice young man convinced them to sign those papers, but hey: people make choices, and they should have to live with them. Unless, of course, they happen to be well-paid executives. Because, of course, that’s different.
I can see treating ordinary people more leniently than the powerful and well-connected. Ignorance of the law, as they say, is no excuse, but if it is to be one, surely it should be an excuse for ordinary people, not for large corporations with their own legal staffs. People need to actually lose when they make bad choices — surely, if one were to make exceptions to this rule, one would want to start with the people who can least afford the loss, and were least equipped to understand why their choices were bad. Which is to say: you’d want to let people who signed on to mortgages that even their brokers didn’t understand escape the consequences of their choices before you let off people who are paid large sums of money for their alleged expertise, and who have the wealth and connections to make sure they understand exactly what they’re doing.
But there’s no sense at all in doing it the other way round: insisting on full accountability when you’re dealing with someone who trusted his real estate broker’s assurances about what he was signing, and who really didn’t have anyone else to ask, but not when you’re dealing with someone who took millions in compensation from Fannie Mae or Freddie Mac when things were going well, and who had the resources and the knowledge to know that getting too deeply into risky mortgages was a stupid thing to do.
Honestly, the only reason I can think of why lawmakers and people who set policy would advocate these sorts of double standards is because they don’t want accountability for people like them. Which is no reason at all.
Another example of the golden rule: he who has the gold makes the rules.
I think most lefties and liberals have no understanding what righ-winger’s mean by “tradititional values.”
I have no problem with the government taking steps to slow a meltdown, but the shareholders absolutely should not be getting money out of it. Losing all your money when your investment is so bad that it risks hurting the economy as a whole as it goes under is how capitalism is supposed to work if it goes under.
Otherwise you get large companies that get to survive when they make horrific decisions and they get to keep making horrific decisions. (See for example US automakers).
Well as long as Congress doesn’t approve it, then there won’t be a “bailout.” A lot of people are clamoring for re-nationalization which perhaps isn’t such a bad idea.
As was talked about a few days ago, the situation with the GSEs isn’t catastrophic because their assets are on the whole rather OK. It’s really all the banks you have to worry about with marked to fantasy asset values. Uh…today isn’t looking so hot for them. With Wamu (which makes IndyMac look small) down 30% as well as several of the regionals. The response if those start to fail will make what to do about the GSEs look simple.
Our new masters, the Chinese, own a lot of shares in Fannie Mae and Freddie Mac.
Our government is simply doing as they’re told.
well hell’s bells hilzoy .. you can’t get the kind of hired help you need to engineer this big of a pluck-up by only offering them 2 mil a year ..
and i’ve been reading you for some while .. and imo .. you’re pretty sharp .. so maybe you can riddle me this:
on the news that the US Gov’t was bailing out FanMae and FredMac .. the US Dollar strengthened .. as a matter of fact it rose in value enough to drop the price of crude oil by a buck a barrel ..
here’s my problem .. since this bail-out entails the US gub’mint borrowing an additional 15 to 20 [or much much more] billion dollars and will require raising the debt ceiling .. which will mean printing even more “bogus bucks” .. how does that translate into “a stronger dollar” ??
thanks in advance ..
Clearly those folks are Communists.
It’s worth noting that the “true conservatives” will inevitably take a very hard line against company bail-outs like this, because they don’t want to look like total hypocrites. They are safe in making these rumblings because they have no delusions that bail-outs will not take place no matter how much noise they make. And since they wouldn’t dream of voting for anyone but a GOP gumba in the upcoming election, they can just chalk this up to evil Democratic Majorities, while extolling their audiences to keep pulling the (R) lever.
Either way, “serious” people will all agree that government regulation is always bad. Government bail outs, however, are necessary evils. Then they’ll remind everyone who will listen that Republicans stand for bail outs while Democrats stand for the economic poison-pill that is oversight of private institutions.
After all, if we’d managed Freddie and Fannie like we manage Medicare or Social Security, what sort of mess would we be in today?
Why does Hilzoy hate America???
Hilzoy, totally agree with the sentiment here. But many of the shareholders in F/F are middle and working class people whose 401k’s and various pension funds were invested by others in what were presumably thought to be safe investments.
But many of the shareholders in F/F are middle and working class people whose 401k’s and various pension funds were invested by others in what were presumably thought to be safe investments.
I really doubt that they constitute any significant portion of outstanding shares. I’m no financial planner but if my broker had even 10% of my 401k in a single company they would quickly be getting calls from an attorney when it tanked.
I agree — I don’t understand why, if we tax payers are going to bail out Fannie and Freddie, why we don’t get to require some shared pain.
As far as I can tell, some of the mortgages backing the defaulting securities were obtained by fraudulent means by brokers and house purchasers who lied about their resources, and I have no problem with them being foreclosed on. Others were essentially lied to by their real estate broker or lender, and should, I would hope, get some relief.
Basically, what I fail to see is why, if the Feds are really providing the $$$ to buy and back all of these securities, why the Feds aren’t getting any control over bond repayments, or the servicing of the loans they already own. And I don’t see any relief being provided for the millions of home owners who were defrauded by deliberately misleading loan agreements.
I’m sick of these people who talk about the benefits of the free market, but who really take bets with other people’s money, and then go running to the Federal government when their bets go wrong. This disconnect between the people who are paid when things go well, and those who pay when things go badly, reminds me of the S&L crisis, only this involves even more money.
I’m also sick of seeing all of the power of the Federal government being used to bail out the wealthy, while ordinary people are left to handle the crisis on their own.
One of the things that really bothered me about the FISA bill was the fact that so many people who don’t think twice about the fate of ordinary people under our criminal justice system were suddenly horrified at the thought that those poor telecoms, with their in-house lawyers, might be responsible for knowing what the law is, and, if in doubt, erring on the side of caution. A kid who acts as a lookout for a robbery that goes bad can be charged as an adult with felony murder, whether or not he had any idea that the law makes this possible.
I might agree with you that this example is something like the FISA compromise, but only if the DOJ went to the kid and assured him that his actions were not only legal but vital to the war effort. Otherwise, your example not at all like the FISA compromise.
A-train is talking about institutional rather than individual investors, Fledermaus. And, you’re right: If you own Freddie Mac shares through your 401k — as you probably do — it’s probably highly diluted because it’s likely owned through a diversified mutual fund. Feedback effects aside, losing that investment probably won’t cost you much.
But I think what A-Train is getting at is that the notion that a shareholder as Gordon Gecko is, well, quite outdated. Virtually everyone who does or may own an IRA or draw a pension has the potential of being an investor, and the largest investors tend to be aggregates of many smaller investors. (This wasn’t always true in Freddie Mac’s case: IIRC, at one point Berkshire Hathaway owned a significant interest. But Buffett, being Buffett, had the foresight to make some changes.)
Whatever the merits of refusing to bail out shareholders — and there may be some merit to it — I don’t think the issue is framed quite right. F’instance, it wouldn’t surprise me to see labor leaders favoring a shareholder bailout to protect the retirement funds of the workers whom they represent.
I don’t have a problem with letting the F&F shareholders and execs take a hit, but a kid selling crack so that his kid sister can have clothes without holes in them? Give me an effing break. Crack dealers do it so they can get operations for orphan puppies!
I agree in principal that shareholders should not be bailed out.
I disagree with Sebastian and others that this is how capitalism should work….. because it is not designed to work that way.
This is a simplistic, quaint view of contemporary shareholder capitalism in the era of huge money management institutions.
85% of Fannie Mae common shares are held by institutions, pension funds, mutual funds (including passively managed index funds like Vanguard’s), hedge funds etc.
That leaves, I suppose, 15% of Fannie Mae shares in the hands of individual shareholders.
All other shares are held by surrogates and in fiducuary trusts.
I’ll wager that many of the folks who say shareholders should be punished for their judgement own Fannie Mae one way or another…… but don’t even know it.
Tell me how the wonderful incentives and disincentive signals of capitalism are supposed to work when you MIGHT find out in a few months or a year from one of your fiduciaries that you own Fannie Mae, or used to.
In fact, I doubt you’ll find out when your fiduciary sold the stock. $73 a share? $42 share? Friday’s $10 a share? They are not required to tell you.
What actions are you going to take? A passively managed index fund owns Fannie Mae whether you like or not.
Modern finance capitalism has all of us locked in steerage and they are not about to tell us how big the icebergs are and what that big scraping noise was along the hull.
The gates are locked and you’re getting a little nervous because the hallway floors are getting wet ….. and is that listing you feel to starboard?
A lot of good it’s going to do you to decide to never take another cruise again.
I doubt the captain is coming below decks to listen to your complaint right now. Besides, he’s wearing a dress and rowing as fast as he can away from the ship.
Or is he? There is no captain. Who were you thinking was going to receive frantic signals?
Also, does anyone really know what they own when they own shares in a publicly traded company? Very few companies are going to let you know ahead ot time that the bank is broken.
That would be unAmerican … to speak negatively about the future. By the time you get ready to send your signal, your signal is worthless.
If you appoint regulatory agency heads who (a) come from the regulated industry (or its lobbiests), (b) don’t believe in regulation, and (c) after their government “service” get to go back to the regulated industry at 7 or 8 figure incomes, these results are not much suprise.
Proof of income for a home mortgage – who needs such ridiculous government interference when there’s good money to make on each deal, and we all know home values only go up (and if we’re wrong, we get bailed out in the end anyway)?
John Thullen, the problem is that Fannie Mae and Freddie Mac have been operating for decades as quasi-government entities. As Professor Bainbridge has argued for years now, they should have been fully privatized long ago. But they weren’t: they were kept in a hybrid state, neither fish nor fowl, and made immune to the pressures that would have caused a traditional private firm to correct course. Moreover, because of the government’s imprimatur, there was considerable debate over whether or not the government had implicitly guaranteed their solvency; certainly, the market assumed so, making alternative institutions less attractive.
Also because they were quasi-governmental entities, the government exempted it from the rules that govern regular entities–which allowed for less loan oversight than normal. Exempting government entities from regular controls is one of the things governments do to save money….
All according to plan :
Privatize profits from risk-taking
(execs and shareholders get the money)
Socialize losses when risks go bad
(taxpayers bail out execs and shareholders)
Heads they win; tails we lose.
This is exactly what Republicans mean by “fiscal conservatism”: government exists to transfer wealth from taxpayers to execs and shareholders of favored corporations.
I thought everyone knew these things.
F/F took 37% of new mortgages in 4Q06. The number was 70% the first part of this year. This was a conscious decision.
The only way I can see that taking on more mortgage debt could be seen as good for the companies’ bottom line in 2007, would be if leadership was banking on a taxpayer bailout that would reward volume over quality.
Our government-backed friends were getting in while others were getting out. I’m not sure that the decisions made in 2007 weren’t fraudulent.
This is exactly what Republicans mean by “fiscal conservatism”: government exists to transfer wealth from taxpayers to execs and shareholders of favored corporations.
I realize that’s the story you’d like to tell, but the truth is far different. The blame for Freddie Mac and Fannie Mae rested in its quasi-governmental status, which left it critically unregulated, overextended, and not subject to market pressures. That status was achieved and fostered by multiple administrations, Republican and Democrat, over a long period of time. Many, many commentators, from the left, right, and right, warned that this day may come. They were unheeded, in part because the FFs were politically linked to both parties and thereby insulated. Moreover, the FFs successful resisted efforts for reform. Either making them full-fledged government agencies (the D solution) or spinning them off and privatizing them (the R solution) would have been better than the status quo.
Somewhere, John Nash is smiling.
Trying to fit this into your preexisting storyline will prevent you from understanding how and why this happened, and it will blind you to future trouble.
This just doesn’t ring true to me Von. Mac and Mae were no less regulated than the rest of the institutions packaging mortgages together into various securities and reselling them.
As to their quasi governmental status, I think that’s irrelevant. They were really no different than any other corporation. There was certainly no guarantee that their quasi governmental status would result in a bail out should things go bad.
It was their dominance that ensured that. Just like Bear Stearns, who had no such quasi governmental status.
Hi Von
I agree that many of the Dems have been complicit for decades. Perhaps I should have said “Beltway Villagers” instead of “Republicans”.
Would you explain for us how Silverado Savings & Loan ended ?
von: ” But they weren’t: they were kept in a hybrid state, neither fish nor fowl, and made immune to the pressures that would have caused a traditional private firm to correct course.”
and:
“The blame for Freddie Mac and Fannie Mae rested in its quasi-governmental status, which left it critically unregulated, overextended, and not subject to market pressures.”
The thing is: the pressures that supposedly would make private firms correct course did not do so until serious systemic problems were a real possibility. Moreover, while I do not want to argue that the regs on Fannie Mae and Freddie Mac were somehow perfect and irreproachable, there are some very smart and well-informed people out there arguing that it was the regs that kept them from going off the cliff with many of the private firms. For instance, Tanta at Calculated Risk:
And Richard Green (via Krugman):
the problem is that Fannie Mae and Freddie Mac have been operating for decades as quasi-government entities. As Professor Bainbridge has argued for years now, they should have been fully privatized long ago.
Is that what Professor Bainbridge is arguing? Because the title of the piece you link to is, “Privatize Freddie and Fannie or Bring them Back into Government”, which seems to me like it might be suggesting that fully privatizing them isn’t the only option. Perhaps there is the option that, “the government takes full control of their management”, as it says in the article Bainbridge quotes.
For the people who think privatizing the GSEs is the answer, would that still be your answer if the effect of that was to make mortgage loans available only under the terms that existed before Fanny and Freddy existed?
In that case, here is what you would need to get a mortgage. You would need somewhere between a 30-50% down payment. You would need to be able to pay off the balance in a 10 or 15 year period, the income requirements would be more strict than they are now, and the interest rate would be several percent higher. In the short and medium term, that would increase the number of financial institutions that become insolvent because it would cause housing prices to fall much further. And in the long run, it would lead to a much smaller percentage of homeowners vs. renters.
Also, do not suggest that privatizing them would avoid market panics such as the one we are enduring now, they were quite common under all the types of mortgage lending preceding the creation of Fanny as a government agency.
Further, your argument that their quasi-government status kept them from making “necessary corrections” bears little weight given what has been happening with companies such as Bear Stearns, IndyMac, WaMu, etc. Why were those companies also unable to make corrections?
Losing all your money when your investment is so bad that it risks hurting the economy as a whole as it goes under is how capitalism is supposed to work
You think the production of incompetent monopolies large enough to hurt the economy as a whole if they fail is how capitalism is supposed to work? Why do you hate free markets?
The telecoms were a tremendous asset in the rescue of the hostages that were kidnapped by FARC in Columbia. I think that the law is that kidnapping and terrorism are illegal and that our govt should do something about it. Think about when daydreaming about throwing the telecom employees in prison.
Our government should do something about kidnapping in Columbia?
Fannie and Freddie have had their management problems. But overall, they’ve had the best underwriting in the mortgage business by far. The problem has been the insane housing bubble is now producing a totally unprecedented housing price drop and that is proving too much for *anybody* in the mortgage business. They are being dragged down in the undertow.
I think that the law is that kidnapping and terrorism are illegal and that our govt should do something about it.
Hi Dave
Thanks –
I bet that most of those who supported the FISA amnesty bill are the same people who rail against amnesty for illegal aliens. I speak as someone who thinks that the immigration laws should be enforced, so I don’t agree with “amnesty” for illegal aliens, but it seems to me that it’s difficult to be for one and against the other, for the reasons discussed in the main post.
“I bet that most of those who supported the FISA amnesty bill are the same people who rail against amnesty for illegal aliens.”
This thought seems familiar. (See next to last line.)
“Think about when daydreaming about throwing the telecom employees in prison.”
Cite anyone here ever suggesting they wanted to see telecom employees punished. Oh, wait, you can’t, you’re completely making sh*t up again and attributing it to people here, which is to say: you’re lying again, DaveC.
You just can’t go a week without making up lying slurs against people here, can you?
And you know what: it’s very offensive.
“The telecoms were a tremendous asset in the rescue of the hostages that were kidnapped by FARC in Columbia.”
P.S.: try at least getting the name of the country right.
Cite
I’m sure there will be cites of FISA targeting Americans just talking to other Americans, or is that RICO? Let’s see ’em!
DaveC,
Could you give a cite that shows how the rescue depended on illegal surveillance that violated FISA? I ask because no one here is saying that telecom employees should be jailed for obeying the law, just that they should face legal sanction when they break the law. I don’t know why you think it is so important that some people be permitted to break the law whenever they want without consequence; doesn’t seem very conservative to me.
I’m sure there will be cites of FISA targeting Americans just talking to other Americans, or is that RICO? Let’s see ’em!
Do you understand that when the government illegally spies on someone, that effort is generally classified, which means that talking about it in public is a crime? Nevertheless, some information is available; you might start reading here.
I have no idea what your RICO comment refers to.
i would prefer this:
“Alarmed by the sharply eroding confidence of karen marie, the Bush administration on Sunday asked Congress to approve a sweeping rescue package that would give officials the power to inject billions of federal dollars into her beleaguered finances through investments and loans.”
DaveC, you wrote: “I think that the law is that kidnapping and terrorism are illegal and that our govt should do something about it.”
Me, too. So I think we should kidnap your mother and saw her legs off until she tells us who did it. Okay by you?
If not, what principle would you say makes it wrong?
“Think about when daydreaming about throwing the telecom employees in prison.”
See, here’s where you accused people of something really nasty.
Now, try either citing where anyone here stated such a desire, or apologize.
This is what you do: you make up lies about what people here say, think, or want. Stop it.
Think about that when daydreaming of how aroused you are by thoughts of torturing children while having sex with them.
“I ask because no one here is saying that telecom employees should be jailed for obeying the law, just that they should face legal sanction when they break the law.”
I’ve never said that; I’ve said only that there shouldn’t be immunity without investigations. I’ve never said a damn thing about punishing anyone, myself.
“Could you give a cite that shows how the rescue depended on illegal surveillance that violated FISA?”
Unlikely. But DaveC doesn’t care. He just wants to lie and claim that people here oppose legal eavesdropping, such as likely went on here. There’s nothing whatever illegal about eavesdropping on two foreigners, but DaveC doesn’t care in his rush to lie about folks here.
“I’m sure there will be cites of FISA targeting Americans just talking to other Americans, or is that RICO”
This doesn’t even make the faintest sense. “FISA” is the “Foreign Intelligence Surveillance Act.” How a law could “target” anyone, well, as I said, it makes no sense whatever. But DaveC rarely makes sense. He just likes to lie and slur. It helps relieve his anger at other people whom he’s too cowardly to face.
Then, the next day, after he’s slept it off, he’s all hurt about why he’s getting responses that are so personal.
Attaching conditions to government capital injections is a fine idea, but what would we want those conditions to actually be in this instance? Fannie/Freddie already have lots of rules governing their underwriting. So what, then? Increased minimum capitalisation? Even tighter underwriting, which would make the housing market even worse?
It needs to get worse. This is what happens with bubbles.
Here I am with my layman understanding, a couple of light economic classes, a couple of financial decision making classes courtesy of my MBA program, and what I can’t seem to understand is how these high muckety-mucks don’t understand the principle of financial leverage. The more you borrow, the more your earning per share rises; however, the more leverage you use the more risk you are in. Is greed simply that blinding?
And yes that’s a rhetorical question, cause I know the answer that I believe.
The next several years are going to be rough, especially as people try to mitigate the fall, and I can’t blame them, this is going to hurt, and hurt hard.
Davebo, you need to research the matter further. I would suggest starting with Mankiw and Bainbridge.
Hilzoy, add Krugman to the list who highlighted a critical lack of capitalization – a concern echoed by Mankiw and Bainbridge.
Yes, you will find people who did (and continue to) defend F/M/M. They’ve always had defenders – that’s why they continued to exist in their present state. Mankiw, however, warned in 2001 of exactly this event. Bainbridge, too, has been warning for years that a downturn in the market could his F/M/M hard because of inadequate capitalization. The structural problem was there to see, despite the fact that many did not (or chose not to) see it.
Attaching conditions to government capital injections is a fine idea, but what would we want those conditions to actually be in this instance? Fannie/Freddie already have lots of rules governing their underwriting. So what, then? Increased minimum capitalisation? Even tighter underwriting, which would make the housing market even worse?
These are good questions, for which I have no answers.
Hey, I am pretty liberal but also know something about corporate finance, and when I read the terms of the deal, I thought it was a good deal for the government.
The capital that the government invested came in the form of preferred stock, which means that the government takes first any equity in the company ahead of shareholders. The only people being “bailed out” by this would be debt holders, and that would only be true is the companies already had negative equity. The reports on their condition seem to indicate that they did not.
The market for the stock in these companies reacted by tanking, dropping around 11% for both companies, reportedly on fear that the deal dilutes shareholders. I think that fear is well-founded, which is why it is not a bail out of shareholders. I listened to NPR yesterday talk about how the stock dip was allegedly a negative factor (“the government has stepped in but the stock has yet to recover”) — talk about not getting it. To show just how dramatic this really was, the early story was that prices of the stocks rose 30% before the market opened, to then drop back for the 11% loss meaning an even bigger swing in just hours. The market expected a shareholder bailout, but the shorts won the day big time.
In addition, the bail out plan resulted in a successful $3 billion bond sale for Freddie Mac on Monday, which was part of the reason for the timing of the deal, as having that sale tank would have been terrible news. The equity cushion restored the bondholders faith in the companies, which is the cheapest way to raise money for these entities. The government in effect leveraged its cash infusion of preferred stock to support the large debt offering.
And comment on another point, I suspect the key to preventing this kind of crap in the future is better underwriting. I remember reading in 2005 and 2006 that the crazy option-arm deals, etc. were a ticking time bomb, but they are a problem only if they can be resold into the Freddie Mac/Fannie Mae system. I have read about efforts to try to rein in some of that craziness, but the Bush administration policy was to block all regulation, even by States seeking to address the issue (federal pre-emption which is a common and sometimes good tactic in banking law, but also another example of conservatives using federal power to protect business).
Sometimes regulation is a good thing, even when it limits the options of the free-market. And actually, it does not truly prevent the free market from offering these types of loans — it just requires those types of loans to be made in the more expensive unregulated part of the lending market, and not receive the benefit of the government supported part of the market. Let them take the risks on their own dime if they want freedom from regulation.
von: I thought you were arguing that Fannie and Freddie were less regulated than they would have been had they been private, not that they should have been required to have more capitalization (i.e., that the regs were wrong.) I completely agree about capitalization; our disagreement involves whether the problem comes from the fact that they are GSEs as opposed to purely private entities, and whether “the pressures that would have caused a traditional private firm to correct course” (a) did in fact have that effect on private firms, and (b) would have been the best way to avoid problems here.
Yes, you will find people who did (and continue to) defend F/M/M. They’ve always had defenders – that’s why they continued to exist in their present state.
They exist in their present state because the government and taxpayers are convinced they serve a useful social purpose. The vast majority of new mortgage loans are going to the GSEs right now because no purely private institution is willing to buy those loans – not without the backing of the United States government. And if the GSEs were made private, they wouldn’t be buying those loans either. The implicit backing of the United States government is the only thing preventing the vast majority of mortgage financing in the US from simply disappearing.
I haven’t heard much from the supporters of privatization on why they think that is a good idea at the current point in time.
Von and Sebastian:
Sorry, I’m late getting back to your comebacks.
Whether or not once answers the question of fully privatizing the “maes” in the affirmative or the negative, I’d like you guys to tell me how it is that, say, a shareholder in Huntington Bancshares, a publically traded but fully privatized institution, regional Ohio bank, should know when to send his or her market signal when the financial officers of the bank were apparently taken by total surprise at the swiftness of the deterioration of the real estate market and their loan portfolio.
Here’s another point. This market you talk about — it opens before you get up in the morning. The institutions have their sell signals in 12 points below yesterday’s closing price and about the only market signal left to the individual shareholder is a coffee spit-take when Bob Pisani on CNBC announces the opening bid and ask.
The individual shareholder (me, in this case)should maybe be wiped out for not intuiting that things might be going awry, but who cares, my signal is worthless.
Maybe I’ll attend a shareholder meeting and shake my fist and rant a bit.
Have that man removed please. Those are very impolite signals he’s sending.