Wednesday, July 23, 2008

More Taxpayer Dollars to Mediocre Financing Companies

The House enthusiastically passed a bill today to bail out Freddie Mac and Fannie Mae (why do they have such similar names? That makes no sense!) using your hard-earned taxpayer dollars. It's a "loan," but cheap enough that the US Government will be losing a fair amount of money on it. Note that no reputable lending institution was willing to give them the money to keep going.

Sometimes I wonder why the economy's not doing great. Then I remember one of the reasons is we use dollars you could be saving/spending and putting them in the pockets of failed and irresponsible big business execs.

Now I'm told that a Fannie/Freddie collapse would be devastating for the US economy. That's also what I was told about Bear Stearns, somewhat passionately and loudly by a few of my fed-loving friends. But after we so enthusiastically spent US taxpayer dollars to keep Bear Sterns afloat, they still collapsed. And the world didn't end. Why?

Turns out, when a company with assets goes down, those assets become very cheap to acquire by other rival companies. Mortgages, for example, can be bought for chump change by banks or other lending institutions. We call this an "investment." If one of Fannie or Freddie collapsed, Bank of America, Wachovia, Citigroup, Morgan-Stanley, or any number of fine US money-manipulating institutions would gladly acquire those mortgages. But some of the mortgages are bad, you say? Well, they'll sell for cheaper. They would almost certainly be sold as a package deal, instead of piecemeal.

And then, these mortgages would be backed by lending instutions A) not run by fools, and B) not on the verge of collapse. I should note that one major reason cited for the collapse of the Soviet economy was the absolute refusal to let failing companies die. One of the reasons any economy works is that companies that cannot make profit don't survive. If they don't make profit, then they're either not offering anything of value or are not running efficiently enough (or some arbitrary regulation is choking off their ability to profit, but I know that's not a popular fact to admit).

And in case it wasn't clear that Congress was trying to help "Homeowners," they are trying to pass a law limiting how much money the Fannie/Freddie execs can get paid. So the Feds are financing a falling company and telling them how much to pay their employees? This sounds like an acquisition.

Ultimately, keeping failing businesses running prevents better businesses from increasing their market share over the burning hulks of the dead ones. So who hurts, ultimately? Consumers. Any talk of all these mortgages disappearing and homes being repossessed is foolishness. Who would repossess them? Fannie and Freddie owned them. If they bleep out of existence, they can't just show up and start throwing people out of their houses as a last dying breath.

If the government feels obligated to act (which it does, because election season is just around the corner!), the best thing to do would be to help manage the transfer of assets from Fannie/Freddie to institutions of less failure, like it's doing with Bear Stearns--when Fannie and Freddie finally collapse from their own poor business practice. But instead, Congress is doing what it does best: ineffectually spending the money of the middle and upper classes for all sizzle and no steak. It's not like the money in the pockets of these productive Americans would help the economy, right?

On the foreclosures: many of these foreclosures are still going to happen. Some people signed onto bad loans that they simply could not afford (you know the whole sub-prime thing by now), and keeping Freddie and Fannie afloat is not going to make them magically able to afford these mortgages. It's possible new lending institutions may be able to restructure or consolidate some of these loans so be more manageable. But if you're broke, it doesn't matter who your lender is, you're not paying him back, and you're losing your house. The bailout really won't help these folks.

9 comments:

Charles said...

I'm not actually up enough on the bailout to comment on whether I think it's a good idea, but a couple of factual corrections:

Any talk of all these mortgages disappearing and homes being repossessed is foolishness. Who would repossess them? Fannie and Freddie owned them. If they bleep out of existence, they can't just show up and start throwing people out of their houses as a last dying breath.

Actually, you don't blip out of existence, you declare bankruptcy. Once you're in bankruptcy, the bankruptcy trustee's job is to collect all your debts to pay all your creditors, which means foreclosing on anything that's not up to date. If you are up to date, you don't get foreclosed on, but the ability to negotiate if you are behind but might be able to get back on your feet will be seriously damaged.

Some people signed onto bad loans that they simply could not afford (you know the whole sub-prime thing by now), and keeping Freddie and Fannie afloat is not going to make them magically able to afford these mortgages.

Fannie and Freddie did not issue any sub-prime mortgages. The (U.S.) definition of a sub-prime mortgage is one that doesn't meet Fannie and Freddie's standards. The sub-prime crisis has done enough damage to the housing/mortgage market in general that it is damaging Fannie and Freddie as well, though.

Charles said...

I'm not actually up enough on the bailout to comment on whether I think it's a good idea, but a couple of factual corrections:

Any talk of all these mortgages disappearing and homes being repossessed is foolishness. Who would repossess them? Fannie and Freddie owned them. If they bleep out of existence, they can't just show up and start throwing people out of their houses as a last dying breath.

Actually, you don't blip out of existence, you declare bankruptcy. Once you're in bankruptcy, the bankruptcy trustee's job is to collect all your debts to pay all your creditors, which means foreclosing on anything that's not up to date. If you are up to date, you don't get foreclosed on, but the ability to negotiate if you are behind but might be able to get back on your feet will be seriously damaged.

Some people signed onto bad loans that they simply could not afford (you know the whole sub-prime thing by now), and keeping Freddie and Fannie afloat is not going to make them magically able to afford these mortgages.

Fannie and Freddie did not issue any sub-prime mortgages. The (U.S.) definition of a sub-prime mortgage is one that doesn't meet Fannie and Freddie's standards. The sub-prime crisis has done enough damage to the housing/mortgage market in general that it is damaging Fannie and Freddie as well, though.

Anonymous said...

There's a lot of complicated stuff going on; I definitely don't know all the details, but I think some aspects are a bit different than you state.

But after we so enthusiastically spent US taxpayer dollars to keep Bear Sterns afloat, they still collapsed. And the world didn't end. Why?

My understanding is that the loan guarantee issued to Bear Stearns was to prevent a run on the remaining assets (due to fear of future lack of liquidity), which would have been disasterous in terms of the domino effect. Once the fear of collapse was gone, the company's remaining assets were sold at market rates. What the government did was right, however the terms on which they did it were dumb. There's nothing wrong with the government as a lender of last resort, but it should be at punitive rates.

The big problem with Freddie/Fannie (and I'm probably parroting the same Economist articles you've read) is that they are public/private partnerships where the private part gets all the benefits, and the public part assumes all the risk. That's not capitalism. One way or the other please... in this case, seizing the remaining assets and nationalising Freddie/Fannie (and then selling off the assets) would have been the right choice. What's been done here is wrong.

I should note that one major reason cited for the collapse of the Soviet economy was the absolute refusal to let failing companies die.

Japan is perhaps a more apt case study here.

Ultimately, keeping failing businesses running prevents better businesses from increasing their market share over the burning hulks of the dead ones.

There's a trade-off here, and I think we've been erring too much on the conservative side. The recent airline bailouts (and the general protectionism in that industry) were atrocious, for example.

Anonymous said...

The big problem with Freddie/Fannie (and I'm probably parroting the same Economist articles you've read) is that they are public/private partnerships where the private part gets all the benefits, and the public part assumes all the risk.

I agree completely, and I think we need to stop making the public assume the risk on private ventures, both because it's unjust to the taxpayer, and also because it gives the Fed a mandate to begin arbitrarily regulating and restricting (and nationalizing) companies in the name of reducing public risk.

--Erik Fogg

desiderata said...

It's so sad! I start paying taxes this year, too. :(

Charles said...

The big problem with Freddie/Fannie (and I'm probably parroting the same Economist articles you've read) is that they are public/private partnerships where the private part gets all the benefits, and the public part assumes all the risk.

Well, I haven't read the Economist articles, but I think you're failing to differentiate between benefits and profits, there. The public part is getting no *profit*. It's getting a *benefit* in that it's creating a nation of homeowners rather than renters, which is something it wants. It is screwing up pure-market-incentives in the process because the market was not creating a nation of homeowners at the beginning of the last century, when Fannie was created. (And the market is, as I noted above, the source of the sub-prime crisis now, which is turning many homeowners back into renters.)

There may be better ways to get the benefit of wider home ownership, or that benefit may not be worth the cost, or you may disagree that it's a benefit at all. But saying there's no benefit in the eyes of the people who created the program is just wrong.

Cooper said...

Having worked for Fannie Mae, I can definitively say that they were not invested at all in the subprime market, and specifically stayed out of that; their portfolio is, in fact, made up of extraordinarily good loans. They're experiencing trouble because they're some of the biggest players in the mortgage industry, and are suffering for the enormous hit their assets have been taking as the housing market's collapsed.

These are not just banks. They are quasi-governmental organizations (Fannie, for instance, is permitted to borrow money at a rate just slightly worse than the government can borrow) designed to support and run the secondary mortgage market. The secondary mortgage market is an economy of debt, buying mortgages from banks, packaging them and selling them to investors as mortgage-backed securities. This tends to stabilize mortgage prices, helps mitigate risk for the banks (the actual lenders), and enables them to offer loans to higher-risk and lower-income borrowers (without the action of the secondary market, these borrowers would often be frozen out).

This machinery works great so long as the other institutions are on board. But when housing prices rise so precipitously, or when banks are offering junk loans to make a buck before foreclosure, even if Fannie doesn't buy those, it hurts their market. When housing prices crash, investors are not as confident in the securities they're offering. When banks get heavily invested in the subprime market, it makes it harder to buy or sell mortgages that investors will be confident in.

They certainly are not perfect - as you may or may not have heard, Fannie Mae has been under scrutiny for errors in its models (and has had to restate its entire set of projections going back 5-10 years) - but these are not just Joe Bank getting punished for being irresponsible. These are critical financial institutions that do a lot to protect the market ... but only when the market is also protecting itself.

Erik Fogg said...

I stand corrected on many of my criticisms. Thanks for the comment, Cooper.

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