Tuesday, September 09, 2008

McCain is wrong. The best thing for Fannie and Freddy IS what is happening.

Today, John McCain and Sarah Palin have an article in the Wall Street Journal pledging to 'protect taxpayers' from any more government 'bailouts' like the current government takeover of Fannie Mae and Freddie Mac.

There is one line near the beginning in which McCain argues that . For years, Congress failed to act and it is deeply troubling that what we are now seeing is an exercise in crisis management rather than sound planning, and at great cost to taxpayers.

I'm not sure it is so much the fault of Congress as it is of regulators who are mostly appointed through the executive branch, but if it is Congress' fault then it is worth pointing out that John McCain has been in Congress for a quarter century and I've never once heard him railing against mismanagement in the mortgage industry. True that Obama has been there since 2004, but the problems of lax oversight began long before that.

They seem to be suggesting (without ever explicitly saying it) that they want the Government to no longer back these companies, downsized or otherwise.

Beyond that, the most I can see is that the article is loaded with vague promises, such as to 'push lenders to provide maximum support to credit-worthy customers,' and similar platitudes.

To see where the problem is though, let's remember why Fannie Mae was created as a government agency in the first place (it was not privatized until 1968.)

The year was 1938. The worst years of the Great Depression had passed, but banks were still gun shy about lending money, pretty much to anyone no matter what their credit was. As such, even people who were making decent money couldn't afford a home unless they had the wherewithall to pay cash for it or build it themselves. Because of the continuning tight credit the Depression continued to linger in industries such as construction, manufactured household goods (in those days if you bought a kitchen table the chances were that it was made from New England maple, not Chinese polymers,) timber and other industries that were at least in some degree dependent on housing and homeownership.

Recognizing that the fundamentals of the economy were on the way up but that bankers were still shell shocked at what had happened over the past decade, the Roosevelt administration decided to fix the problem themselves. They created Fannie Mae so that the bankers would have the backing of the Federal Government when they lent money out. And it worked, they went right back to lending out money again.

Now, I'm not suggesting that the current economic crisis is anything like the Great Depression. However it seems that McCain and Palin are unaware in their article that there was a reason why these companies were designed with the backing of the Government. Without it millions of Americans would simply have been denied an opportunity for home ownership, not because they couldn't afford loan payments or were bad credit risks, just that by 1938 risk-aversion had become so ingrained in the banking system that it practically took a Rockefeller to even get a serious review of a loan application.

Today we are in a situation with similar tight credit. We could point the finger of blame back and forth, but it is a fact that today the tight credit situation, even hurting people who are completely credit-worthy makes it necessary that we do more than "push lenders to provide maximum support." It is after all their money on the line and the only real leverage we have is if we can at least partially cover them for a loss if the play goes badly.

Even if bankers could be induced to start lending money out right now without Government backing, would they be so quick the next time a big crisis erupts in 10, 20 or 30 years (recall that the S&L crisis was not all that long ago either)? Likely credit would be the last thing to recover if there was no such backing (just as was the case during the Depression) and in so doing it would deepen and prolong any other economic downturn.

The problem of course with the concept of private companies with Government backing is (as has been mentioned numerous times by many people over the past week) that it 'privatizes the rewards and socializes the risks.'

So I agree that a return to the status quo is a bad deal. Now the the Government is in effect holding ownership of Fannie and Freddie however I'd suggest that there is a case to be made for going back to the the pre-1968 nature of Fannie Mae for both companies. Between 1938 and 1968 Fannie Mae worked quite well despite Government ownership. Bad mortgages that had to be paid back to lenders were more than offset by the money that was coming in from banks holding new mortgages. Now it is true that any industry is cyclic, but in this situation both the risks AND the rewards would be socialized-- so the Government would be able to keep any profit (as it did in the early years of Fannie Mae) and put some away as a provision against a rainy day.

So my answer to this is that we ahve the perfect situation now to get credit moving again. Let's just keep Fannie and Freddie running as government entities.


Daniel said...

Eli, I've decided that you're one of the best bloggers I have come across. Much better than many of the "professional" bloggers, including for NBC, ABC, etc. It's a shame you're not a full-time journalist. I would love to have you in the White House Press Corps! Then no matter who becomes the next POTUS, we'd count on you to hold his feet to the fire.

Bridget said...

Ah--but lets not forget that the current government has almost a 5 trillion dollar deficit. There is no going back to the "good ole days" of the depression for this country.

Not being a financial wiz by any stretch of the imagination, how does the US recover from corporate welfare of this magnitude? The dollar is already tanking and where can we go to borrow more money?

I'm real tired of lousy CEO's not being held accountable and walking away from their messes with fortunes.