Sunday, July 20, 2008

DIFFERING VIEWPOINTS #1: Fannie Mae and Freddie Mac

Unless you've been living under a rock, you probably know that Freddie Mac and Fannie Mae are probably going to join the long list of companies that have had government bailouts. You know, along with the S&Ls, the airline industry, etc. etc...

The problem, many believe, is that private companies should not have government bailouts....ever. Firstly, it's immoral: private corporations shouldn't be getting money from the government. The logic behind this is obvious. People who invest in corporations are naturally taking an obvious risky option, and the people who own major corporations are (presumably) the wealthy. Why pay off a bunch of rich people because they screwed up?

The second argument is a more practical argument. When Freddie and Fannie do well, the stockholders reap all the profits. When Freddie and Fannie do bad, the taxpayer is left holding the bag. Socialized costs and private benefits, it is argued, tend to lead to excesses. If I lose little of my own money, and but get all the rewards if I win, I'm going to be taking a lot of risky actions.

So, bailouts are bad.

The second bit is the logic one of my friends uses in his argument, in one of the companion pieces to this post. You can see the whole thing here

However, I disagree with both of the above least to some degree.

In the first: Increasingly,, regular people are owners of equity. It's not just Warren Buffet who gets hurt when the Dow Jones tumbles 2,000 points. It's also your neighbors and the California teachers. This doesn't necessarily mean that it's right to bail out companies in order to buoy stock prices. After all, we could still help those people out through other means (liberals would argue, perhaps, by increasing social security benefits). But it's something to least if only to recognize that, when the financial market gets hit, everyone else hurts too.

In the second, as Krugman points out, Freddie and Fannie weren't the ones innovating in high-risk securities. That's those "other" companies, like Bear Stearns, Countrywide, etc etc. You know...those other guys that are getting bought out.
That's because Freddie and Fannie were highly regulated in addition to having an assurance of a government bailout. So, they only were investing in relatively safe loans. It looked like a bad bet when everyone was making money in the 90s and the early millennium...doesn't seem too stupid now.

However, even Freddie and Fannie are getting hurt...but that's because the whole system is hurting:
In Los Angeles, Miami and other places, anyone who borrowed to buy a house at the peak of the market probably has negative equity at this point, even if he or she originally put 20 percent down. The result is a rising rate of delinquency even on loans that meet Fannie-Freddie guidelines.

That, in addition to the fact that Freddie and Fannie were pressured to start making near-subprime loans after the private sector started failing, meant that they weren't in all too great a shape. And that's because everyone else screwed up, not Freddie and Fannie. It's a great example of how everyone is connected.

But, there are SOME inherent problems with the two giant mortgage companies. The companies generally have too little capital on hand. Part of the point of having them be semi-private companies is that they could raise capital buy selling stock, hence being somewhat independent of the government.

Still, though, the government bailout isn't showing how Freddie and Fannie have failed. It's showing how regulation in the financial industry has failed.

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