Editor’s note: This op-ed is by Audrey Pietrucha, founder of the Southern Vermont Liberty Council, and it first appeared in the Bennington Banner. She can be reached at vermontliberty@gmail.com.
Treasury Secretary Timothy Geithner’s recent announcement of a plan to eliminate the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation — affectionately known as Fannie Mae and Freddie Mac — included a shocking admission.
Speaking of the federal government’s overwhelming involvement in the U.S. mortgage industry, Geithner said “I think it’s absolutely the case that the U.S. government provided too much support for housing, too strong incentives for investment in housing. We just took that too far.”
Well, maybe this isn’t so shocking to anyone who followed the upward trajectory of housing prices from the early 2000s through 2006 and recognized the role easy credit played in both the birth and demise of the housing boom. After years of hearing politicians such as our own Sen. Bernie Sanders blame everyone but the government for the crash that led to our current bleak financial situation, however, it was satisfying to finally have public confirmation that government-sponsored enterprises (GSEs) such as Freddie and Fannie had played a large role in the financial meltdown.
Fannie Mae and Freddie Mac were set up 40 years ago as mortgage securities brokers. They did not provide mortgage money directly but bought mortgages and mortgage-backed securities from banks and other financial institutions. Though technically private, they enjoyed government support in the form of lower interest rates than what were available to other lenders. They also received implicit assurance of federal assistance should they find themselves in financial trouble, which, of course, they did.
It was fun while it lasted — private lenders found a new pool of customers as people who should have been renting were encouraged to take advantage of creative financing options, many of which required little or no money down. These private financial institutions took on risky customers knowing the government-sponsored enterprises would gobble up the loan packages, thus providing the money to finance more questionable loans.
Freddie and Fannie were having a great time of it — borrowing at low rates the money to purchase these mortgage packages, making a tidy profit for themselves and their investors in selling, earning large salaries for management and even holding some capital, all the while allowing the federal government (that would be we, the taxpayers) to bear the risk.
Meanwhile, politicians of both parties raked in hefty campaign donations, especially from Freddie and Fannie, who over a decade spent almost $200 million in lobbying and contributions. The top three recipients in the Senate of Fannie’s and Freddie’s largess were Democratic senators Christopher Dodd, Barack Obama and John Kerry. This is important to note because it was Democrats such as Dodd and his House counterpart Barney Frank who blocked attempts by Republicans in early 2003 to investigate some funky accounting practices being used by the GSEs.
As often happens when other people’s money is at stake rather than one’s own, Fannie, Freddie, and their Washington enablers pushed things too far. The politicians saw an opportunity to make political inroads with yet another constituency group — the unhoused — and pressured lenders to provide mortgages to more and more people who, unfortunately, couldn’t really afford to own homes. In 2004 the Bush administration decreed that within four years, 56 percent of Fannie’s and Freddie’s mortgages should go to low-income households and 28 percent of the mortgages to those with a “very-low income.” Rather than curtailing a lending strategy which made “sub-prime loans” desirable financial instruments, Congress pushed for even more aggressive lending. Old-fashioned requirements like down payments and even income were dispensed with in the effort to get every American into a house (or two or three) of his or her own.
Reality has a way of rearing its unwelcome head and did so in September of 2008. All those new customers who were brought into the housing market through easily obtained mortgages pushed up the cost of existing homes. High home prices encouraged immoderate new construction, which led to the overproduction of housing and, eventually, falling prices. Homeowners found themselves in foreclosure and many walked away from homes that were worth less than they owed. Fannie and Freddie found themselves in crises and were brought under government conservatorship. Estimates of what this will eventually cost American taxpayers range between 350 and 750 billion, though some say the total cost will reach into the trillions. This doesn’t include the inestimable effect on what should be a free economy when as large a player as the federal government decides to manipulate the market. The unintended consequences of government intervention in the housing market have become painfully apparent to all Americans, and all continue to feel the adverse effects.
The move to transition the U.S. mortgage industry away from government dependence is a good one. According to Geithner it will include reforms that will benefit both lending institutions and consumers, also good. Smoothing over government’s footprint in the housing market sand will take time, though, as it is wide and deep. Could we at least use that time wisely, study the lessons of Freddie and Fannie and apply them by keeping government out of enterprises where it really has no Constitutional right to be?
Permalink |
It’s not as complicated as that; the reason is simply this: greed.
And the government certainly participated – by all the convoluted inducements to *short-term* profit that we’ve built into it. We worship a quick buck; that’s our national religion and our laws reflect this perfectly.
However the tired old saw of “Fannie Mae and Freddie Mac pushed lenders into it so it’s their fault!” holds as much water as Reagan’s tired old saw of “Welfare Queens” draining the system – it’s blown *completely* out of proportion.
And at this cynical stage, one might further wonder, if the reason it’s blown out of proportion, is to continue the wholesale gutting of anyone who isn’t fast enough (and rich enough) to gut someone else first.
Permalink |
Actually, it is not that simple because human interaction is not that simple. An economy is made up of trillions of individual economic decisions and you cannot simply label them all as “greedy.” Many other factors influence and motivate human behavior.
And greed is not confined to the private sector – it is a human trait and thus shows up in all human beings, politicians not excepted. In the case of Fannie and Freddie their greed for votes (and the perks and privileges of holding national office) may have influenced some of them to apply pressure to F&F to behave in ways that were irresponsible. I’m not saying greed was their only motivation – as I said, human beings and their decisions and transactions are complex – but it could certainly take a nobler aspiration, such as securing home ownership for more Americans – and cause them to overlook the possible negative consequences of making home ownership too easily available.
Permalink |
What’s wrong with greed, Marc? I’m greedy to get the money to finish my roof and replace some worn tools. As the classical economist Henry George said, people will satisfy their desires with the least exertion.
Pietrucha’s point about government intervention distorting the marketplace is well taken. Misguided tax policies caused the land (real estate) bubble in the first place: taxing productive activity harder and harder to fund an ever-growing government, but refraining from taxing speculation on real estate and natural resources, our common assets. This encourages speculation, and causes production to move elsewhere, such as out of Vermont. Details at http://ProsperVermont.com
Every 18 years like clockwork, the speculative bubble crashes, as speculative land prices recede to the real levels. My learned colleagues in the field of economics keep being taken by surprise, then scramble to find quotes from their own work that would indicate that they weren’t. And what do they recommend, to remedy the effects of government intervention and control? More intervention!
As an Independent candidate for the Vermont Senate, I’m not under the control of a DC party or corporate lobbyists, so I’m free to proclaim, ‘Government, get out of our way, off our farms, out of our factories and our wallets’.
Permalink |
Great post.
The irony is that a program aimed at making home ownership more affordable actually made it less so. The price of houses went up faster than mortgage rates went down because the easy money brought speculators as well as unqualified buyers into the market.
Now, with housing prices down AND interest rates low, is a perfect time to start removing these harmful government distortions from the market. More on this at http://blog.tomevslin.com/2011/02/end-federal-wealth-insurance.html
Permalink |
I’d feel better if we removed the investment bankers – who, through their own “distortions” in the market, took the economy over a cliff and walked away rich – from their cushy mansions into prison cells. They did far more damage than any government agency or program, yet they got rewarded for their perfidy.
Permalink |
As the former director of consumer communications for Fannie Mae, I feel compelled to add a few thoughts to this discussion. First, Fannie Mae was pressured by both political parties to provide incentives for first time and/or moderate income home buyers in key congressional districts. While the value to the politicians was constituent loyalty there was also a belief that homeownership benefited neighborhoods. You could walk through a blighted inner city neighborhood and easily pick out the homes that were owned versus rented. Homeownership does a lot for schools, safety, real estate values, local businesses, etc. So not all the motivation was so Machiavellian…some of it was the belief that owning a home brought a greater level of commitment to neighborhoods that were the most in need.
Permalink |
Holly, thank you for your post. It is wonderful to have someone who was so close to the “action” available to add her perspective.
I absolutely understand that politicians from both sides of the aisle applied political pressure to FM and FM. After all, it was Bush who upped the lending goals. If you are wondering why I included the information about the Democrats who benefitted from donations, it is because I think the people of this state are far too soft on the Democrats and refuse to see they are part of the problem as much as Republicans are. It might help you to know I am an independent voter who writes from a Libertarian perspective, which means there are things I can appreciate and dislike in both parties.
Of course you are right that there were noble sentiments involved in the push for home ownership. But I would submit that it is not owning a home that makes the difference so much as earning that home. Things obtained cheaply are not respected nearly as much as those that are bought through effort and sacrifice. I learned this a few years ago when a little girl in my neighborhood did not have a bike. We had an extra one and I gave it to her. The next day I found it abandoned in the bushes on the side of the road. If I offered to sell her the bike for five dollars, and she agreed and then earned that five dollars by helping her parents with chores or doing a couple of odd jobs for her neighbors, you can bet she would have experienced great pride in purchasing that bicycle and she would not have dumped it within a few hours of getting it. We cherish the things we have given part of ourselves to.
And talk about good intentions paving the road to Hell – the speculation in housing, with even television shows about flipping houses was a particularly ugly and unforseen outcome of these cheap loans
Permalink |
I appreciate the noble sentiments involved, however there is a quote from CS Lewis that i find very applicable here:
“Of all tyrannies, a tyranny exercised for the good of its victims may be the most oppressive. It may be better to live under robber barons than under omnipotent moral busybodies. The robber baron’s cruelty may sometimes sleep, his cupidity may at some point be satiated; but those who torment us for our own good will torment us without end for they do so with the approval of their own conscience.”
Government planning has, is, and always will be, doomed to failure.
Permalink |
The debates in these columns are lively, even heated sometimes, but they are still usually thoughtful. A statement like “Government planning has, is, and always will be, doomed to failure.” sheds plenty of heat but no light at all. Let’s not debase the discussion with nonsense. The next time you drive on an interstate highway, or drink tap water, or purchase wholesome food, or take medicine, or fly in an airplane, or a thousand other things you do which “Big Government” planning makes safe and possible to do, take a moment to consider.
Permalink |
There is another side to this. Fannie and Freddy were created to assist lending institutions in maintaining liquidity; if Fannie bought a mortgage from a local bank that allowed the bank to loan more money locally. We could have made laws that prohibited Fanny from participating in politics, we could have let Fanny make good loans instead of instructing them to provide loans to groups that were not financially sound.
This proposal could be the death nell of what few small and local banks and credit unions are left. This will strengthen the large financial institution over which we have far less control than Fannie or Freddy, to create the next bubble/scandal.
T
Permalink |
Small banks and credit unions functioned for many years without programs like Fannie Mae and Freddie Mac so what has changed? I am not an expert on the banking industry so I am asking that in good faith so I can learn.
If I had to guess, I would say laws and regulations have been put in place that make it impossible for the small, local guys to compete. Over the past few decades power and money have been centralized in D.C. and Wall Street. It’s time we take that power back by once again demanding state sovereignty and local control.
Permalink |
What changed? The Great Depression.
Permalink |
How concise. And what caused the Great Depression?
from various wikipedia articles:
Ludwig von Mises and Friedrich Hayek warned of a major economic crisis before the Great Depression. Hayek made his prediction of a coming business crisis in February 1929. He warned that a financial crisis was an unavoidable consequence of reckless monetary expansion.
Rothbard blames the interventionist policies of the Herbert Hoover administration for magnifying the duration, breadth, and intensity of the Great Depression. Rothbard explains the Austrian theory of the business cycle, which holds that government manipulation of the money supply sets the stage for the familiar “boom-bust” phases of the modern market. He then detailed the inflationary policies of the Federal Reserve from 1921 to 1929 as evidence that the depression was essentially caused not by speculation, but by government and central bank interference in the market.
Read up on the Austrian school of economics. You might learn something.
Permalink |
Although they are central institutions in the US mortgage market, Fannie Mae and Freddie Mac hardly had a large role in the creation of the financial mess. As a matter of fact, Fannie Mae was privatized in 1968 and Freddie Mac was privatized in 1970. As “Government Sponsored Enterprises” (GSEs), they were not part of the government, although markets made an implicit assumption that the government would back their debt obligations. They weren’t re-nationalized until the Housing and Economic Recovery Act of 2008, and this was a good thing. This enabled the GSEs to address their systemic risk, but it did not prevent the final systemic crisis, triggered by the failures of Lehman Brothers and AIG.
The US financial system was regulated in the 1930s as a result of the financial excess, over-borrowing, over-lending, and over-investment which marked the run-up to the Great Depression. The market-based response of the Hoover administration (closing banks, liquidating firms, real estate and farmers, etc.) ensured that the economic consequences would be severe.
To avoid those mistakes this time around, deregulation and under-regulation, coupled with a slew of invented “creative financing methods” such as various types of collateralized debt obligations (CDOs) and structured investment vehicles (SIVs) were promoted as remedies. These instruments allowed mortgage originators and holders, bankers, and securities brokers to assign values to their debt obligations and repackage them and resell them on the unregulated market (“originate and distribute”). They were supposed to regulate themselves, according to Fed Chair Alan Greenspan.
The stage was set for these developments with the deregulation of the early 1980s, fueling a housing boom fueled by petro-dollars that was unsustainable. The political climate was also right to erase the boundary between the securities banks and the investment banks, a boundary initially set up after the Great Depression. This was finally accomplished by the Gramm-Leach-Bliley Financial Modernization Act of 1998. The Reagan administration also had made it clear that they would seldom, if ever, enforce antitrust laws. This ultimately led to an orgy of mergers and acquisitions leading to the creations of institutions viewed as “too big to be allowed to fail”. Although some of the deregulation was slowed in the late 1980s, the general financial landscape did not change, and most of the problems emerged from areas which were entirely unregulated. The new financial instruments were being invented faster than they could be regulated.
Enter the developing country debt crisis of the 1980s (fuelled by the petrodollar profits), the Asian financial crisis of the 1997-1998, and the near-failure of the hedge-fund management company Long Term Capital Management (LTCM), in which the government orchestrated a private-sector bailout of LTCM. The market participants were thereby led to believe that the Federal Reserve would not allow even an unregulated firm such as LTCM to fail.
It was open season on the Treasury, and investment banks, commercial banks and the securities industry, now competing with each other, went on a feeding frenzy, while the Fed, among others, was assuring the public that the banks would regulated themselves and market forces (“originate and distribute”) would protect the public.
Then they woke up. The failures of Bear Stearns, AIG, WaMu, LTCM, and especially Lehman Brothers, and other institutions domestic and abroad could not be contained. And the same day that the Fed facilitated the sale of Wachovia (the sixth largest bank by assets) to Citigroup, the U.S House of Representatives rejected the proposed TARP, turning what had been a systemic financial crisis into a potentially devastating economic crisis. During the following week, global stock prices dropped severely, credit ceased to be available across the economy, and the public lost confidence in the financial system. And none of this played out in a vacuum – the meltdown was, and was responded to, on a global basis.
That’s some perspective on the walk-on role Fannie Mae and Freddie Mac played in the financial collapse. And the absurd suggestion blithely tossed out in the last sentence regarding the “constitutionality” of both of those institutions deserves to be challenged, but that’s another column.
Permalink |
Nice, friend Paul, let me add, per Fannie/Freddie:
Subprime lending triggered this financial mess, but the house of cards the banks created didn’t need much to fall apart. Data from the Federal Reserve indicate that most subprime lending was not being done by regulated lenders, nor Fannie/Freddie. In 2006, according to the Fed, more than 84 percent of subprime mortgage loans were made by private financial institutions. Of the 25 largest subprime lenders that year, only one was subject to the Community Reinvestment Act. When subprime lending was booming, Fannie and Freddie’s share of subprime loan purchases on the secondary market dropped by half.
Permalink |
Thanks for wading through my post, John, you may be alone in that. I’m not sure how this fits exactly in, but let me quote from the Financial Crises Inquiry Report:
“GSE mortgage securities essentially maintained their value throughout the crisis and did not contribute to the significant financial firm losses that were central
to the financial crisis.”
Those who held stock in the GSEs were wiped out along with homeowners, but it looks to me like they all were caught up in the catastrophe sweeping the financial firms. Subprime loans were in the mix, but I think the financial mess would’ve happened anyway.
Permalink |
Re: Fannie and Freddie – you don’t need to listen to me, or Paul, or even Ms. Tippett, if you don’t want to. Listen, instead, to Nobel laureate Dr. Paul Krugman: http://www.nytimes.com/2010/12/17/opinion/17krugman.html?_r=1&partner=rssnyt&emc=rss
Permalink |
I can do without listening to Krugman, thanks:
http://mises.org/daily/3291
http://mises.org/daily/3691/Paul-Krugmans-Identity-Crisis
http://mises.org/daily/4993/My-Reply-to-Krugman-on-Austrian-BusinessCycle-Theory
Permalink |
>investment bankers – who, through their own “distortions” in the market, took the economy over a cliff and walked away rich
Indeed? They were/are play a game, with rules set by government intervention. Who could blame them for trying to make money in as corrupt a system as is in place?
Is the parlance of our occasionally misguided youth, “Don’t hate the player, hate the game, baby!”
Permalink |
Unintended Consequences? Yes, perhaps. But there is a lot more to our financial crisis than just Fannie Mae and Freddie Mac.
I have to agree somewhat with Marc. You can boil this all down to “greed”. And, Audrey is also correct that greed is a “human trait”. While I agree that we don’t want to “over-regulate” our citizens, businesses, banks, etc., as a society we haven’t yet figured out yet the proper balance point between onerous regulation and irresponsible deregulation. So I predict that before I retire in the next decade or so, we will have yet another Big Bubble Burst … POP!
I am not sure you can call what happened over the last decade “unintended consequences”. There were a handful of smart people out there that gave us some WARNINGS. Harry Markopolos gave warning about the Madoff scandal to the SEC, to no avail. Brooksley Born warned about the need for financial derivatives reform to Alan Greenspan and others in the Clinton Administration. About 10 years later the mortgage-backed securities, collateralized debt obligations and credit default swaps hit the proverbial fan.
http://www.pbs.org/wgbh/pages/frontline/warning/
http://business.timesonline.co.uk/tol/business/industry_sectors/banking_and_finance/article5663759.ece
The repeal of the Glass Steagall Act by the Gramm-Leach-Bliley Act of 1999 also contributed to some “unintended consequences”.
Also, the Wall Street Ratings agencies played a part in the housing / financial collapse. While Standard & Poors gave GM and Ford “junk bond” status in 2005, they later gave “AAA” ratings to various mortgage backed securities!!! The Wall Street investment firms that took advantage of the repeal of Glass Steagall Act needed AAA ratings to peddle their risky investments. Many of these investment “products” were sold overseas, which spread our financial mess across the globe. To this day, can we really trust Standard & Poors and Moody?
Fannie Mae and Freddie Mac and the politicians that supported then (or vice-versa) should rightly be called out. But they are just two bad actors in a large cast of characters over the last decade.