fannie mae and freddie mac

Administration Allies Float Trillion Dollar Bailout to Offset Rising Savings Rate

by Hans Bader on November 1, 2010

in Bailout Watch, Economy, Stimulus to Nowhere

Alarmed by the rising savings rate, which liberal Keynesian economic theory views as potentially bad in a weak economy, intellectuals with close ties to the Obama administration, such as Matthew Yglesias, and liberal commentators such as Noam Scheiber, are floating the idea of a trillion-dollar bailout at taxpayer expense, using government-controlled mortgage giants Fannie Mae and Freddie Mac. The bailout would involve Fannie and Freddie writing off part of the mortgage balances of many people who are perfectly capable of making their mortgage payments, not in order to prevent defaults, but just in order to increase borrowers’ purchasing power so that they can spend more money. (The bailout would not cover all Americans, only many of the loans held by Fannie and Freddie.)

The cost of this bailout — perhaps a trillion dollars — would be borne by taxpayers, since Fannie and Freddie are already insolvent, and are expected to need as much as $363 billion more in taxpayer bailouts, even if this massive bailout proposal is not adopted.  (Democrats in Congress blocked GOP proposals to reform Fannie and Freddie or wind them down in May.)

This entire proposal, like many of the administration’s stimulus proposals, is based on the faulty assumption that weak consumer demand is the primary reason for the slow recovery. In fact, personal consumption has resumed rising, while private investment has fallen and remains low. Private investment is way down compared to past recoveries, driven partly by lack of confidence in the administration (a well-deserved lack of confidence given the administration’s anti-business policies).  The savings rate has only increased slightly and remains lower in the U.S. than in most of the world.

Matt Yglesias of the Center for American Progress (CAP) is one of the people floating this proposal. CAP is widely credited with “shaping the agenda of the new Obama administration.”

Yglesias concedes that this proposal may not even be legal, and that “there are real doubts as to whether the Housing and Economic Recovery Act of 2008 actually authorizes this.”  But legalities are unlikely to stand in the way for this administration, which showed little reluctance to take actions in the past that were deemed illegal by many commentators, like the multi-billion dollar auto bailouts, which were criticized for flouting federal bankruptcy laws, the TARP statute, and the Constitution.

Behind such radical proposals are the false assumption that we are in a recession due to “a collapse” in private consumption.  But as Mark Calabria notes, “private personal consumption” is “actually up and higher than at any point during the boom, after reaching bottom in the Spring of 2009.”  Meanwhile, “unlike consumption, which has largely rebounded, investment today is about 20% below its peak.” It’s investment that needs to increase dramatically, not consumption.

There is no reason to think this proposal would help the economy even in the short run.  As Yglesias concedes, this proposal would not be costless even under liberal assumptions: “if the US government deliberately takes on a trillion dollars in additional debt, that may lead the interest rate the US government needs to pay on its debt to rise. Rising interest rates on treasuries will increase interest rates throughout the economy and hurt growth.””

Other bailout proposals have ended up harming rather than helping the economy.  A $75 billion Obama mortgage bailout program is actually harming the economy, the housing market, and the construction industry, economists and real estate experts say.  Many other Obama administration jobs programs have backfired, like a biofuels program that wiped out jobs, and a green-jobs program in the stimulus package that ended up funneling money mostly to foreign firms.  The stimulus package wiped out jobs in America’s export sector, and even the Congressional Budget Office, which claims it will help the economy in the short run, admits it will reduce the size of the economy in the long run.

There are additional problems with the trillion-dollar bailout proposal that its floaters don’t recognize.  The increased national debt it produces would lead to higher taxes and interest payments in the future — crowding out private investment in the future, and thus shrinking the economy in the long run.  And most of the bailout might be saved rather than spent by its recipients, preventing it from increasing consumption in the short run.

Another Reason Why Fannie Mae and Freddie Mac Need to Go

by Alex Schibuola on October 26, 2010

in Bailout Watch, Economy

The monthly payments a home mortgage has depend on two variables (among others): the initial down payment and interest rates. A larger down payment means a lower mortgage balance; this results in lower monthly payments. Lower interest rates lead to lower monthly payments.

A 2006 study by Fannie and Freddie finds that, by virtue of their existence, homeowners pay 30 basis points (bps) less on interest rates (e.g., a 5 percent interest rate = 500 bps).* The study also highlights how they permit greater homeownership by offering mortgages that require lower down payments. Further, they “estimate the total savings to homeowners from Freddie Mac and Fannie Mae activities reach the $18.8-26.9 billion range.”

That’s an interesting number. But what does this mean for an individual homeowner? I created an amortization table to see:

In World A^, without Fannie and Freddie, a homeowner purchases a $200,000 home with a $40,000 down payment and takes out a $160,000 mortgage with a 5 percent interest rate.

World A monthly payment: $858.91

In World B^, with Fannie and Freddie, a homeowner does the same as in World A, except he or she pays a 4.7 percent interest rate instead (30 bps lower because Fannie of Freddie exist).

World B monthly payment: $829.82

In World C^, with Fannie and Freddie, a homeowner purchases the same home with a lower $20,000 down payment and takes out an $180,000 mortgage at a 4.7 percent interest rate.

World C monthly payment: $933.55

Between World A and World B, which have different interest rates but the same down payment, the homeowner saves $29.09 per month ($349.09 per year). This is ludicrous. At the individual level, one cannot justify saving $29 per month after incurring losses of hundreds of billions of dollars at the expense of all taxpayers.

Between World A and World C, our prospective homeowner is actually worse off because of Fannie Mae and Freddie Mac. Because the down payment is smaller, the mortgage balance is larger thus increasing monthly payments. The homeowner ends up paying an extra $74.64 per month ($895.68 per year) because of Fannie and Freddie. This is super-ludicrous.

Not to be naïve, the homeowner in World C, might not be a homeowner at all, because he or she may not be able to raise $40,000 to buy a home in today’s World A. However this person would be better off renting and saving up for a down payment in the future. In either event, given that the micro-level effect of Fannie Mae and Freddie Mac’s existence is so small or even harmful, they need to go.

*The Federal Reserve estimates (Passmore 2005) that it’s actually only a 7 bps advantage bestowed by Fannie and Freddie. I’m being nice, though, and giving Fannie and Freddie the benefit of the doubt.

^Assumptions: 30-year fixed-rate mortgage. $200,000 is purchase value of home. 5 percent and 4.7 percent are annual interest rates which are then adjusted for 12 monthly periods.

The Economic Change We Need

by Iain Murray on November 12, 2008

in Bailout Watch, Economy

I have an article on that very subject over at NRO today. Check it out!

“One of The Great Success Stories of All Time”

by Iain Murray on October 16, 2008 · 3 comments

in Bailout Watch, Economy

While conservatives are angry about a number of things at the moment, they should be at least as angry that the Congressional Democrats who helped stoke the mortgage crisis are getting away with blaming everyone else for it. Today, Senator Chris Dodd, the prime recipient of GSE lobbying funds and proud holder of a sweetheart mortgage from Countrywide, is holding hearings where the witnesses will blame everyone but Dodd, Barney Frank and their cronies. Republicans asked to invite witnesses but were barred from doing so. The Wall Street Journal has more:

In February 2004, while Republican colleagues warned of the systemic risks posed by Fannie Mae and Freddie Mac, Mr. Dodd pronounced the mortgage market “one of the great success stories of all time.” A year later, the Connecticut Democrat voted against a reform that would have limited the size of Fan and Fred’s mortgage portfolios…At today’s hearing, his mission is to weave a tale that somehow manages to avoid mentioning his own role in this debacle. That won’t be easy, but Mr. Dodd has shrewdly selected a series of witnesses who, like him, contributed to the mess, and have every incentive to point fingers elsewhere.

Read the whole thing for details of the ridiculous witnesses and a strong suggestion for who should be called. Meanwhile, in The Washington Post, Peter Schiff has a good outline of how government – and the actions of Bill Clinton – really did help cause this mess and is probably now making it worse:

Yes, many Wall Street leaders were irresponsible, and they should pay. But they were playing the distorted hand dealt them by government policies. Our leaders irrationally promoted home-buying, discouraged savings, and recklessly encouraged borrowing and lending, which together undermined our markets…By refusing to allow market forces to rein in excess spending, liquidate bad investments, replenish depleted savings, fund capital investment and help workers transition from the service sector to the manufacturing sector, government is resisting the cure while exacerbating the disease.

There’s actually a school of thought that this decade is paralleling the 1930s quite closely (see the Oct 7 edition of The Short View, about 2 minutes in) and that we’re in the thick of something that actually began in 2000 or so. Over in Britain, Gordon Brown has apparently decided that increased public spending is necessary. The 1930s all over again, indeed. We need to get angry about the wool Chris Dodd and co are pulling over our eyes.

Lehman Bros hearing — Rep. Maloney blames deregulation, ignores her own role as Fannie’s enabler

by John Berlau on October 6, 2008 · 2 comments

in Bailout Watch, Odds & Ends, Politics as Usual

At the hearing being held today by the House Oversight and Government Reform Committee, in which former Lehman Brothers CEO Dick Fuld is now testifying, an earlier panel attempted to look at the causes of Lehman’s collapse and the broader credit cirisis. And this gave an opportunity to committee members to ride their various hobby horses.

Rep. Carolyn Maloney’s horse and “whipping boy” was deregulation. She blamed the entire crisis on deregulation, and specifically the repeal of the Depression-era Glass-Steagall law that separated commercial and investment banking. The repeal was done through the Gramm-Leach-Bliley Act, which Maloney neglected to say was passed on an overwhelmingly bipartisan vote and signed by President Bill Clinton in 1999. Clinton, in fact, recently defended the law, saying it didn’t contribute much to the current crisis, and has even alleviated it by allowing banks to save failing brokerages. (Clinton is right, as a Wall Street Journal editorial points out).

But if Maloney wants to know a more proximate cause of the systemic risk from bad mortgages, she should look no further than her own attacks on Competitive Enterprise Institute President Fred Smith when he testified before the House Financial Services Committee in 2000. Maloney was one of many lawmakers who enabled Fannie Mae and Freddie Mac to take excessive risks by ridiculing longtime critics of he government-sponsored enterprises (GSEs) such as Smith. As Smith recalled in a recent op-ed in Investor’s Business Daily, Maloney poo-poohed his argument that Fannie and Freddie’s government privileges could result in a bailout.

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Kling hits secondary market — misses benefits

by Fran Smith on October 3, 2008 · 2 comments

in Bailout Watch, Economy

Arnold Kling hits the creation of the secondary market for mortgage loans as the major factor — 50 percent — causing the current financial crisis. As Kling wrote:

In hindsight, I think that the crisis was caused by
a) creation of the secondary mortgage market (50 percent)
b) low down payment mortgages (30 percent)
c) the “suits vs. geeks” divide (15 percent)
d) other (5 percent)

The more I think about the secondary mortgage market, the less I like it. Any widespread benefits, such as lower mortgage interest rates, are microscopic. On the other hand, several times (not just recently), the market has been used to create or enhance regulatory loopholes that undermined the safety of the financial system as a whole.

I am surprised that Kling so lightly dismisses the benefits as “microscopic” of one of the most positive innovations in the mortgage market.  Just think about it.  Financial institutions — primarily savings and loans — prior to the creation of the secondary market, took in short-term deposits and made long-term, fixed-rate loans (30 years).  Until the early 1980s, Regulation Q set the limit on the interest rates that could be paid on deposits.

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Republican Study Commitee plan now best viable alternative

by John Berlau on September 29, 2008 · 9 comments

in Bailout Watch

The stunning defeat of the Hank Paulson’s socialism-for-Wall Street bailout on Monday has just made planks of a pro-free market alternative much more viable. As Open Market has noted before, The Republican Study Comittee, a caucus of pro-market members of the GOP Congress, has presented such a plan that would be much more effective at stopping the contagion than the Paulson bailout, and many of its provisions would not cost taxpayers a dime.

The RSC plan is chock-full of measures to remove barriers to economic growth and market-distorting subsidies. It would suspend capital gains taxes to put trillions of dollars of capital in the economy, and set Fannie Mae and Freddie Mac, which as CEI has documented were at the root of this crisis, on the road to full privatization.

Most importantly for the crisis at hand, the RSC plan would make regulatory agencies suspend the mark-to-market accounting rules that a range of experts agree are spreading the contagion by forcing solvent banks’ to “write down” their assets, based on the last fire sale of a highly leveraged bank. As Gary Gorton, finance professor at Yale and member of the National Bureau of Economic Research has written, “With no liquidity and no market prices, the accounting practice of ‘marking-to-market’ became highly problematic and resulted in massive write-downs based on fire-sale prices and estimates.”

You can read more about mark-to-market regulations in my op-ed in the Wall Street Journal last weekend. My Open Market post early last week, as well as CEI’s new podcast, explains how the Paulson bailout may make things worse by forcing more paper losses that threaten healthy banks with “regulatory insolvency.”

The problem with the Paulson buy-up plan or some new variant of it is if the government pays pennies on the dollar, mark-to-market rules would make every other bank take this paper loss on its books. So there will be a tension between getting the best deal for the taxpayer and not spreading further systemic risk from massive writedown the government purchase could force. Even Ben Bernanke acknowledged this tension in his Congressional testimony last Tuesday.

All the more reason to go with the RSC plan instead of a reformulated Paulson plan, which would throw $700 billion and the free market out the window and still not solve the crisis at hand.

Bailout fails — Move on to Mark-to-Market Reform

by John Berlau on September 29, 2008 · 13 comments

in Bailout Watch, Economy

Oh, Happy Day! And it certainly is for all those who value freedom, responsibility and the true free market in which individuals are free to profit from their risks on the condition that they don’t stick the rest of us with their losses.

It’s not hyperbole to say the Republican and Democratic backbenchers who defied both parties’ leadership to defeat this $700 billion package of Wall Street socialism literally saved America. Whatever their reasons, this defeat (or rather victory for freedom), means that America is much less likely to turn into France, Venezuela, or the old Soviet Union, as this bailout/nationalization package would have set us on the road to becoming.

Several great speeches on the Right and Left were given. Democrats Brad Sherman of California and Earl Blumenauer of Oregon gave powerful speeches against corporate giveaways. And conservative leaders of the Republican Study Committee — such as Jeb Hensarling, Jeff Flake, Mike Pence, and of course Ron Paul — spoke about how government intervention was largely the cause of this predicament, but the bailout would doom arguments for the free market form here on out. The idea of the government making this kind of outlay to high-flying risk takers just didn’t jibe with members, and certainly not with the American people.

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