Tuesday, July 15, 2008

The greater of two failures 

Lots of good material being written on the bailout of Fannie Mae and Freddie Mac, all pointing in the same direction. Arnold Kling:

The plan that Treasury Secretary Paulson announced on Sunday appears designed to shore up the GSEs and to return to the status quo prior to the recent loss of confidence by investors. In fact, however, I think it is unrealistic and undesirable to return to the status quo.

If you had it to do over again, you would not allow the GSEs to become more than 50 percent of the mortgage market. Instead, you would create a system that diversifies mortgage finance across many institutions. The �regulatory arbitrage� that the GSEs enjoyed should be replaced by a level playing field, which reduces the capital requirements for banks to hold investment-quality loans while increasing the capital requirements for GSEs should they continue to stray out of the arena of low-risk, high-quality mortgages.

Gerald O'Driscoll:
We must also realize that, whatever the deficiencies of the mortgage market in Depression-era America, that era is over. There is no "market failure" in housing finance today, except the one created by government-backed institutions dominating housing finance. Money flows where it is rewarded. Home mortgages are plain vanilla financial instruments, perhaps partly due to Fannie and Freddie. So by all means, let us thank them for their service as we bid them adieu in their present form.
Brian Wesbury and Robert Stein:
One of the reasons Fannie/Freddie are too big to fail (at least right now) is that their access to government credit has �crowded out� what could otherwise have been a flourishing competitive market in mortgage securitization, with no one firm dominant enough to necessitate federal help. In addition, because Fannie/Freddie were able to dominate the market using subsidized credit, they pushed private firms toward the fringes of the securitization process and into territory which included subprime and Alt-A loans. Clearly, Fannie/Freddie led to a world with greater securitization of mortgage debt than would otherwise be the case.
Willem Buiter:

So let�s call a spade a bloody shovel: nationalise Freddie Mac and Fannie Mae. They should never have been privatised in the first place. Cost the exercise. Increase taxes or cut other public spending to finance the exercise. But stop pretending. Stop lying about the financial viability of institutions designed to hand out subsidies to favoured constituencies. These GSEs were designed to make losses. They are expected to make losses. If they don�t make losses they are not serving their political purpose.

So I call on Secretary Paulson, Chairman Bernanke and Director Lockhart to drop the market-friendly fig-leaf. Be a socialist and proud of it. Come out of the red closet. The Soviet Union may have collapsed, but the cause of socialism is alive and well in the USA.
Don't care if the current Paulson plan is a temporary sandbag; eventually, we want the flood to remove this inefficiency. Contra Jim Hamilton, that there is a dollar limit on what the Congress can stake on the bailout is like those commercials telling you to set a limit on how much you gamble (that are a staple of the Texas Hold'em shows on TV): That just invites you to lose that much money. Better will be to simply remove these guarantees; if it pushes mortgage rates up 25-50 bp, that would simply be recognition of a subsidy that has long since lost its usefulness. If making losses ever was useful.