Why the Bail Out of Freddie Mac and Fanny Mae is Bad Economic Policy

[Better Believe It]

July 15, 2008
A CounterPunch Special Report

Rewarding the Bubble's Enablers
Why the Bail Out of Freddie Mac and Fanny Mae is Bad Economic Policy
By MICHAEL HUDSON

Michael Hudson is a former Wall Street economist specializing in the balance of payments and real estate at the Chase Manhattan Bank (now JPMorgan Chase & Co.), Arthur Anderson, and later at the Hudson Institute (no relation). In 1990 he helped established the world’s first sovereign debt fund for Scudder Stevens & Clark. Dr. Hudson was Dennis Kucinich’s Chief Economic Advisor in the recent Democratic primary presidential campaign, and has advised the U.S., Canadian, Mexican and Latvian governments, as well as the United Nations Institute for Training and Research (UNITAR). A Distinguished Research Professor at University of Missouri, Kansas City (UMKC)

--------------------------------------------------------------------------------------------------------------------------------------

My modest proposal

Shareholders of FNMA and Freddie Mac probably will be wiped out, as were S&L shareholders in the bailout of S&L depositors in the 1980s. There’s a simple way to save FNMA’s and Freddie’s public functions, if they indeed are deemed necessary to keep supporting the debt market. This can be done without bailing out the speculators who bought the mortgages it packaged.

First of all, not all the mortgages that these two agencies have bought or guaranteed are junk. Most are genuine and are being paid. The poor are honest, after all, and think that they should pay as a matter of honor even if it is not in their economic interest to do so when their homes fall into negative equity. Let these mortgages continue to back the existing FNMA and Freddie Mac bonds to the degree that they actually receive mortgage debt service. If there is a shortfall, let bondholders take the usual haircut that is supposed to go hand in hand with risk. That is why these mortgages had such high rates of interest, after all. The loss would be proportional to the financial and real estate fraud they have enabled. This is the law for all other bondholders when their investments go south. Why make an exception for participants in the real estate bubble?

To keep their activities current, let Fannie and Freddie issue a new series of bonds – the “we won’t fake it anymore” series. They would be based on a new honesty based on more realistic appraisals of the affordability of housing, which they were supposed to be promoting all along. These steps would not cause a collapse.

Prior to FNMA and Freddie Mac, banks that issued mortgages held onto them, because there were no outside blind buyers. This was the pre-fraud era. It is now looking like a Golden Age. Housing prices were lower, and buyers did not have to go so deeply into debt to purchase homes. But the Senate and Congress – at least the Democrats – are urging the FHA and other government agencies to prop up the mortgage market by issuing zero-down-payment loans and other subsidies. The immediate aim is not to help homeowners – who indeed will have to pay more if the housing market re-inflates. Each new economic crisis adds a few new words to the English language. This time we get “reflate.” Others include NYU Prof. Roubini’s “stagdeflation” for a combination of debt deflation of incomes and price inflation for commodities as the dollar sinks in response to the balance-of-payments deficit resulting largely from the war in Iraq. But that is another story. Today’s story is about how Congress is aiming to bail out the banks that have bought or packaged these junk mortgages, about how needless this bailout is, and about how much simpler and more fair to just write off the bad debts.

Please read the entire article at:
http://www.counterpunch.org/hudson07152008.html

I don't have an opinion on this matter because I'm trying to figure out what is happening and like many here I'm learning from people who have a better understanding of capitalist economics. So I'd like to hear other DU'ers opinions on this subject.

[tjwash]

1. Sad what has happened to the program that was made by Roosevelt...

...as part of the new deal in 1938. It was made so that regular folks like you and I could actually buy houses, and own their own little piece of this country. Johnson privatized Fannie Mae in '68 in order to remove it from the national budget, because (surprise-surprise) the war was sucking up money out of the budget just like this one is. After that point, Fannie Mae was a GSE, generating profits for stock holders while enjoying the benefits of exemption from taxation and oversight as well as implied government backing.

If it would have just stayed under FED regulation to begin with, they wouldn't be in this current mess. Sadly, corruption and greed have destroyed it.

[Virginia Dare]

3. Corruption and greed have destroyed the entire country..

I'm starting to think that it's going to get much worse before it gets better.

[Justitia]

2. It creates "moral hazard", just like the S & L crisis & bailouts of GM, Bear Stearns, airlines, etc

When you assume that the Fed Gov't (translation - you & me, the taxpayers) will pay your bills for you, it's easier to take big risks w/other people's money (translation - our money).

This is a direct result of deregulation and an attempt to loot the US Treasury (translation - us) for the enrichment / benefit of certain private citizens (see once again the S & L crisis, assorted bailouts and the repeal of the Glass-Steagall Act for Citicorp).