A letter to my buddy:
I've been composing a manifesto response to your email! I need to find a way to cut it down.Until then...
I found this very interesting article written by the NYT about Fannie Mae and Freddie Mac, the two government institutions that own or guarantee $6 trillion in U.S. mortgage debt (i.e. 50% of outstanding mortgage debt), and currently guarantee 90% of all new mortgage debt issuance. I highly recommend reading the article. After you do so, please allow me to give you my background on the situation (parens are my additions to the following story):
The first time I learned of F&F was summer 2006 at UBS. Some of my boss's clients (my boss's name is Danny) owned F&F debt. I had never heard of a Fannie Mae nor a Freddie Mac company, and asked Danny what F&F did, thinking they were normal businesses. Danny answered, "F&F are government entities, but are also corporations and are listed on the NYSE. F&F buy mortgages directly from banks (both big and small), and then guarantee the mortgages (i.e. if the mortgage doesn't get paid, F&F pays the bills). They then resell these mortgages in packages to investment banks, who then packaged the F&F mortgages and lastly turn around and sell them to investors, or hold them on their balance sheet, or sell them back to F&F."
"Investors buy F&F debt because there is an implicit guarantee that if F&F can't pay back their debt, the government will bail them out. Based on this perverse perception, F&F issue debt to investors and pay very low interest rates, rates so law that they are barely above U.S. government debt (U.S. gov't is the lowest debt of them all, because they are backed by the full faith and credit of the U.S. gov't). This is an attractive investment for my older clients who want higher interest payments, but don't want to hold riskier corporate bonds (riskier because 100% private corporations can't tax or print money to pay the bills)."
When I spoke with Danny again during summer 2008 I asked him what he thought about F&F needing a bailout He said, "I advised my clients to sell F&F debt before the 2007 F&F bubble popped. Even though everyone knew the government would cover F&F losses, I urged my clients to hold cash and straight U.S. government debt (which subsequently increased in price and became a top investment during 2009-2010)."
Now it would be crazy to say that the government didn't have a hand in the mortgage crisis. F&F was a government subsidy of the housing market...it's a fact that the government owns or insurers ~40% of mortgages...talk about an environment for perverse incentives! F&F makes buying a house more easier, which sounds like a great goal and a way the government can intervene to shorten that socioeconomic ladder, however the unintended consequence of F&F's subsidies is increased housing demand which causes prices to rise, creating a a misallocation of resources (how many incoming Poly freshman wanted to do Construction Management in 2005, myself included) a large bubble, and ultimately a painful crash with a whole lot of unemployed construction workers. F&F's guarantees led to longer (riskier) mortgages, less prudent credit profiling and smaller down payments, all of which do not promote responsible lending and borrowing. Add on top of that Wall Street's penchant for making easy money, and boom goes the dynamite.
So I haven't seen the 2011 Best Documentary "Inside Job" (cue to 1:50), but when I do, I will be very disappointed if the directors don't touch on the government's role in this most recent economic crisis via F&F, not to mention the U.S.'s mortgage interest rate tax deductions, the Federal Reserve's purchase of F&F mortgage debt, and the Federal Reserves extended low interest rates after 2001. It wasn't just a corrupt private sector (which arguably took advantage of the easy F&F subsidy and low interest rates by the U.S. Federal Reserve Bank, now a major holder of F&F debt) alone that promoted a perverse incentive structure pre-2008, it was very much the government's fault too.
I've been saying it since Winter 2009...F&F must go. Finally Obama, Republicans and Democrats are beginning to agree. Now remember, F&F cost us over $200 billion...more than any bank bailout, GM bailout, or AIG bailout...combined (but don't get me wrong, I don't think any of them should have been bailed out!).
On top of all this, F&F was a top lobbyer on the hill. Chris Dodd, author of the recent Dodd-Frank financial regulatory bill, was a top recipient of F&F lobbyist money. In fact, F&F lobbied everyone hard, the GOP and Dems. So it was the government lobbying the government--a conflict of interest similar to the Federal Reserve buying Federal government debt and then calling that debt money--all in the name of promoting something so well intentioned: housing for all! All in the name of trying to shorten that socioeconomic ladder.
I say, beware of unintended consequences. The greatest enemy of knowledge is not ignorance, it is the illusion of knowledge. I place my trust in a purely private mortgage market where the government does not interfere in the marketplace (talk about a slippery slope).
Side note: who was pushing for more regulation of F&F? Find out here!
Overall, you have to blame the government and the private sector for the crisis. I will take it a step further and say that it was the collusion of government and powerful corporations, known as "corporatism" (aka crony capitalism), that helped bring the economy to its knees.
Thoughts?
John
i have to send you the book All the Devils Are Here - you'll love it!
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