When the government created this near monopoly on mortgage lending by two quasi public companies, it was also inevitable that the risk of a downturn would be socialized by us tax payers.

The alternative of allowing the Macs to fail would have tanked the financial markets and plunged the world (not just the US) into a financial meltdown. It was that large.

I hope McCain is being truthful about breaking up the Macs and privatizing them so we can safely allow individual companies to fail in the future without causing a world wide financial meltdown.

Now, what do we do about the failing near monopoly on pensions known as Social Security?
 

I'm not sure privatization is a panacea. Fannie Mae and Freddie Mac were effective precisely because they occupied that quasi-governmental position and had (mostly) transparent standards for approving loans. Given the large number of private lenders that have gone out of business (or "temporarily suspended" their lending departments), the standards set by Fannie Mae provided the sole bit of security in a very tumultuous real estate market.

Since intervention has proven necessary time and again (yes, perhaps not in a perfect free market, but those don't exist yet), the question is whether the government should--in the future-- use taxpayer money to bail out private banks or use it to prop up GSEs that provide underwriting standards and stability to the market as a whole.

I think I prefer the second option to the first. I would like my tax money to go (at least nominally) where it benefits the country, rather than the country club.
 

The Fannie Mae/Freddie Mac bailout is but the latest example of the fallacy of deregulation in the interests of "small government".

When you have people in charge of other peoples' money, it is not 'light touch' regulation which is required but 'onerous' regulation, because the 'greed is good' syndrome will always prevail over commercial morality.

Historically, banks and others lent by way of mortgage to creditworthy customers only - who were able to put up a reasonable deposit and demonstrate ability to repay. They then kept those debts on their own books and made sure there was a prudent ratio of long-term lending to short-term deposits. If they got the assessment of the credit worthiness of borrowers wrong - or the prudential ratio of lending to deposits wrong, then they failed.

Along come the "get rich quick" kids. New formula:

"Let's lend lots of money imprudently to non-credit-worthy borrowers. Then we package all those imprudent loans into new 'mortgage backed' securities which we can trade so as to spread the risk" - as if securitisation makes an imprudent loan prudent.

And the "magic powder" which effected the transformation of an imprudent loan into a marketable security ? - The Fannie Mae/Freddie Mac guarantee.

Result: a liability to the international financial system which is the equivalent of the entire US National Debt. These securities have been traded all over the world. In the UK housing prices have already fallen and it is estimated they will fall by up to 25%. New mortgage credit is almost impossible to find as lenders struggle to get their balance sheets back in order as they take the billions in write-downs on their US portfolios.

Who will ultimately take the hit ? Mostly the members of pension funds which put part of their members' assets into 'safe' equity securities such as bank shares.

And will the auditors, "the light touch" regulators", the treasury secretaries, the corporate whizz-kids do jail time for another repetition of the oldest fraud in the world - not likely.

All institutions which take deposits need regulation of the FDIC banking kind - examiners who turn up without warning and go through the papers with a fine toothcomb.

It's expensive - Yes. It creates a Federal bureacracy - Yes. It inhibits innovation - Yes - and a jolly good idea too.

It makes the sort of people who give huge donations to the Republican Party to encourage "free markets" a lot poorer - Yes - and a jolly good idea too.

From the South Sea Bubble to Enron to this, the rule has never changed - if a proposition sounds too good to be true, then it probably is. And it is the duty of government to regulate to prevent it. Otherwise only two consequences can follow: a great depression or a bail-out at taxpayer expense.

Ain't it a bleeding shame? It's the rich that get the profits but the poor what gets the blame!
 

pms:

If by panacea you mean future lending institutions will not fail, then free markets certainly will not provide that panacea. Indeed, one of the necessary functions of a free market is the "creative destruction" of replacing the inefficient with the efficient and thus imposing risk discipline on the players in the market.

We need to return to a situation where it is relatively safe for lending institutions to fail. Where the government comes into the picture is by enforcing anti-trust laws to keep these institutions from getting too big and to keep an eye in the loan instruments being offered. It is not to violate the precepts of the anti trust laws and the free market by creating its own lending monopolies.
 

Mourad -- Unless your goal is to have the government make certain people don't make foolish investments, I am not sure the necessity of what you propose. Under your scenario, there would be no securitization (or credit derivatives or other investments on mortgages and perhaps other investments). This would lead to significantly less people owning their homes, significantly less money being generated in the economy, a significant amount of tax revenue missed and a an even larger percentage of financial investment and innovation moving to London and Hong Kong.

Perhaps you are stating that only risky investments shouldn't be securitized. But who defines risky? If a certain risk theoretically exists but has never happened, should we stop that investment? If so, you stop many failures, including Long Term Capital Management. But you also have created a flight to Europe for capital and/or a huge decrease in the capital generated in our economy.

If Congress thought certain investments (such as sub-prime mortgages) allowed too much risk for Fannie Mae/Freddie Mac (or investment banks), Congress should have intervened to slow the risky investments. In fact, had we approved the Basel II capital structure more quickly, some of these risks would have been abated for the investment banks. But Congress didn't act and the market acted as it normally does -- some people succeed and other people fail. The costs to the taxpayers is much higher because Congress didn't act in time.

The rating agencies thought the securitized investments were good and the investors knew the risks they were taking. The economy thrived due to securitization; other than labor/costs in China, I believe securitization is the main driver that have kept interest rates so low for such a long period of time. Just because the market is not perfect and some people lose money does not mean we should eliminate the market. It just means people need to be more observant to the risks on the fringe.
 

I hope McCain is being truthful about breaking up the Macs and privatizing them so we can safely allow individual companies to fail in the future without causing a world wide financial meltdown.

Wow. A Republican worried about conglomeration and monopoly. That's a first.

Arlo Guthrie had a good spoof of this attitude a while back when the Republicans/big-bidnessmen asked for a bailout.

If you're little and you "fail", well 'eff you (or worse, we'll eliminate individual bankrupcy and force you nto indentured servitude). If you're big enough to hurt the fat cats when you fall, gub'mint will step in with a bailout of your "rsky schemes" and then you'll get your relief.

"Bart" misstates the genesis of the Macs as well: "When the government created this near monopoly on mortgage lending by two quasi public companies...."

Didn't quite happen that way. And they didn't get into trouble because of what the gub'mint did (ingoring externalities such as stoking a housing bubble while trashing the economy that would pay for it), but because of what they did after the gub'mint cut the reins.

Cheers,
 

A further note:

... two quasi public companies ...

Huh?!?!?

Were the Macs more "public" than the raft of companies traded each and every day on the NYSE/NASDAQ?

Cheers,
 

This comment has been removed by the author.
 

Bill, I think you misread Mourad (he can speak for himself, of course). As I understood his post, it was a call for regulation, not a call to require banks to keep the mortgages they write.

The issue is, though, that when banks don't keep the mortgages, there's a risk of externalities. I understand Mourad to be calling for regulation as a hedge against that.
 

Speaking for myself, but with a deferential hat-tip to Mark, I think there are a number of issues:-

1. I do not agree with the theory espoused by Bart de Palma that "small is beautiful", "regulation is bad" and "banks should be allowed to fail". Banks take deposits from a lot of people who cannot afford to lose the money but at least Mr & Mrs Small depositer are covered by FDIC. But what about Mr & Mrs small employer and their employees with a pension fund which has invested monies in a regulated bank thinking it was a safe investment.

2. I think the aim of regulators of deposit taking businesses should be that the audit and regulatory controls should mean that no bank or other deposit taking institution of any kind should be allowed to fail. Rescued - by forced take-over yes.

3. Nor should there be artificial restraints on banks growing and and expanding. The days of the single town or single state bank or even single country bank are over. This is an industry where there are increasing efficiencies of scale - where most retail and business banking will be conducted on-line. When is the last time anyone posting on this blog actually needed to visit their bank for any reason? Here, 90% of employers pay by direct transfer, social security payments likewise and 80% of bills are collected by direct debit. Cheques are rapidly becoming a thing of the past. Bills that are not paid by direct debit are paid by online transfer. I don't think I have written a cheque for anything household for 6 months. Bank branches are closing over here at a great rate - often re-opening as pubs under names like "the banker's draft".

4. Yes, Bill, I am unhappy about securitisation in the form it has taken. Not against the financial instrument per se, but against the duff credit risks being stuffed into the securitised packages. It reminds me of the legal definition of "a guarantee" - "a guarantee is when someone who can't pay gets someone else who can't pay to say that he will pay". A mortgage where the borrowers are required to put up 25% or 30% of the capital required to complete their purchase is one risk - a mortgage where the lending is 110% of the selling price of the property is quite another. Likewise as of late there has been little consideration of the ability to repay. People who should have been living with their parents or in rental property have been encouraged to get on the housing ladder before they were ready. Now the hoovervilles are beginning to develop under freeways and elsewhere and were I a democrat, I would be running ads about them in their full ghastliness.

5. Yes, Bill, I agree about Basel II. No, I disagree about overseas investors knowing or caring about the risk - they knew that the US government would have to stand behind Fannie Mae and Freddie Mac, so the "greed is good mob" paid themselves excessive compensation knowing that the general body of tax payers would foot the bill.

6. If there was ever an argument that the costs of regulatory intervention should fall as a levy on the financial services industry rather than on the general body of taxpayers - this is it. That means the industry becomes genuinely self-regulating - because the good and prudent operators will encourage the regulators to close down the shady and imprudent sooner rather than later.
 

Now, what do we do about the failing near monopoly on pensions known as Social Security?

Considering huge numbers of people have private pension plans, 401(k)'s, IRA's, Keough plans, and other sorts of private retirement investments, it is not honest to call Social Security a near monopoly. Nor is it "failing"-- indeed, it is probably the single most successful US government program in history.
 

Social Security is the best government program in the country.

BUT, Willie Clinton was so kind as to have his boys come up with "core inflation" which excludes food and energy, I won't ask.

This allows the government to keep the yearly raises in SS at a much lower figure.

It has always surprised me that our media just goes along with this lie. Like the NYT reporter tell us that "core inflation" is the real figure.

If I received in my Social Security payment the correct amount of inflation it would be doubled.

And I worked 45 years paying into SS each week and it is not a government handout as is so often stated.

Also if Congress and Johnson left their hands off of the money instead of using it for wars etc. it could pay what was promised to each and every worker that paid in.
hal scranton
 

On the subject of "greed is good" the New York Times has a relevant footnote to our Fannie Mae/Freddie Mac discussion in an article Reduced Exit Packages Urged for Ousted Executives. The key information is this:-

"Under the terms of his employment contract, Mr. Mudd could receive a package worth up to $9.3 million if his dismissal is deemed to be “without cause,” according to an analysis by the consulting firm James F. Reda & Associates. That is on top of $12.4 million in salary, bonuses and profits after cashing in stock options he has taken home since becoming chief executive in 2004, according to Equilar research.

Mr. Syron could receive an exit package of at least $14.1 million on top of the $17.1 million he has taken home in cash, bonuses and stock option profits since becoming chief executive in 2003.

A big chunk of that exit package comes from an unusual clause that was left in his employment agreement when it was renegotiated in November. That provision, part of a contract extension negotiated by Freddie Mac’s board and approved by its regulator, allows Mr. Syron to give up a stock award that has plummeted in value for an $8.8 million cash payment.

If that's what the so-called regulator thinks is an appropriate compensation package for guaranteeing worthless securities at the expense of the taxpayer, I wonder what would be the appropriate package in your "democracy" for simply taking taxpayer dollars on receipt and feeding them into a furnace.

I'm all for "performance-related pay" provided it cuts both ways. It is apparent that the "performance" in this case was artificially boosted by accounts that significantly understated the proper provisions which ought to have been made in accordance with generally accepted accounting principles - and, presumably, the accuracy of those accounts was certified by the Board of Directors and the Chief Executive as well as being approved by the auditors.

Of course, part of the problem may be the extent to which the regulators were also involved in the process of allowing duff accounts to pass muster.
 

Perhaps it will come as no surprise that the first shareholder suit seeking class action status has apparently been filed in SDNY Federal Court - Complaint

This may be only the beginning - I understand that a lot of sovereign wealth funds are involved - and they have very deep pockets and some take these things very personally.
 

dilan said...

BD: Now, what do we do about the failing near monopoly on pensions known as Social Security?

Considering huge numbers of people have private pension plans, 401(k)'s, IRA's, Keough plans, and other sorts of private retirement investments, it is not honest to call Social Security a near monopoly. Nor is it "failing"-- indeed, it is probably the single most successful US government program in history.

Unfortunately, only half or so of the nation invests for their retirement while everyone who pays SS taxes is supposed to receive social security. Even among those who invest, SS will probably be their primary source of pension. Thus, I would suggest that "near monopoly" is a good term for SS.

SS is a ponzi scheme depending on working children to pay their parents way. As such, it can only work if the children outnumber their parents and their parents do not stay retired long before dying. In fact, the boomers declined to have many children to support them and are projected to live around two decades during retirement. Thus, the system is due to start going bankrupt before I begin to collect.

SS is an exceedingly bad investment. Today's retirees might receive about a 2% return on investment for their SS contributions. My cohort at the ass end of the boomer locust swarm will almost certainly lose money.

If you are middle aged now, you better be either planning on working past 70 and/or socking a large portion of your income away in investments making a serious ROI.
 

While the US social security system may be considered valuable by many, it is, of course far from perfect. But it was traditionally, and rightly, considered "the third rail" of American politics: touch it and die. That attitude should be instilled in every child from secondary school onwards. A civilised state has to provide some kind of safety net for all its citizens.

By European standards, the basic US system is fairly rudimentary. Any safety net must cover:-

(i) a minimum income for those unable to work or retired;
(ii) acceptable basic health care for all;
(iii) an assurance that all families have access to decent affordable housing
(iv) access to quality education.

Nobody denies that the provision of such a safety net is very expensive. The myth that the benefits are financed out of the contributions paid into the system is just that - a myth. The contributions are nothing more than a form of payroll tax for employers and employees. Insofar as there is any separate accounting for social security systems what actually happens is that one generation's contributors subsidise the previous generation to some extent and the balance is made up out of taxation.

There is a fundamental reason for this - a principal one being that costs in the healthcare and social care sectors are rising much faster than general inflation.
Diseases which were incurable and resulted in early death are today treatable - expensively. But they often leave those treated unable to work.

Nor is it true that the solution is for everyone to have private insurance cover. Insurance companies are in business to make money - and that means not taking on an unacceptable level of risks. In short, they will provide an umbrella as long as the sun is shining, but once it starts raining they will want their unbrella back PDQ.

Therefore there has to be a state guaranteed minimum, funded from taxation with encouragement for those who are able to obtain private top-up provision.

And if Bart is doing as well as he makes out then there is no good reason why he should not be taxed at a higher arate on his income over 300k. It's certainly more just than the scandalous levels of child poverty in the USA - see Child Poverty in America - Facts and Figures.

And before Bart and those of his ilk start to come back with accusations that I am a bleeding heart liberal - consider this: those children are the future wealth of the country. The days of huge profits from 'making or growing things' are coming to an end and what is needed to remain competitive is a huge pool of well educated young graduates, not future sharecroppers or production line workers.

So I do not advocate a safety-net on altruistic grounds - but because it makes economic sense.
 

And before Bart and those of his ilk start to come back with accusations that I am a bleeding heart liberal - consider this: those children are the future wealth of the country.

I hate to say it, Mourad, but many people would say that using the words "children are the future" in a row is high on the list of the diagnostic fieldmarks of the "bleeding heart liberal." :)
 

Unfortunately, only half or so of the nation invests for their retirement while everyone who pays SS taxes is supposed to receive social security.

And why does only half of the nation save for retirement, and/or have to count on SS? If $38k is the cutoff for the bottom 40% of family incomes, I would like to see you save enough at that income level (even 5% of that would be a big hit to a family) after food, shelter, and utilities, not to mention transportation, to have a retirement fund that is credible. And if you have to pay for college, or major medical expenses (if you have viable insurance at a job paying in that range), or lose your job for an extended period of time, where is this magical ability to save to provide for yourself going to come from? I think that's why it's a safety net, to provide for those who couldn't otherwise provide for themselves.