Larry Summers, one of my favorite economists, explains why:
What went wrong? The illusion that the companies were doing virtuous work made it impossible to build a political case for serious regulation. When there were social failures the companies always blamed their need to perform for the shareholders. When there were business failures it was always the result of their social obligations. Government budget discipline was not appropriate because it was always emphasized that they were “private companies.” But market discipline was nearly nonexistent given the general perception — now validated — that their debt was government backed. Little wonder with gains privatized and losses socialized that the enterprises have gambled their way into financial catastrophe.
I wonder how general the lesson here might be. My fear is fairly general. Inherent in the multiple objectives urged for creative capitalists is a loss of accountability with respect to performance. The sense that the mission is virtuous is always a great club for beating down skeptics. When institutions have special responsibilities it is necessary that they be supported in competition to the detriment of market efficiency.
It is hard in this world to do well. It is hard to do good. When I hear a claim that an institution is going to do both, I reach for my wallet. You should too. (emphasis mine)
In other words, the incentives were never aligned. It’s profit motive conflicted with its altruistic motive and the altruistic motive usually won. Given the fact that the losses were always going to be absorbed by the government, that negative feedback loop that is so essential in the private industry was removed - making the GSE’s a disaster waiting to happen. So we have to align the incentives - make them either a fully private enterprise, capable of going bankrupt, or make them a fully government enterprise with the government taking the losses. Since they are already in serious debt, so serious that we can’t let them go bankrupt, the only option left is nationalizing them.
The full post, which really should be read in full, can be found here.
Update: Greg Mankiw seems to agree and Russell Roberts explains it a different way.
Try this on for size. We were trying to get a contract on a foreclosure that is owned by Fannie Mae. The asking price for the home was $290,000. The home had no appliances, holes in the walls, exposed wiring, etc. We fell in love with the home and most of the things wrong we could repair ourselves. So we made some offers on the home. Our final offer was $278,500. Well, they declined all of our offers wanting $290,000 for the home. (all of this took place over the last few weeks - April 2009). I went and looked to see if the home is still up for sale (we are under contract on another home now) and they are asking $268,900 for the home! This is almost $10,000 less than our last offer. We were already pre approved for more than what we were offering on the home, but Fannie Mae obviously has some kind of problem on accepting offers on this particular home. It has been on the market for almost 2 years and they decline offers on the home but then turn around and drop the homes price to below what the last counter offer was. Can you say discrimination! We are white middle class Military family. Why would Fannie Mae decline an offer of $278,500 and then turn around and lower the price to $268,900??? Kind of makes you wonder how many other families they have done this to just to keep homes on their books. No wonder they needed a Federal Bailout! To top this off I have been trying to contact Fannie Mae to find out the reason behind this but of course you never get to speak to a representative and they NEVER return phone calls! Something is obviously very fishy with Fannie Mae. Maybe the government needs to take an even closer look!
In response to Diane
The problem with these mega corporations is that they really don’t care about reality, they care about protecting their butts. So, no one is able to make a decision, nor do they care to…the bottom line is they really don’t care.