Thomas Sowell always has something interesting to say:
Among the Congressional “leaders” invited to the White House to devise a bailout “solution” are the very people who have for years created the risks that have now come home to roost.
Five years ago, Barney Frank vouched for the “soundness” of Fannie Mae and Freddie Mac, and said “I do not see” any “possibility of serious financial losses to the treasury.”
Moreover, he said that the federal government has “probably done too little rather than too much to push them to meet the goals of affordable housing.”
Earlier this year, Senator Christopher Dodd praised Fannie Mae and Freddie Mac for “riding to the rescue” when other financial institutions were cutting back on mortgage loans. He too said that they “need to do more” to help subprime borrowers get better loans.
In other words, Congressman Frank and Senator Dodd wanted the government to push financial institutions to lend to people they would not lend to otherwise, because of the risk of default.
The idea that politicians can assess risks better than people who have spent their whole careers assessing risks should have been so obviously absurd that no one would take it seriously.
But the magic words “affordable housing” and the ugly word “redlining” led to politicians directing where loans and investments should go, with such things as the Community Reinvestment Act and various other coercions and threats.
The roots of this problem go back many years, but since the crisis to which all this led happened on George W. Bush’s watch, that is enough for those who think in terms of talking points, without wanting to be confused by the facts.
In reality, President Bush tried unsuccessfully, years ago, to get Congress to create some regulatory agency to oversee Fannie Mae and Freddie Mac.
N. Gregory Mankiw, his Chairman of the Council of Economic Advisers, warned in February 2004 that expecting a government bailout if things go wrong “creates an incentive for a company to take on risk and enjoy the associated increase in return.”
Since risky investments usually pay more than safer investments, the incentive is for a government-supported enterprise to take bigger risks, since they get more profit if the risks pay off and the taxpayers get stuck with the losses if not…Alan Greenspan, then head of the Federal Reserve System, made the same point in testifying before Congress in February 2004. He said: “The Federal Reserve is concerned” that Fannie Mae and Freddie Mac were using this implicit reliance on a government bailout in a crisis to take more risks, in order to “multiply the profitability of subsidized debt.”
Chairman Greenspan added his voice to those urging Congress to create a “regulator with authority on a par with that of banking regulators” to reduce the riskiness of Fannie Mae and Freddie Mac, a riskiness ultimately borne by the taxpayers….
If Fannie Mae and Freddie Mac were free market institutions they could not have gotten away with their risky financial practices because no one would have bought their securities without the implicit assumption that the politicians would bail them out.
It would be better if no such government-supported enterprises had been created in the first place and mortgages were in fact left to the free market. This bailout creates the expectation of future bailouts.
Phasing out Fannie Mae and Freddie Mac would make much more sense than letting politicians play politics with them again, with the risk and expense being again loaded onto the taxpayers.
The full article can be found here.
I would call Sowell’s comments “predictable”, rather than interesting.
Shorter Sowell:
“Even though Republicans have controlled both the Presidency and the Congress for six of the last eight years, Democrats are to blame for everything that is going wrong.”
Foe someone who claims to be an economist you should know the current crisis in Wall Street is more complicated than just regulations on Freddie Mac and Fannie Mae.
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1. Easy money from the Federal Reserve. On January 3, 2001, the Federal Reserve cut the federal funds rate by 50 basis points, to 6.00%. They continued to do so until the rate hit a bottom of 1.00% on June 25, 2003.
2. Mark-to-market accounting rules. This refers to an accounting practice that forces a balance sheet to value an asset at its current market price (that is, what it could be sold for at the time). Mark-to-market is an arbitrarily-restrictive accounting practice that should be scrapped for assets like securities which generate current income. Doing this alone would solve much of the problem.
3. The rating agencies who assigned AAA ratings to mortgage backed securities and derivatives that had sub-prime exposure; these professionals did a job that was comparable to the intelligence on weapons of mass destruction in Iraq yet we hear virtually nothing about their lack of performance on risk assessment
4. Investment banks engaging in leverage of as much as 30:1 without any regulatory oversight
5. Basell II international banking rules that applied increased capital requirements for conventional mortgages but NOT to mortages held in the form of securities
6. Financial advisers advocating home equity loans/mortgages so that the money could be invested on the stock market
7. Failure of government to regulate emerging hybrid securities in the investment banking industry
LaurenceB,
Republican control, Democratic goals (affordable housing). I’m not saying one party is completely at fault - just balancing out the image that the average joe has.
frank,
I’ve never claimed to be an economist. It’s more of a hobby for me. I am an electrical engineer by trade.
Regarding your response - alot of that is true, but even that doesn’t tell the full story, it’s much more complicated than that.
The economy and the current crisis is more like a multiple order control system in which any abrupt changes in any feedback input can upset the control system and cause it to become unstable, and the root locus model is not fully understand or worse yet may not be properly modeled and therefore any changes in feedback can not be really understood or anticipated.
Very true!
Frankly, I think this shows that macro economics has a lot of wholes. Micro economics I think is pretty strong - near scientific, IMHO. Macro, on the other hand, needs alot more work and goes down to near “educated opinion”.
It isn’t like this caught us completely by surprise. Even most people that entered the real estate market knew it was a bubble…they just hoped they it could go up long enough that they could make some money off of it. How could the supposedly macro economics models have missed this? All seems so primitive still.