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The President’s proposed overhaul of the financial system ignores two key contributors to the crisis last fall. Fannie, Freddie Were at Center of Financial Crisis But Are Not Included in Obama’s New Financial Regulations
…Testifying before the Senate Banking Committee on Thursday, Treasury Secretary Tim Geithner said that the administration’s new regulations were only meant to address the most fundamental issues of the recession.
“We considered a full range of options and decided that now is the time to pursue the essential reforms,” Geithner said. “Those that address the core causes of the current crisis, and that will help to prevent or contain future crises.”
Those “essential reforms” include the establishment of a new Financial Oversight Council to coordinate between banking regulators and watch for systemic risk; new powers for the Federal Reserve to supervise all systemically important firms; a new National Bank Supervisor to oversee all federally chartered banks; and new powers to allow the federal government to wind down any failing financial institution…
Apparently Fannie and Freddie are just annoying distractions. A strange position for the White House to take, when you consider this:
The absence of either Fannie or Freddie is notable, because the two companies once owned or controlled nearly $6 trillion worth of home and commercial mortgages, nearly half of the total U.S. mortgage market – and both companies were pioneers of the now infamous sub-prime mortgages that caused the mortgage market to implode late last year.
And this:
During Geithner’s Senate testimony, he admitted that both Fannie and Freddie played a central role in the financial crisis, telling Sen. David Vitter (R-La.) that the two government-sponsored enterprises (GSE) were a “core part” of the country’s financial woes.
“Absolutely,” Geithner said. “Fannie and Freddie were a core part of what went wrong in our system.”
Don’t worry, though. Mr. Geithner plans to free up some time to deal with the duo, sometime:
Geithner explained that the administration did not have the time to come up with coherent regulations regarding Fannie and Freddie because of its other legislative priorities.
“We did not believe that we could have, in this time frame, lay out a sensible set of reforms to guide and determine what their future will be,” said Geithner. “We didn’t think it was an essential thing to do just now, but we do believe it is an essential thing to do.”
The delay is because he hasn’t yet come up with an endgame:
“Our challenge with Fannie and Freddie, and this is true about the government’s role in the housing market more generally, it’s more a challenge for exiting, what the future should be,” said Geithner.
“We have to fundamentally rethink what the appropriate role of the government is in the future [because] we did not get that right [in the past],” said Geithner. “It’s more about the questions we face about how the government gets out of and dials back and reverses these extraordinary actions we’ve been forced to undertake.”
I think Mr. Geithner and President Obama know exactly what role they want the Federal government to play in the housing market. They want more control, not an exit strategy, and the free market poses a fundamental problem for that. Why else did their reforms focus on increasing Federal control of the private sector?
Much of the blame for the demise of the financial system as we knew it can be placed on the doorsteps of Fannie Mae and Freddie Mac. Both of them are shareholder-owned companies with political missions, such as keeping mortgage interest rates low and encouraging affordable housing. So why did they collapse and why did the government have to take them over? In a September, 2008, article The American Enterprise Institute tells the tale: The Last Trillion-Dollar Commitment
The government takeover of Fannie Mae and Freddie Mac was necessary because of their massive losses on more than $1 trillion of subprime and Alt-A investments, almost all of which were added to their single-family book of business between 2005 and 2007. The most plausible explanation for the sudden adoption of this disastrous course–disastrous for them and for the U.S. financial markets–is their desire to continue to retain the support of Congress after their accounting scandals in 2003 and 2004 and the challenges to their business model that ensued. Although the strategy worked–Congress did not adopt strong government-sponsored enterprise (GSE) reform legislation until the Republicans demanded it as the price for Senate passage of a housing bill in July 2008–it led inevitably to the government takeover and the enormous junk loan losses still to come.
The collision of politics and sound business practice resulted in the present financial carnage:
As GSEs, Fannie and Freddie were serving two masters in two different ways. The first was an inherent conflict between their government mission and their private ownership. The government mission required them to keep mortgage interest rates low and to increase their support for affordable housing. Their shareholder ownership, however, required them to fight increases in their capital requirements and regulation that would raise their costs and reduce their risk-taking and profitability. But there were two other parties–Congress and the taxpayers–that also had a stake in the choices that Fannie and Freddie made. Congress got some benefits in the form of political support from the GSEs’ ability to hold down mortgage rates, but it garnered even more political benefits from GSE support for affordable housing. The taxpayers got highly attenuated benefits from both affordable housing and lower mortgage rates but ultimately faced enormous liabilities associated with GSE risk-taking. This Outlook tells the disheartening story of how the GSEs sold out the taxpayers by taking huge risks on substandard mortgages, primarily to retain congressional support for the weak regulation and special benefits that fueled their high profits and profligate executive compensation. As if that were not enough, in the process, the GSEs’ operations promoted a risky subprime mortgage binge in the United States that has caused a worldwide financial crisis.
The special relationship with Congress was the GSEs’ undoing because it allowed them to escape the market discipline–the wariness of lenders–that keeps corporate managements from taking unacceptable risks.
There’s much more at the link, including the history of Fannie Mae and Freddie Mac and the political purposes their creation was meant to fulfill.
The article concludes,
Unfortunately, the sad saga of Fannie and Freddie is not over. Some of their supporters in Congress prefer to blame the Fannie and Freddie mess on deregulation or private market failure, perhaps hoping to use such false diagnoses to lay the groundwork for reviving the GSEs for extra constitutional expenditure and political benefit in the future. As the future of the GSEs is debated over the coming months and years, it will be important to remember how and why Fannie and Freddie failed. The primary policy objective should be to prevent a repeat of this disaster by preventing the restoration of the GSE model.
It seems to me that there are similarities with the saga of Fannie Mae and the current federal takeover of General Motors. While GM is not a government-sponsored enterprise in terms of Congressional legislation, it has a lot in common with it, in that the government is essentially managing the company through the appointment of its officers, finances it and has announced GM’s mission to produce environmentally-friendly cars, a political purpose. This doesn’t bode well for taxpayers, if the history related in this article is any guide.
