Relevant:
2008-07-20 — ml-implode.com
By Aaron Krowne, ML-Implode.com founder.
You probably think nothing new can be added to the debate on the fate of the GSEs Fannie Mae and Freddie Mac, but I'm going to try anyway.
At this late point in what passes for the discourse on the matter, it seems basically a foregone conclusion that some sort of bail-out is needed. The main questions are whether the support should come from the Federal government or whether shareholders should be required to raise capital in the private markets (to their own detriment). To those that think the Federal government should be a part of the bailout, the questions are merely whether the backing should be limited or unlimited, and whether the shareholders should be forced to take the brunt or be made whole (because after all, lots of "public welfare" institutions like pension funds own these shares).
All of these perspectives make one gigantic presumption: that Fannie and Freddie are good for the country, or at least critical for the survival of our housing market. Bolstering the latter more existential view is the fact that nearly all of the housing market activity now flows through the GSEs since the private side of the market virtually collapsed last year (as we know well here at the Implode-o-Meter, being the lead chroniclers of that phenomenon).
But just because heavy use of the GSEs is now being made, it does not follow that this role should be made permanent by bailouts or "props" of other forms. By way of analogy, a drug addict should not be permanently given access to the drug he is abusing simply because taking that drug away abruptly will kill him. A transition plan away from the dysfunction must be made as soon as possible. Everyone knows this intuitively.
So why doesn't it hold for the GSEs? Probably because most people don't really understand what the dysfunction is: price fixing. Fannie and Freddie are and always have been gigantic schemes to fix the prices of mortgages lower than their natural, market rate. Until now this price fixing has been acheived by pretending there is a government backing but providing no such contractual guarantee, giving investors the impression of a solid backing but allowing the government to keep the GSE's obligations "off its books". It is a grand case of "having your cake and eating it too."
Now that fake guarantee is transitioning to an explicit one -- apparently with the government no longer having much concern over how horrible its books are or how many present and future taxpayers it enslaves into debt serfdom.
But the fact remains that this is all to keep the collossal price fixing scheme in place. The ultimate imperative seems to be that we must keep mortgage rates in the ballpark of 6-7%, even though interest rates virtually nowhere else in the economy match this low level. Credit card rates, applied to the same set of consumers, are in the range of 10-30%. Major banks raising capital are having to do it in the range of 8-12%. The only other area of low interest rates is very limited Fed financing -- the 2% funds rate provided to various banking entities, which is itself another artificial price fixing scheme to help temporarily keep them afloat.
Has the mortgage price fixing policy really ever helped anyone? Not really. We have seen that fixing mortgage rates low for a wide swathe of the market simply results in home prices rising to the point where there is no overall benefit conferred to homeowners. The first ones in the scheme get a benefit, of course, but it doesn't take long until the next round of buyers are back where they started. While this phenomenon has been most starkly demonstrated in recent years by private "affordability" loans with teaser rates, the same facts hold for price fixing through the GSEs, though over longer periods of time. The presence of the GSEs is exactly why the prevailing fixed rate mortgage now is 30-year instead of 15-year, as it once used to be. And it's exactly why prices for homes are high and will stay obscenely high, even moreso in areas that have been deemed "high cost areas" (which is simply a statement that the government has resolved to support irrationally high prices in areas with limited supply, thus perpetuating the problem)
My point: the GSEs are not worth saving because they do not serve a purpose that can even theoretically lead to any good for society. All they can do is distort the market, transfer wealth through price fixing from "late receivers" to "early receivers," put our country deeper in debt, and provide more bureaus for politicians to use as plum patronage vehicles.
Yes, the GSEs are now doing most of this country's housing business, and if we were to dismantle them, it would be quite painful. But it only follows then that we "must" bail them out if you believe all pain should be avoided. Keeping in mind that the outcome would be to alleviate all the above long-term ills, and lower home prices to a natural level so more people (including perhaps your children or grandchildren) can once again afford them without government aid, perhaps it is time for all of us to swallow that pill.
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Comments:
Justin at 02:32 2008-07-21 said:
It seems to me that the price-fixing symptom is just a result of the easy credit/risk-subsidizing/moral hazard/government backstop. Any GSE is de facto backed by the credit of the government. It's this backing that leads to GSEs taking on more risk than they can manage, which leads to prices being lower than they otherwise would be. As we understand with the Austrian Business Cycle (ABC), easy credit leads to malinvestment leads to cycles of booms and busts. We see this with the Fed and we see it also with Freddie and Fannie. The big picture is that the government-backing virtually guarantees that any and all GSEs will inevitably overextend themselves, which will result in calls for their sponsor to bail them out. After all, that's what the sponsor is there for. So the solution, as I see it, is stopping the buck. And as long as the buck stops at the government, we'll continue to see bailouts. Therefore, the solution is to get rid of government sponsored entities. Why should the government ever backstop any business, particularly one that has such sweeping power with regard to credit (Freddie, Fannie, Fed, FDIC are all examples)? And all of this points to the real end game for housing -- risk being priced back into assets, which will result in drastically higher interest rates and collapse house prices. Permalinkmichaelblomquist at 03:51 2008-07-21 said:
Aaron, Another great article!My point: the GSEs are not worth saving because they do not serve a purpose that can even theoretically lead to any good for societyExactly, We should organize the troops to stop the bail out; file RICO & APA actions against these criminals. They should be arrested, disgorged and convicted. For starters all patriots should be sign the petition below. No jail No bail! Foreign investors realize that America has inflated its way to prosperity and regardless of proposed current bail outs will not continue to fund our Ponzi scheme. It will be less painful if we renegotiate our debts now than after bailing out Fannie and Freddie. "Attempting" to bail out Fannie/Freddie will still lead to our insolvency, but will be much more costly for the middle class. The outlook for inflation and the middle class is completely unknown. Once again we are only delaying the inevitable. The big difference is there have been very few arrests relative to the size of the theft. No jail No bail! It has been said that the pen is mightier than the sword; hopefully this is true today. We need to rally the troops. Prudent citizens and taxpayers of all sizes are being screwed big time. Crimes of biblical proportions have been committed and yet very few arrests. This needs to change NOW! No jail...No Bail. The answer should not be unlimited supply of funds to bail out the GSEs. Sign the following petition. http://market-ticker.denninger.net/ http://financialpetition.org/petition-bail.shtml Take a look at i-Tulips recent post to see where we could soon be headed. http://itulip.com/forums/showthread.php?p=41130#post41130 Permalink
Tobby at 07:55 2008-07-21 said:
Long before the housing bubble banks were complaining that the GSEs had an unfair advantage. That advantage of "presumed backing" has been well documented to have a value of 1/8% to 1/3% depending on the economy. Banks spent millions on lobbyists trying to get them to explicitly prohibit the backing of the GSEs. Now of course the banks are running to mama to buy their loans. The proponents of the bailout correctly point out that liquidity in the mortage market would disappear if the GSEs were allowed to fail. The answer is simple. Cut the old GSEs loose to sink or swim and start another GSE. Except this new one will have the explicit backing of the government. Of course all the loans would be properly underwritten and it would not buy any of the old garabage loans from the banks. This would ensure future liquidity and provide proper market based punishment for the investors in the old GSEs. PermalinkEquityHunter at 09:41 2008-07-21 said:
We need to come together. Just like John Lennon wrote. Now more than ever we need to send a message to "gov't". You guys are probably too young to ever have been involved with real PROTESTING. Out on the streets/off the internet. The gov't doesn't care about stupid internet sites! Get on the street! Organize. That's what get's real action. Meet your Neighbor in person, who you do not know, and discuss these subjects. Organize. Until we organize they will NOT take us seriously. You could have a million websites which don't mean squat! Nothing will change! And you Krowne are just looking to sell your "beautiful" site. You're a SHILL! You don't give a crap about this country. Grass Roots Trumps Internet Everyday. PermalinkAaron at 22:44 2008-07-21 said:
EquityHunter: I believe the bible says something about pointing out flaws when you have a "splinter" in your eye... You have some nerve with your high and mighty attitude. Your generation immediately went home from the "real" protesting, put on suits and ties, and got jobs being "financial shills". Not only were all the unsound trends left in place, but they accelerated, under your watch. You people sold your children down the river, and now we have to deal with it. You were the early-receivers of all the inflation and bubbles. We're the broke ones, most of us, forever. And now you're manifestly ANGRY that one of us might be making some money the hard way -- building up a business and selling it -- in a world you designed to make that impossible. Pathetic. As for the "real grassroots activism", the internet is the most powerful tool for that to come along in a century -- perhaps ever. We are building a new media -- a decentralized media -- because manipulation of information is where the problems begin and take root. And by the way, many of us HAVE been on the streets protesting. Don't see a lot of you all out there, though. Permalinkangryvoodoo at 01:58 2008-07-22 said:
nice AK, good handle. Why can't both be true anyway... he could make a buck without making a stink. Way to trash a man's life work! apathy is hard set. I have been out talking to people; they are too busy and their opinions are too different to get a street protest going anyway. people need to be led not consulted. sorry! tis true. I think its a shame... if people were more intelligent they would have properly invested off the bubble opportunities, and more people should have known not to get in... but everyone wants to be the next American Idol. I assert that these generations may be wasted. forget banking. I think it is time to address education. Personal Financial Responsibility 101 needs to be taught in schools, maybe then no matter what schemes are cooked up on 'the street' it won't take hold among citizens simply by appealing to the impulse-buy gland. Until people have nothing, there is no fixing banking because the vaccuum is ON and the mentality and habits are set. Abu Dhabi could refi our entire banking system and the same would inevitably occur in 10 years. PermalinkJustin at 02:15 2008-07-22 said:
Personal Financial Responsibility 101 needs to be taught in schools, maybe then no matter what schemes are cooked up on 'the street' it won't take hold among citizens simply by appealing to the impulse-buy gland.How do you teach responsibility in a public school that you don't pay for to attend? At base, our entire system shirks responsibility, pushing it back onto the government. Of course, this is what government wants, but the shift needs to be to reject government control/freebies and move back to personal responsibility in all aspects of life. No bailouts ... *anywhere*. Permalink
angryvoodoo at 02:25 2008-07-22 said:
that just speaks to its curruption doesnt it? that the gov would not want to teach such things because its real agenda is the kicks it makes from the companies that milk the consumer. However, if people were more educated regarding financial decisions (aka pay for this or that in cash because financing it does not make sense, or simply going without the new handbag / leather jacket / car du jour), the economy could scale back and we could have a strong dollar as people would be into saving. which means we wouldn't have a need for such a huge deficit (borrowing) and therefore remove the crutch of corporate kicks. who knows. it would be nice if it was a mandatory core. And yes, society @ large has become litigous and passing blame is the norm. I knew we would be in trouble when my Math building at college (42 rooms) had 2 rooms for Math and the others were POLI SCI! nothing changes if nothing changes eh Permalinkadd a comment | go to forum thread
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