This Could Get Very Ugly

by hilzoy

The news about Fannie Mae and Freddie Mac sounds terrifying to me:

"Shares of Fannie Mae and Freddie Mac, the beleaguered mortgage finance companies, plummeted again on Friday morning, as senior Bush administration officials consider a plan to have the government take over one or both of the companies and place them in a conservatorship if their problems worsen, according to people briefed about the plan.

Fannie Mae stock was down 36 percent in early trading compared with Thursday’s closing price; Freddie Mac stock was down 41 percent."

And that was after big previous losses. As of right now, Freddie Mac is down over 87% from a year ago; Fannie Mae is down over 85%.

The FT has a nice, short summary of the problem:

"As house prices have fallen and foreclosures have soared across the US, the two institutions have suffered deep losses, which they have tackled by raising more capital. Many observers believe that a collapse of Fannie Mae and Freddie Mac could bring the US mortgage market to a complete standstill, with severe repercussions for the financial sector and the economy as a whole.

Many investors in Fannie Mae and Freddie Mac have come to assume that the government would eventually come to their rescue because of their importance to the system. However, concern has risen recently that contingency plans for a government bail-out might involve wiping out public shareholders to minimise the cost to taxpayers, while confidence that senior debt would be protected has held up."

Bringing "the US mortgage market to a complete standstill" does not sound like a very good idea. What are the alternatives? One is a conservatorship:

"Under a conservatorship, the shares of Fannie and Freddie would be worth little or nothing, and any losses on mortgages they own or guarantee — which could be staggering — would be paid by taxpayers."

The shares that would be wiped out presently amount to about $18billion. But the liabilities we, the taxpayers, might have to assume are staggering:

"What Americans need to know is how damaging such a failure would be. This wouldn't merely be a matter of the Federal Reserve guaranteeing $29 billion in dodgy mortgage paper, a la Bear Stearns. Fannie and Freddie are among the largest financial companies in the world. Their liabilities – mortgage-backed securities (MBSs) and other debt – add up to some $5 trillion.

To put that in perspective, consider that total U.S. federal debt is about $9.5 trillion, compared to a total U.S. GDP of $14 trillion. About $5.3 trillion of that debt is held by the public (in the form of Treasury bonds and the like), while $4.2 trillion is intragovernment debt such as Social Security IOUs. This is the liability side of America's federal balance sheet, and its condition influences how much the government can borrow and at what rates.

The liabilities of Fan and Fred are currently not on this U.S. balance sheet. But one danger is a run on the debt of either company, putting pressure on the Treasury and Federal Reserve to publicly guarantee that debt to prevent a systemic financial collapse. In an instant, what has long been an implicit taxpayer guarantee for both companies would be made explicit – committing American taxpayers to honoring as much as $5 trillion in new liabilities. U.S. debt held by the public would more than double, and the national balance sheet would look very ugly."

$5 trillion dollars in liabilities is a staggering amount, even when you consider that not all many of the loans we would guarantee would not go bad*, and so we would almost certainly not be on the hook for the entire amount. But if Fannie and Freddie become insolvent, it would beat the alternative, which is, as best I can tell, more or less shutting down the market for mortgages.

***

Which leads me to an important point. Unlike Bear Stearns, Fannie and Freddie really are too big to fail. What this means, as far as I'm concerned, is that we need to take steps to ensure that they won't fail. This, to me, was one of the huge lessons of the S&L crisis (and, for that matter, of plain common sense): when the government is on the hook when things go bad, the government should take steps to ensure that things don't.

Mark Thoma quotes Robert Reich:

"Here we have another example of socialized capitalism. The executives of Fannie and Freddie have been among the best paid in all of corporate America. We're talking tens of millions a year in CEO pay alone. Fannie and Freddie are treated like giant investor-driven entities as long as they're healthy and their investors and executives are doing well. But when they start to go down the tubes they become public entities with public responsibilities, the rest of us have to bail them out."

And adds:

"If failure of these firms endangers the broader economy, and hence threatens to impose large costs on people who had nothing to do with creating the problems, then policymakers need to step in and do what they can to prevent a downward economic economic spiral. In addition, they need to change the rules and regulations that allowed the problem to emerge in the first place, and add new rules and regulations as needed to lower the moral hazard worries going forward."

Exactly.

(NB: it's worth noting that the housing bill, which the Senate is considering today, would do just this. Better late than never. But it should have been done years ago.)

Footnote: this originally read: not all the loans we guaranteed would go bad. I was trying to find some estimate of how many might, hoping that it would provide support for some phrase like "many loans would not go bad" -- though which phrase would depend on what I found.

Alas, I didn't find much, so I went with what seemed like the very noncommittal 'not all would go bad'. But after reading comments, I realized that while I was basically trying to stay away from making any strong claim, it read like a rather apocalyptic statement. Thus, the correction. And this note is mostly because I wanted to indicate what it had originally said: you can see that 'not all' has changed to 'many', but without this note, the insertion of 'not' wouldn't be clear.

Comments

[liberal japonicus]

Also, I didn't know that washingtonpost.com is completely separate from the newspaper. Why would I? How many people do? They certainly don't make much effort to tell us.

Though if I were them, I would, given that they have Ramesh Ponnuru setting up a discussion group here. It was linked to their front page, and the jaw dropping shamelessness of it all, even for one of the dimmest bulbs in that group, is really astonishing.

[Slartibartfast]

But what do you think, Slartibartfast?

Good question, but I think your assessment is fairly accurate. To add to it, though, I think that Republican voters are, for the most part, voting Republican because they oppose Democratic social policy, similar to the Democratic bracing against Republican policies we've seen described in this very thread. I include myself, historically at least, in "they", but there are lots like me. I won't make any attempt to estimate how many, but one only needs to read conservative pundits just a bit to see that most of Republican politics is about foiling Democratic policy.

Speaking only for myself, I passed the point where I'm willing to hold my nose and vote D, or simply abstain, in isolated cases, a few years ago. I'm not willing to vote D where the D choice is obviously worse than the R choice; there were a couple of examples two years ago. Other than those, the choice between Katherine Harris and Bill Nelson was, sad to say, not a difficult one to make.

[Anarch]

Sebastian: That is why I think it is perfectly ok to start from a position of fairly extreme skepticism when new spending is proposed

I agree, though (like Gary) I think we differ on where the lines should be drawn.

Gary Farber: I'd suggest that a) there is very little grass-roots power in the Republican Party, and if you've never looked into the highly top-down control structure of the Republican Party, you might want to, as I think that would answer a great deal of your question, and b) that most Republicans are ignorant of a.

You're missing the obvious one: c) they're being lied to. And its partner in crime, c') the degradation of both education and journalism has proceeded to the point where most are unaware of c).

[Gary Farber]

"You're being way too harsh here, Gary."

I didn't think I was being harsh at all. Just suggesting that people take care in attributions, is all. I wasn't criticizing anyone.

"Also, I didn't know that washingtonpost.com is completely separate from the newspaper. Why would I?"

Indeed. It's only if one is a commentator on news that it would be reasonable to expect someone to know how the business they're a commentator on works. There's no reason to expect anyone else to be paying attention.

People who engage in blogging about the media, on the other hand, should, I tend to think, have some clue as to what they're talking about. Mere readers, no.

"They certainly don't make much effort to tell us."

Actually, it's been written about in numerous columns in both the paper and the site, as well as by the ombudsmen, and so on, and short of putting up big banners on every page, I'm not sure what else they could do; but, as I agreed, there's no reason to expect ordinary readers to pay attention to this sort of thing.

Thanks for your last response, Slarti; I don't have anything to add, other than agreement, but I really appreciate what you said.

And similarly to Anarch's comment, about which I'd say that, sure, of course the Republican representatives and leader lie like crazy, and simply represent an endless numbers of lies, from many premises, to whose interests they work in, to many other aspects of their work; but it's easy to go from "you are being lied to" to being perceived as saying "and you are stupid for not realizing it," which doesn't tend to go over well with most anyone.

Oh, but Slart? "...most of Republican politics is about foiling Democratic policy."

There's a term for this, as it happens: it's called being a "reactionary."

It's significantly different from being a genuine conservative. As it happens, I'm quite conservative in a lot of my political beliefs: I actually do believe that government should be no bigger than necessary, that taxes should be no higher than necessary, that we shouldn't change basic structures of government without very good reason and much consideration and thought, that we should be cautious about any sorts of drastic changes, that we should always consider the possibilities of the Law of Unintended Consequences, and so on.

It's just that in a political landscape dominated by reactionarism, and ignorance, and deceit, those characteristics of my beliefs tend to be masked by the need to fight what dominates us, and so my inherent conservatism in many things isn't as obvious on the surface as it might be in another environment.

But it shows up in things like my strong doubts about eliminating the Electoral College, or my strong support for actual states' rights, or the way I flubbed getting the Iraq war right in 2003, when I more or less stayed on the fence, rather than realizing just how malevolent the Administration was, and how doomed to horror Iraq was with that endeavor.

I have a smattering of mildly "radical" beliefs: I tend to be fairly absolutist about seeing no reason for immigration barriers to exist, beyond not granting citizenship to serious criminals, and my beliefs on children's rights would be seen as radical by some, and so on, but, really, I'm by nature rather conservative, and that comes out in more than a few of my positions.

Mixed economy democratic socialism with regulated capitalism is by this point in political/economic history a pretty conservative system to support, I'd assert, as well, in that it's a system that we know how to make work reasonably well, as seen in Scandinavia, Canada, Europe, Israel, and much of the world, and which does a good job of staving off actual radical revolution, while preserving plenty of capitalism, and the ability of lots of people to get quite rich, an economy to grow significantly, and keeping most people relatively happy, rich and poor alike, after all. As I see it.

[Slartibartfast]

It's significantly different from being a genuine conservative.

We agree!

And, actually, my biggest issue with illegal immigration is not the immigration part but the illegal part. That, and the under-the-table nature of employing said illegals, and the illegally lower payscale, etc. I'd be relatively ok with making it all aboveboard, and having their employment status be aboveboard, and having them pay taxes and such. And there'd be the equalizing effect of it no longer being quite so advantageous to employ noncitizens, so the whole purported job-stealing effect would disappear.

In the best of worlds, anyway.

Aside: at age 47 (actually, this has been in the works for a few years, so it didn't just happen) I think I've finally gotten over the driving need to oppose liberal policies because, well, They Must Not Be Allowed To Win, Ever. That said, I'm still not 100% sure of which levers I'm going to pull, come November. I'm not crazy about McCain, but I'm also uncrazy about Obama.

The Obama-uncraziness has absolutely nothing to do with the fact that he's a closet Islamofascist, I swear.

WAY kidding, there.

Oh, and thanks for the rest of your last comment; it's nice to hear what's behind the scenes of your political viewpoint. And thanks too for reading what I said, and responding in kind, and kindly.

[Gary Farber]

"And thanks too for reading what I said, and responding in kind, and kindly."

Hugs all 'round! Cats and dogs living together!

There must be human sacrifice going on around here, somewhere.

I've got a bunch of libertarian views, as well. It's just that there's also a lot of other stuff that many libertarians believe that I don't. Mostly I'm just a boring wishy-washy liberal moderate, or moderate liberal, though on any kind of finer grain, I'm an issue-by-issue a la carte guy, who doesn't like any kind of prix fixe politics.

I'm not really a fan of labels; I simply bear with them as necessary shorthand in many circumstances, but I don't like them. Labels usually hinder more than they help, IMO.

I prefer to just talk specifics.

Of course, I only say that because I'm a communist.

[hilzoy]

I'm a bit like Gary in having conservative bits that are presently masked. I really think that the last decade or so has been so bizarre that it's hard to get a sense of how people would come off in more normal times. (Say, during the GHWBush administration.)

I tend to be very conservative (in the original, "conserving, be careful" sense) about things like wars: on this point, I completely buy the idea that hubris about what one can accomplish on purpose is dangerous. I'm less so about things that don't involve Great Big Destructive Changes -- e.g., I think we'll be able to handle gay marriage just fine. But on a lot of foreign policy, you could call me a mixture of caution about means, but concerned with morality (as opposed to just narrow self-interest) about ends -- though since I also think that in general, we advance our self-interest by doing the right thing, I don't normally have to choose between decency and selfishness.

I think that I might count as slightly conservative on domestic issues in the alternate world in which everyone took it for granted that there was a non-negligible set of problems best solved by collective action (often meaning government); that there is no particular reason to think, in general, that attempt to solve those problems via government must fail (and fail worse than leaving it all up to private actors who might, but often will not, have some reason to try to advance the public good); that designing good public policy is not impossible, but achievable through skill and dedication, like anything else; and that when we decide to undertake some policy, we should be willing to pay for it, via taxes.

I do not think that government is the solution to all of life's problems - I mean, I'm nowhere near that view - but these days, I think all it takes to count as a liberal is to think that sometimes -- maybe only rarely -- the right solution to a problem involves government action.

(I mean: if we didn't already have, say, laws saying you only get to drive on one side of the street, and someone proposed them, I honestly think most of the conservative blogosphere would just erupt in fevered opposition. Why not leave which side you drive on to individual choice? Or the market? Aren't we conceding a vital freedom here? Won't government just inevitably screw up the important choice between left and right? It will be just like the DMV, only -- well -- without the lines, or the building, or the bureaucrats, and while driving! And won't there be times when you just need to drive on the other side of the street? And who asked the government, anyways? Is this among Congress' enumerated powers? Etc., etc., etc. And imagine if someone proposed, for the first time, having the government run the armed forces...)

Also, that the US ought to be a lot fairer than it is, where "fair" doesn't mean e.g. socialist levelling, but the kind of fairness I talked about in the post on Double Standards, and the kind that's destroyed when poor kids are warehoused in schools that might as well have been designed to destroy their interest in any of the subjects taught, for good.

A whole lot of what passes for my liberalism, these days, just consists of saying: you know, it's not impossible that we, as a society, might try to solve (or in some cases: ameliorate) this problem (for various values of 'this problem'), and succeed. I mean, we've sent people to the moon, sequenced the genome, and so on: why on earth should it be impossible to find a way not to have kids routinely die in foster care, or manage to rebuild our bridges before they collapse?

[Slartibartfast]

I'm a bit like Gary in having conservative bits that are presently masked.

I know that about you, hilzoy, which is why I hesitated a bit to paste the "liberal" label on you, even though you might gladly and proudly paste it on yourself.

Not that I think there's anything wrong with that, just that I didn't think it told the entire story.

[russell]

It will be just like the DMV

A data point:

I doubt that I've spent more than 10 or 15 minutes at the DMV on any visit I've made there in the last 15 or so years. Used to be worse, but they got their act together.

The people are uniformly helpful and friendly. There's a lovely woman at a reception desk that asks you what you're there for, and then directs you to the proper person to help you. Often -- if it's something simple, like surrendering plates -- she takes care of it herself. You're in and out in 5 minutes.

In contrast, my wife and I have spent dozens if not hundreds of hours dealing with customer support organizations of various private companies in an effort to resolve any number of insanely trivial issues. Quite often, without ever finding a resolution.

When people tell me that government is always wasteful, bureaucratic, and unresponsive, and that the private sector always does a much better job of things, I find I have to choose between believing them or my own lying eyes.

Thanks -

[hilzoy]

russell: alas, my experiences of the DMV are all they say, and more.

Slarti: the thing is, what I said above is enough to make me a wild screaming liberal these days, especially given the fairness bit. I mean:

Thinking that we ought to be paying more or less what we're spending rather than accumulating debt for our kids, means that I think we should raise taxes. (I'm not a balanced budget fanatic; I think that now, in the midst of a recession would be a bad time to do this. But that, according to me, means that the next time the economy picks up, we should make up for it.)

This is all the more true since I also think that even as far as what most people would think of as totally normal governmental functions, like repairing bridges, we have several decades' worth of backlog to make up.

And then there are the things I think government ought to do that might actually be controversial. Health care, for instance: health care simply does not work according to a normal market model, and the only way to make it work according to one is to do away with insurance, leaving people to save up for that bypass operation they might need the way they now save up for retirement, only without Social Security or pensions.

Moreover, health insurance falls squarely under my 'stuff should be fair' rubric: while some people's bad health is their fault, most people's is not, and if there's a way of setting things up so that having the bad luck to have a chronic disease doesn't mean you have the further bad luck of dying for want of medical care, being unable to work, etc. It's exactly the sort of thing we should try to equalize, where equalizing does not mean some sort of bad levelling or homogenization, but rather everyone having the ability to do what they want to with their lives, in all its weird individuality, whether or not they're lucky about health.

Really, in the present environment, thinking that government action is one of many possible ways one might imagine solving some problem, as opposed to a way that faces a huge and unique burden of proof, puts me way off to the left.* Personally, I think this is silly: it is, according to me, everyone else who has gone way off to the right. But then, I would think that. ;)

* (Not that there aren't characteristic problems with government action, which need to be taken into account; but I think there are also characteristic problems of market solutions -- e.g., sometimes you need there to be a general set of rules (like for driving on the right, or pollution controls that set the limits within which market players can operate), and market solutions, being decentralized and disorganized, will often not be good for that. Decentralized decision-making by a host of independent actors: excellent in the software industry, very bad in constituting an army. They're just quite different ways of dealing with things, each with characteristic strengths and weaknesses, and the devil is always in the details.)