Moral Hazard Watch

Jesse Walker | September 7, 2008

The Associated Press's Alan Zibel (didn't he use to write for Saturday Night Live?) reports:

The Bush administration, acting to avert the potential for major financial turmoil, announced Sunday that the federal government was taking control of mortgage giants Fannie Mae and Freddie Mac.

Officials announced that the executives of both institutions had been replaced. Herb Allison, a former vice chairman of Merrill Lynch, was selected to head Fannie Mae, and David Moffett, a former vice chairman of US Bancorp, was picked to head Freddie Mac.

Treasury Secretary Henry Paulson says the actions were being taken because "Fannie Mae and Freddie Mac are so large and so interwoven in our financial system that a failure of either of them would cause great turmoil in our financial markets here at home and around the globe."...

Both companies were placed into a government conservatorship that will be run by the Federal Housing Finance Agency, the new agency created by Congress this summer to regulate Fannie and Freddie.

Philip Klein explained what was wrong with this idea back in July.

Comments

SIV|9.7.08 @ 2:31PM|#

Telling that neither campaign will attack the bailouts and the "public/private" arrangements that lead to these problems.

Adam|9.7.08 @ 2:38PM|#

Nor addressing the role of the government in creating these bubbles.

|9.7.08 @ 3:04PM|#

I haven't seen any argument yet explaining why this is the worst move they could have done. I suspect, given the situation, it may be one of the best moves, distasteful as that is to type.

Elemenope|9.7.08 @ 3:15PM|#

For once, I agree with SIV. They are being awfully quiet...one assumes in hopes that nobody will notice.

Kolohe|9.7.08 @ 3:20PM|#

I haven't seen any argument yet explaining why this is the worst move they could have done. I suspect, given the situation, it may be one of the best moves, distasteful as that is to type.

I tepidly agree.

My problem is that they should have done this 2 months ago - or at the very least halted trading in the common stock. Doing this now, after all the gyrations since July, makes it look like 'the fix has been in' as Kramer has said.

"If it were done when 'tis done, then 'twere well it were done quickly"

Jennifer|9.7.08 @ 3:27PM|#

I suspect, given the situation, it may be one of the best moves, distasteful as that is to type.

Because it's half-assed socialism: the profits remain in private hands, but losses are made public and covered by the taxpayers.

Plus it's based on two flawed assumptions: one, that a company which makes catastrophically stupid decisions should not suffer the economic consequences of its stupidity; and two, that it would be just awful if housing prices dropped, because God forbid Americans be able to afford to buy homes without taking on enormous quantities of debt.

A few years ago I was getting almost as many mortgage-loan offers in the mail as credit-card offers. I still had a heavy student-loan debtload back then, equal to nearly a year's pretax pay, yet banks were offering to loan me mortgages equivalent to nearly ten years of my pretax salary. Even had I not suffered subsequent job loss, there's no way in hell I could possibly have afforded to pay that money back, and any banker with an IQ higher than a brain-damaged earthworm should've been able to figure that out. Simple: "If you make X dollars a year AND owe nearly X dollars in student loans, you cannot afford an additional loan equal to X times 10."

So I rejected all those loan offers, because I had this idea that "It's bad to borrow money you can't afford to repay, and also bad to buy a house far more expensive than you can afford." Now who benefits from these bailouts? The banks who offered loans they knew they'd never see repaid, and the borrowers who borrowed money they could never repay.

Mike Laursen|9.7.08 @ 3:29PM|#

Other than vague handwaving about their being "so large and so interwoven in our financial system that a failure of either of them would cause great turmoil", what exactly would be expected to happen if the two companies simply started the normal bankruptcy process?

|9.7.08 @ 4:00PM|#

It was government intervention in the financial markets, which is now supposed to save the situation, that created this problem in the first place. Oh, how typical.

Those *gasp* evil financial institutions were "redlining", and not giving huge loans with ridiculously easy terms to the kind of people who can't even stay current on their utility bills.

So, naturally, those champions of liberty (read monopolists of force and coercion) stepped in with the Community Reinvestment Act, which forced lenders to to lend in neighborhoods where neither they nor the politicians would be caught dead just driving through.

Now comes the blowback, and the same government intervention that brought on this mongolian "cluster-f**k" is supposed to save the day.

Politics (to the surprise of few of us) is mostly about taking credit for something you did not do when it turns out well, and blaming others for things you did when they go awry. They only get away with this because we let them.

|9.7.08 @ 4:14PM|#

"Fannie Mae and Freddie Mac are so large and so interwoven in our financial system that a failure of either of them would cause great turmoil in our financial markets here at home and around the globe."...

How on Earth did the Justice department allow this monopoly to stand unchallenged?

Oh, yeah.

|9.7.08 @ 4:18PM|#

To the contrary, a lot of these shitty loans weren't made with CRA provisions. Those ones didn't help either, but a lot of these loans not getting paid back are things more along the lines of middle-class households that didn't have problems paying their bills. Then they saw people getting rich and decided to play the game with a second, third or more house.

But somewhere along the line people forgot that the rule was "buy low; sell high" and decided that the new rules were:

1: Buy high
2: ????
3: Profit!

Or maybe they all remembered the biggest rule of all, if it doesn't work out, declare bankruptcy and walk away. And the banks remembered the rule, if it doesn't work out stick it to the taxpayer and walk away.

|9.7.08 @ 4:42PM|#

Now who benefits from these bailouts? The banks who offered loans they knew they'd never see repaid, and the borrowers who borrowed money they could never repay.

Don't forget the firms that foolishly bought the bundled up loan packages. As I've been saying since this fiasco reared it's ugly head, fuck each and every one involved with a loan that cannot be repaid.

Shall we now discuss who doesn't benefit from this bailout?

Since you and I were prudent enough (stupid enough?) to live within our means and not make speculative investments, that would include us, wouldn't it?

|9.7.08 @ 5:06PM|#

Too many people watching celebrity reality shows and trying to live beyond their means

Jennifer|9.7.08 @ 5:34PM|#

Since you and I were prudent enough (stupid enough?) to live within our means and not make speculative investments, that would include us, wouldn't it?

Bingo. As things stand now, I personally would be in MUCH better financial shape had I chosen, a few years ago, to take on a monstrous debt which I knew damned well I could never pay back. And as an added bonus: I could rack up lots of sympathy points for being a helpless victim, too!

If the government had the ability to handle diseases the way it handles finances, virgins would be the only people to ever suffer from STDs, and cirrhosis would be exclusive to lifelong teetotalers.

toddb|9.7.08 @ 5:36PM|#

These are the kinds of stories that I just keep forwarding to my Republican friends with comments to the effect of "please remind me why Republican's are less socialist than Democrats..."

I never get responses.

Fluffy|9.7.08 @ 5:56PM|#

One thing that disturbs me about this bailout is its timing.

Fannie and Freddie were, frankly, muddling through. Speads for their debt had widened over treasuries, but not absurdly so. Both firms had recently done regularly scheduled debt offerings at decent terms.

So what's the rush?

Something tells me the rush is that Bush didn't want to take the chance on a crisis in October, as more of the agency debt started to roll over. Better to splurge with taxpayer funds now, to try to paper things over until November, to give McCain the best possible chance.

I have no doubt that an administration that wrote its Iraq war timetable with an eye towards mid term elections would write its Fannie/Freddie takeover timetable with an eye toward an upcoming Presidential election.

The Government|9.7.08 @ 6:01PM|#

"Jennifer, we've noticed that due to your lifelong habit of eating in moderation, you are slender enough to easily see your own feet. In order to solve the national obesity problem, we're going to use taxpayer-funded liposuction to remove 50 pounds of fat from the body of Rosie O'Donnell and inject it into your own ass."

Jennifer|9.7.08 @ 6:04PM|#

And now I must stop posting for the evening, because I have to literally work my ass off to cover my share of the government's "bail out the stupid and greedy" programs.

|9.7.08 @ 6:37PM|#

Wow! Do you think Dictator Bush and his regime FINALLY realize that everything is not as hunky dory as they thought it was? What a bunch of idiots.

JoshMan
www.anonymize.kr.tc

|9.7.08 @ 7:06PM|#

"I haven't seen any argument yet explaining why this is the worst move they could have done. I suspect, given the situation, it may be one of the best moves, distasteful as that is to type."

JD: This move is positive only in the short run (next year or two). This move will only serve to cause excessive risk taking during the next bubble, with the expectations that the government will bail out anyone who does not get out before the bubble pops.

SIV|9.7.08 @ 7:14PM|#

As to joe and others accusations that I'm a "Republican shill", if Barack Obama was making an issue of the weak dollar policy, railing against the Federal Reserve, demagoguing against Wall Street and calling our financial system rigged and proposing it return to free market principles I would be looking at his campaign quite a bit differently--even if I disagreed with the particular examples he gave.

|9.7.08 @ 7:57PM|#

The only way this can work rightly is if the shareholders are bought out for some predetermined asset value assessed on Fannie and Freddie. The shareholders get a one time payment of $0.30/share based on the value of mortgages held by Fannie and Freddie and told to go away. Then, the treasury dept (or federal reserve or other dept.) is given the task to lead the accountants still working at Fannie and Freddie to sort out the mortgages in a systematic way without fear of a run on the bank. Beyond that, Fannie and Freddie should be dissolved and the whole affair ended.

They won't do that though and we'll muddle along with some half-assed attempt at fairness that ends up screwing everyone over.

|9.7.08 @ 8:47PM|#

Interesting that this story comes out opening day of the the NFL. I almost didnt notice. I better go pickup another 3lb bag of Fritos before the price goes up.

jmd|9.7.08 @ 10:01PM|#

moral hazard doesn't apply to me. i didn't make any irresponsible loans. i didn't take out any irresponsible loans. i bought a house and always make my payments. now i'm supposed to suffer with higher mortgage rates just so we can teach the big lenders and stupid borrowers a lesson? screw that. the bailout will probably lower mortgage rates and allow me to refinance at acceptable terms. my share of the expense of the bailout will be far less than i will be able to save on my mortgage payments. so by all means, bail out freddie and fannie. it's not gonna cause me to be morally irresponsible.

T|9.7.08 @ 10:37PM|#

now i'm supposed to suffer with higher mortgage rates just so we can teach the big lenders and stupid borrowers a lesson?

No, if we let dumbasses go bankrupt, people with good credit are still a gold mine for lenders. The only way to attract business as the formerly stupid bank who loaned reprobates money is to give those with good credit good deals. Why would you refi at a worse rate? Why are your mortgage rates going to change because the irresponsible and feckless go broke? The only way to ensure you don't get screwed is to tell the morons to go pound sand and enjoy bankruptcy.

The Lounsbury|9.8.08 @ 8:48AM|#

Charming ideologues the lot of you, but in reality the Treasury proposition looks pretty reasonable.

As to what would happen if Freddie and Fannie "just went bankrupt" (normal bankruptcy? Which flavour), you'd have roughly 75pc of American mortgage lending evaporate overnight, a likely complete lock-up in mortgage backed securities trading (which despite simplistic comments are largely decent inventions), which all the implied liquidity shock to you financial system.

In short, you'd see your financial system collapse and fine Depression worthy of the 1930s. Esp. when the middle american banks that hold large amounts of GSE paper go bankrupt after their capital evaporates. Bloody amusing that.

But hey, what's more important, knee-jerk irrational hatred of Government as such, or a rational cost-benefit analysis?

In any case, the penalty rates being paid on the Super Preferred US Treasury equity injection (10pc) plus the current preferreds being wiped out (no dividend), plus dividend to your Government when and if payable, actually looks decent.

As for the timing, of course no matter when action is taking people whinge on and on, "oh why now?" Or "Why not earlier."

The reality is with the 150 odd basis point spreads on their debt issuances, and ongoing losses, both GSEs were on the way to failure burning through their capital cushion (partially effectively overstated in using tax assets, perfectly legit but utterly fictional in current circumstances) at an increasing rate. Especially when one looks at the accelerating defaults on the 2006-2007 portfolios. US Gov was probably fairly well-timed in taking action, and from the information available, seems to have done a structure that more or less wipes out current equity holders ability to profit from the rescue directly. Of course if they hang on, maybe they get an upside with the probable spin outs (assuming the GSEs are broken up into littler entities and privatised fully as they should be).

Bloody ideologues whankers.

|9.8.08 @ 9:58AM|#

In short, you'd see your financial system collapse and fine Depression worthy of the 1930s.

Fuck, you're a goddam genius! Now if we can just get the feds to take over the big three domestic auto manufacturers*, all will be well.

In short, you would see home purchase become more affordable, future risky borrowers denied loans and irresponsible people who created this fucking fiasco, reap the whirlwind. All of those properties ain't going anywhere.

*Oh wait, they're working towards that laudable goal as we speak.

Kreel Sarloo|9.8.08 @ 10:03AM|#

"Bloody ideologues whankers."

It might be early enough to start drinking where you are, but here on the East Coast of the USA it's only 10 am.

|9.8.08 @ 11:11AM|#

I'm guessing none of you has checked the price of Fannie stock this morning. Take a look and come back to me with an explanation of how the shareholders were bailed out.

Mike Laursen|9.8.08 @ 12:02PM|#

In short, you'd see your financial system collapse and fine Depression worthy of the 1930s.

The two things you described don't sound like complete financial system collapse to me. There would still be 25% of current mortgage lending, in a system widely acknowledged as making too many mortgages. And you described the elimination of mortgage-backed securities trading only, but not all of the many other things that are traded.

Why the two things you mentioned so vital to our many-faceted economy compared to, say, trading in commodities or trading of industrial or service-based business securities?

|9.8.08 @ 1:41PM|#

How exactly does the government go about "taking over" these entities? If they are privately owned, publicly traded, does that mean the government is exercising eminent domain over a controlling number of shares?

Mike Laursen|9.8.08 @ 2:10PM|#

Freddie Mac and Fannie Mae were chartered from their beginning as "government sponsored enterprises". It probably says in their charters that the government can put them into conservatorship at will. Does anybody know?