Bush Administration Social Democracy: Smart or Dumb?

There are stupid ways to run a modern economy. And there are smart ways. Nearly everyone with a clue has long agreed that the short-term money market--the supply and demand of liquid assets--has to be a government-controlled market rather than a free market. Now the debate is over what to do with the long-term finance market for housing. It appears that Treasury Secretary Henry Paulson is weighing in on the side of nationalization:

Chris Bowers: Mortgage Industry Nationalized: I'm not versed enough in economics to know if this technically qualifies as the nationalization of a major financial sector, but it sure sounds like it.... The problem I have with this is not the move to nationalize the mortgage industry. That actually seems like a good idea to me. The problem I have is with the incredible cognitive dissonance surrounding "big government" in our national political discourse. Even as we have reached national consensus on nationalizing industries, which is the literal definition of socialism and big government, politicians of every party keep talking about "small government" as though it were a virtue. I mean, the day after the Republican convention, which included countless attacks on big government, the Republican administration goes out an nationalizes a major industry. It will probably be done in the typical corporate welfare style typical of American government--privatize the profits, socialize the risk--but it is still nationalization.

Voters, Democrats, Republicans, Independents, Conservatives, Moderates, Progressives, Greens--everyone is in favor of "big government" moves like nationalizing the mortgage industry now. And yet, all of those same people keep talking about how terrible big government is, and how we need to stop it. It is massive national lie. It is as though the entire country is a homophobe who is actually a closeted homosexual. It is as though the Emperor has no clothes, but now the entire nation has decided to dress to match.

Can we all stop lying to ourselves on this one? Please? Pretty please? This national self-delusion is a major obstacle to having an honest ideological debate in this country.

I don't see the necessity for nationalizing Fannie and Freddie right now. They both are still cash-flow positive, right? If they fail to rollover their bonds and become cash-flow negative, the Treasury can finance them with preferred plus warrants, right? There is an argument to be made on the side of equity for expropriating the common shareholders--they and their predecessors have made fortunes in the past by playing off of their quasi-public status, and that wealth properly belongs to the taxpayers.

I clearly need to think a lot more about this. My prior is the Laura Tyson position that the business of guaranteeing and packaging conforming mortgages is properly a public function, and that Fannie Mae as Charlie Schultze and company created it in the late 1960s is an unfortunate human-animal hybrid, as George W. Bush would say. But my opinion isn't a particularly informed one.

Comments

[amy]

The reason you are puzzled is that you are not understanding what the end game is. It is not to nationalize these entities. It is to carve them up and sell them in pieces to the private sector and completely privatize the mortgage industry.

[amy]

what i am trying to say, however inartfully, is that this is less to do with what makes sense (or is warranted) economically, and far more about what makes sense ideologically, and what furthers the raid on American private and public wealth, which includes not only the shareholders, but the taxpayers.

[save_the_rustbelt]

Don't Fannie and Freddie have largely the same bad management and dull boards of directors they had last year?

Reason enough to fix the mess.

Next step - design something new -- private, public/private, public, to replace these blazing hulks.

[Phil P]

This is what's going on: The legislation proposed by Paulson, which Congress passed, was designed to make it easier for the GSEs to raise equity capital by promising that the government wouldn't let them go bankrupt - it would inject capital itself if necessary. But investors believed that if the government did bail the GSEs out it would wipe out the common shareholders, and perhaps even the preferred shareholders. (A couple of weeks ago Bill Gross said the companies were already effectively priced at zero - at $3 or 4$ a share they were perpetual options with a strike price of zero). Why they didn't anticipate this I don't know. Their most recent short-term debt auction didn't go too well either. Meanwhile on Friday Bill Gross comes on CNBC and says he's not buying Fannie and Freddie's debt anymore. So the handwriting's on the wall; might as well do it sooner rather than later.

[Ken Houghton]

So they're leaving the equity holders intact--most of whom are those Directors mentioned above--and making certain the cost will be higher in the long-term.

Once again, the Bush administration f*cks over the next President's attempt to solve the mess. Otoh, they hate both candidates, so they don't care.

And--especially if next week means Tom Paxton has to update "I'm Changing My Name to Chrysler" to include Ford and GM--"free-market capitalism" takes its place firmly and finally along with Santa Claus, the Easter Bunny, "I gave at the office," and "I won't *** in your mouth" as the lies we tell the naive.

[Ragout]

From the Bush administrations point of view, this is a great opportunity to help out their friends in the financial industry. At the very least, by nationalizing and then auctioning off the GSEs they eliminate the competition for the big investment banks. Better yet, they may be able to sell them off at artificially low prices to their buddies. It's just like their previous attempts to privatize social security.

[MobiusKlein]

>posted in wrong thread first, sorry<

I found a quote in the AP article http://www.sfgate.com/cgi-bin/article.cgi?f=/n/a/2008/09/07/financial/f082013D47.DTL&tsp=1 saying
'The Federal Reserve and ... said in a joint statement Sunday that "a limited number of smaller institutions" have significant holdings of common or preferred stock shares in Fannie and Freddie, and that regulators were "prepared to work with these institutions to develop capital-restoration plans."'

by "capital-restoration", do they mean some of the shareholders will get money, others not? That certainly sounds like privatizing the profits to me.

[John(2)]

For all those conservatives who think this is going to result in the privatization of F/F think again. Whatever has happened the fact is these two are essential to greasing the wheels of the US housing market. To some extent this is a holding operation intended to deal with overseas concerns about the quality of their paper and to ensure that the retail mortgage market doesn't freeze up. Ultimately the odds are these two will have to be fully nationalized, their status returning to that of FANNIE before 1968 and their obligations taken on the national balance sheet. That means raising the public debt ceiling another five trillion or so and since Bush has already doubled it he didn't want to leave office having tripled it. Putting all this on one side this is a huge event. In the short term it's going to help stabilize mortgage rates, but make no mistake about it the US taxpayers have just taken over a five trillion dollar enterprise. At the end of the day there was no alternative and in that sense it's good public policy.

[Walt French]

From Secretary Paulson: "...in 2010 their portfolios will begin to be gradually reduced ... eventually stabilizing at a lower, less risky size."

So, either he's expecting a mortgage market MUCH smaller than today's, or privatization will result. Who will pick up the slack? You'd have to believe we will have many PNMAs, which would not be viable without government backing / insurance, no?

This nightmare would still have happened with 50 different, competitive private firms and in fact it might well have been worse, because individual firms would be jostling for market share to be profitable, and carve capital to the bone in order to leverage up their earnings.

Individually, it'd be pretty bad if a single one of these failed, but a widespread mortgage problem like today's would take down a fair fraction of them, and we'd have dozens of workouts / takeovers after the Management and Boards had paid out as much to themselves as they could.

So my question is: how much will these institutions pay for the privelege of being Too Big To Fail? At least with FDIC, there are theoretically premia paid based on risk levels, even if it appears that our current policy has been to assess those at way below loss expectations.