Thursday, September 11, 2008

The case for "re-nationalizing" Fannie Mae and Freddy Mac

Contrarian economist extraordinaire Robert Kuttner is clearly at the top of his game right now; his writings and accomplishments in recent years as the head of non-profit think tank makes him a member in the small clique of progressive economics who helped create and manage two of the most important institutions the progressive movement has relied upon as a clearinghouse for new voices, independent news and the proffering of fresh opinions and perspective.

Continuing to stick closely to his academic fascination in how powerful political forces (and, of course, politicians) have in the past managed to be so successful in determining our nation's domestic, economic and (industrial) regulatory policy agendas.

This brings us to a blunt, unsentimental and yet timely and well-argued article Kuttner wrote for the Huffington Post two days ago entitled "Nationalize Fannie Mae? It Worked Until It Was Privatized"
When asked by journalists about the takeaway lessons imparted by his article, Kuttner discussed what he believed to be the crux of the policy issue:
In the past several days, before the U.S. Treasury Department acted to seize Fannie Mae and Freddie Mac, several people asked me if I thought it was a good idea for the government to "nationalize" the two mortgage giants. In virtually none of the coverage of the Bush administration's latest emergency action did anyone bother to tell the backstory. Fannie Mae, [previously known as] the Federal National Mortgage Association (FNMA), began life as a government invention. It was born "nationalized" -- and it worked beautifully until it was privatized.

Of historical note is that in reality, the FNMA was part of the New Deal's trinity of housing agencies -- the other two being the Home Owners Loan Corporation and the FHA agencies that Roosevelt formed in order to literally create the modern mortgage system. Before the New Deal, there were no long-term, self-amortizing mortgages. The loan was due and payable at the end of the term -- usually five years -- and if you couldn't persuade a bank or savings-and-loan to roll it over, you lost the house. After foreclosures exploded during the Depression, Roosevelt invented a whole new system. FNMA's job was to buy approved mortgages from banks, to replenish their working capital, so that they could make more mortgages. As the biggest buyer, FNMA also maintained standards.

The system worked like a fine watch. Home-ownership rates soared. Loan standards were generous but not stupid. Nobody in the home mortgage business got filthy rich, and mortgage lenders hardly ever went broke. The government's bank insurance funds regularly turned a profit. And here's a quaint, archaic concept: It operated in the public interest.

Then in 1968, as part of a general budget reform, government technocrats decided to get FNMA off the government's books. This was intended as a purely technical revision. It was tacitly understood that Fannie was to keep doing the same thing it always did -- buy mortgages from banks, turn them into securities, keep some and sell others, but maintain its standards and service to the public good.

It took about two decades for the wise guys to realize that there was big money to be made. And I am sorry to report that this was a bipartisan trough. In the Clinton era, many of the wise guys at FNMA were Democrats.

Criticism was limited to the Right and Left. Both the Wall Street Journal as well as (neo)libertarian think tanks regularly warned that Fannie was getting too big and too speculative for a self-regulating quasi-governmental financial institution with an implicit government guarantee. A few progressives like your faithful writer objected that FNMA's true purposes were being perverted and the system was being put at risk so that insiders could get very rich.

After 2000, Fannie also served to abet the subprime mess. For the most part, Fannie refused to buy the very worst subprime loans, but it was happy to buy so called "Alt-A" loans, which were a slightly milder version of the same abuse -- very risky loans with exorbitant interest costs (and profits) and almost nonexistent standards. Those loans are now going into default at almost the same rate as subprime loans.

Under private management, Fannie did a 180. It was perverted from a government-sponsored and well managed agency that served the public interest into a privatized casino whose big bets enriched a few insiders and then helped crash the entire system.

So now, the Bush administration is playing half-of-FDR. It is saving capitalism from itself as Roosevelt did -- but without getting serious about regulatory standards going forward. The taxpayers will bail out Fannie, but the rules for regulation of the mortgage system have yet to be written. That will await the next administration. And if the next administration is led by John McCain, the top financial guy is likely to be former Sen. Phil Gramm, the senate's biggest cheerleader for reckless deregulation.

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