Moral Hazard Be Damned! Fed Takes Over Fannie & Freddie

I can’t let the Federal take-over of Fannie Mae and Freddie Mac pass without comment.  The federal government has now crossed a new threshold of fiscal irresponsibility, making a quantum leap from its old paradigm of pretending that one day we’ll balance the budget and pay down the national debt, to a new paradigm of doling out mortgage money with reckless abandon, not caring if and when it ever gets it back because it’s the taxpayers who will be on the hook.  Our national debt has jumped overnight from $10 trillion to $15 trillion. 

Last night, Treasury Undersecretary Ryan was interviewed on PBS’ Newshour with Jim Lehrer.  He was asked whether the federal government would operate these companies now with the well-being of the taxpayers in mind, or whether it would loosen lending standards even further in order to carry out its mandate of stoking the economy with mortgage money.  He squirmed a little and tried to take the tack that, now that the government has restored investor confidence, Fannie and Freddie will have no problem pouring money back into the mortgage market.  When asked whether the government has created a “moral hazard” problem (giving investors the perception that the government will always bail them out), he replied that, since stockholders took a big hit and since the CEO’s were fired, the moral hazard issue was adequately addressed. 

But bondholders were bailed out.  Why?  I think it’s obvious.  Bonds are the mechanism the government uses to fund its deficit spending.  It doesn’t dare risk investors getting even an inkling that their bond investments may ultimately be defaulted upon by the federal government.  Wiping out the bond investors of Fannie and Freddie would have done exactly that.  It would have sent the message that the U.S. government can’t be relied upon to pay its debts.  That would result in a rapid melt-down of the whole global economy. 

The root cause of all of this is quite clear.  The trade deficit has drained so much money from the economy that there is nothing left.  The only way to keep the economy running is to print boat loads of money and pass it out to everyone in the form of “loans,” which the government knows full well will never be repaid.  Not to worry!  We’ll just print more to replace it!  Sure, this will continue to drive down the dollar and stoke inflation.  But we have an answer for that, too!  We’ll print even more money!

Well, it isn’t going to work.  The reason Fannie and Freddie failed so quickly, only weeks after Congress was reassured by Bernanke that they had plenty of money, was because their source of “capital,” our foreign creditors, have gotten wise to our financial problems and were no longer willing to pour money down a rat hole.  This will only accelerate the issuing of bonds by the Fed, and it won’t be long before they grow leery of those as well.  The sell-off of America will now accelerate dramatically, but will take an ominous turn as our foreign creditors shun our bonds and start demanding hard assets – anything and everything, including federal land.  With all of this will come more foreign control. 

It’s so sad to see what’s become of this country.  I thought that things were bad in 1979, following the Vietnam War, Watergate and the Iran hostage crisis.  For those too young to remember, that was a really bad time for Americans.  It was probably the worst we’d felt since the Great Depression.  Well, today’s climate is even worse and I’m beginning to think that my prediction of only a recession was too optimistic.  I think there’s a good chance that a full-blown depression is on the way.  Only a world war and a lot of government spending pulled us out of the last one.  This time, it’s the trade deficit and government spending that will start it.  This time, there may be no escape.

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5 Responses to Moral Hazard Be Damned! Fed Takes Over Fannie & Freddie

  1. nextgen08 says:

    Great post! I couldn’t agree more. If the government wanted to “help” in this situation, they would have been better off breaking Freddy and Fannie into smaller pieces, then at least all our eggs weren’t in one basket.

    I can’t imagine how this will work out. If these companies start to turn a profit again, does the U.S. government put that money into the treasury? I doubt it. If they do poorly, they would most assuredly take money from the U.S. treasury.

    What mess. Thanks again for the post. I hope to hear more from you in the future.

    Jerame Clough
    -Next Gen Politics

  2. Pete Murphy says:

    I doubt that Freddie and Fannie will ever turn a profit, because that’s not their mandate. Unlike private banks and lenders, they have no interest in making a profit. Their mandate from Congress is to prime the mortgage market. That’s what I find so disturbing about this whole thing: the corrosive effect it’ll have on the profit motivation of companies. Profit motivation forces companies to operate in a fiscally responsible manner. Remove that motivation and the efficiency of American companies will be systematically destroyed.

  3. Uh-oh Pete, you are starting to sound nearly as cynical as the King of Simple. LOL

    I also wrote two articles on Fannie and Freddie that mirrored your concerns. I wrote an article today about Japan that you may find interesting.

    You are quite correct about saving the bond holders who are mainly foreign governments and letting the stock holders take their lumps. Firing the two CEOs was only mutually agreed window dressing as they are leaving with some $24 million in severance, hardly a tough way to end a career.

    The elevated pace of the failure in our system is simply the exponential function of our flawed mathematical basis gaining ground. This economy failed around 1970 and the acceleration of the exponent will continue to gain speed from now until the end of sustainability.

    The sad part is that the U.S. and Canada could be saved, but not under our current systems.

    Good article Pete, I could feel the fire.

  4. Pete Murphy says:

    Mike, what’s your prediction for when the “end of sustainability” arrives? Personally, I think we’re getting close. The U.S. has clearly been bankrupted and the rest of the world is getting uneasy about our ability to redeem their bonds. The Fed is struggling mightily to keep things from getting totally out of hand. To me, this all says that the end of the line may be drawing close.

  5. Pete,
    I don’t have a crystal ball and I’m not even on a first name basis with the wizard, however, I believe that this is the last hoorah for the Middle Class.

    I did a comparison of the growth in both personal and public debt since 1980 as compared to wage growth. Debt has risen by some 1200% while wages have risen less than 300% on average.

    Mathematically, this is a phenomenon that cannot continue unabated without catastrophic results. Our government refuses to recognize the imbalance in our system that began in 1970, as can be seen here http://mikefolkerth.com/2008/09/04/growth-debt-and-demise/

    The practice of microeconomics is clearly in control of our leadership.

    From a time standpoint, we are involved in a long slow train wreck. The cars carrying Fannie and Freddie just derailed. Government continues to push the time of reckoning out by artificial means and remains supportive of growth as the magic elixir to heal our ills. Nothing could be further than the truth.

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