Thursday, September 25, 2008

Information about the bailout

As I stated before CRAFT typically sticks to education issues and local politics however this election and now the bailout will have a great impact on the economy and our taxes. A friend of ours wrote the piece below.


Dear Friends: I rarely send out an email on purely political matters, but I feel compelled to do so tonight. I’ve been listening to radio broadcasts of Nancy Pelosi constantly spewing her pro-regulation hogwash morning and night and I guess I’m totally sick of it. Too bad most people are ready to swallow this mush whole … namely her implicit notion that there are some extremely prescient people in government (no doubt herself included) who would have passed legislation that would have prevented this. How utterly preposterous. I find it interesting that despite their having enjoyed leadership of two Democrat-controlled houses of Congress for the past two years, Pelosi and regulation-happy friends must have managed to overlook this little matter. What a joke.

I have an apparently novel idea about what caused this mess. To explain it I must first ask you to guess who were the two biggest financial institution failures so far this year. Here are some possibilities:

Merrill Lynch
Bear Stearns
American International Group (AIG)
Lehman Brothers
Countrywide Financial

Thinking hard? Really hard? Well if you guessed any of the above, even AIG, you are not even close. You’re not even in the ballpark.

Now I’d like for you to read up on a “bank” called Fannie Mae. Here’s an excellent summary on Wikipedia: If you don’t have to read this all, let me extract some salient sentences for you:
Fannie Mae was founded as a government agency in 1938 as part of Franklin Delano Roosevelt's New Deal to provide liquidity to the mortgage market. For the next 30 years, Fannie Mae held a virtual monopoly on the secondary mortgage market in the United States.

Fannie Mae (and Freddie Mac) buy loans from mortgage originators, such as banks and non-bank mortgage firms. It repackages the loans, as mortgage backed securities, and sells them on the secondary mortgage market, with a guarantee that the interest and principal will be paid, whether or not the original borrower pays. Also, Fannie Mae may hold the purchased mortgages for its own portfolio. By purchasing the mortgages, Fannie Mae and Freddie Mac provide banks and other financial institutions with fresh money to make new loans. This gives the United States housing and credit markets flexibility and liquidity.[6].

OK got that? Now I’d like for you to look up another huge “bank”: Freddie Mac, at Once again I’ll provide excerpts for the time-stressed:

From 1938 to 1968, the secondary mortgage market in the United States was monopolized by the Federal National Mortgage Association (Fannie Mae), which was a government agency during that period. In 1968, to help balance the federal budget, part of Fannie Mae was converted to a private corporation. To provide competition in the secondary mortgage market, and to end Fannie Mae's monopoly, Congress chartered Freddie Mac as a private corporation.

The Financial Institutions Reform, Recovery, and Enforcement Act ("FIRREA") of 1989 revised and standardized the regulatory mechanisms for both Fannie Mae and Freddie Mac. Prior to that, Freddie Mac was owned by the Federal Home Loan Bank System and its member thrifts and governed by the Federal Home Loan Bank Board which was later reorganized into the Office of Thrift Supervision. FIRREA severed Freddie Mac's ties to the Federal Home Loan Bank System, created an 18-member board of directors to run Freddie Mac, and subjected it to HUD oversight.

Freddie Mac's primary method of making money is by charging a guarantee fee on loans that it has purchased and securitized into mortgage-backed security bonds. Investors, or purchasers of Freddie Mac MBS, are willing to let Freddie Mac keep this fee in exchange for assuming the credit risk, that is, Freddie Mac's guarantee that the principal and interest on the underlying loan will be paid back regardless of whether the borrower actually repays.

Alright let’s do a time line here:

Franklin Delano Roosevelt, the guy who brought us the New Deal (including Social Security) and whose policies probably extended the Great Depression for 10 years unnecessarily, created a government “bank” called Fannie Mae, whose purpose was to back financially irresponsible loans (i.e. loans that no private enterprise in its right mind would undertake).

In 1968 the federal government decided that we didn’t have enough of this, so it created Freddie Mac to help vastly increase the number of irresponsible loans by providing competition to Fannie Mae. Both of these “companies” were subject to the direct government supervision, regulation, and oversight by HUD (a federal agency).

Both Fannie Mae and Freddie Mac were in the business of vastly distorting the home mortgage market by making it far too easy to get money to buy houses. This was their charter, their stated purpose. They did this by functioning as a guarantor for investors who saw no risk in investing in the packaged mortgages that these two “government corporations” were offering. This in turn made enormously unnatural amounts of cash available for primary mortgage lenders (i.e. your local banks) to lend to irresponsible borrowers, at no apparent risk to either the local banks or the borrowers.

By 2008 these two “government corporations” together indirectly held half of all the residential mortgage debt in America. One could say that it was almost exclusively through the irresponsible policy of these two “corporations” that the current debacle was made possible at all.

If you would like some further data on this, please read this very interesting article written in 2005. It seems to me that if we are going to listen to anybody about this issue, we should be listening to people who understood the problem years ago (like this article’s author) and not to the jaw-flapping jokesters (both presidential candidates and our Speaker of the House included) who are now telling us about closing the barn door after all the horses have escaped, and the wrong door at that.

So to summarize:

The financial impact of the failure of Fannie Mae and Freddie Mac dwarfs all the other bank failures combined.

Fannie Mae and Freddie Mac were both federal-government-created entities that artificially inflated the demand for mortgages in a way that no consortium of privately-owned firms could even imagine doing.

True to the pattern of most government-run debacles, these “companies” caused enormous mis-investment and irresponsibility due entirely to the lack of accountability that is inherently built into almost all government agencies.

Now that the catastrophe is in full bloom, the supporters of these government-created monstrosities are running around blaming the supposed lack of private sector regulation.

So please, the next time some brain-drain tries to drill into your head the idea that markets don’t work (kinda like saying that the laws of physics don’t work) please think before accepting the argument as some sort of obvious truth backed up by current circumstances. This country hasn’t had anything resembling a free mortgage market since FDR’s reign of socialism, made worse by LBJ’s exacerbation of FDR’s policies in the late 60s. To lay this problem at the feet of our supposedly unregulated markets is like blaming Bigfoot. Sorry, there hasn’t been a free market in mortgages during the lifetimes of anyone reading this.

Nancy Pelosi, please take note.

Dave Ziffer
Batavia, IL

P.S. If you find this analysis interesting, please circulate it to your friends, politicians, and the press. Thank you.

Bush warned congress a number of times about impending failure congress choose to ignore his warning. Read about it in several places.

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