Fannie, Freddie, and full faith

I don’t exactly disagree with what Tim Duy, Calculated Risk, and Dean Baker are saying about the decision to explicitly back Fannie and Freddie. But I think it adds to our understanding if you think of Fannie and Freddie as being, in effect, in the same business as the Fed these days.

That is, if you think about what the Fed is doing when it engages in “quantitative easing” — expanding its balance sheet by buying unconventional assets — you realize that it’s part of a broader provision of credit to the private sector by governmental or quasi-governmental agencies, which are ultimately financed or at least backstopped by public debt.

Why do this? Part of what depressed the economy during the financial crisis was a widening spread between government debt and private borrowing costs — not just in things like the TED spread, but also in mortgage rates:

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This spread was narrowed thanks to a combination of Fed actions and the expansion of Fannie-Freddie lending.

And the administration very much wants to keep this kind of intervention going. You can argue that some other policy — inflation targeting by the Fed, expanded fiscal stimulus, whatever — would be better. But none of these things seem politically possible. Keeping Fannie and Freddie fully engaged in the mortgage-support business is one of the few tools available to prop up a still very weak economy. And so they’re doing it.

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robob18 December 29, 2009 · 8:52 am

There is every indication that were another economic plan possible and legislated, it would never be staffed or managed, since some Senator from the opposing party would block the President’s nominee no matter how serious the position was to economic security or welfare of the populace.

Of course, then if something does go wrong at the agency where the Senator was blocking the nominee, then the Senator could sanctimoniously bray about incompetence even though they had been acting to subvert the legitimate political process of staffing a federal agency to protect Americans.

So then it would be a win-win-win for the opposition party, all the more so if helped along by an ex-official throwing rocks at the incoming administration and ankle-biting about safety issues his party exacerbated in the Senate.

All power to the current federal agencies who can act despite the Senate.

Anon23 December 29, 2009 · 9:10 am

robob18,

Your scenario only works because it seems like nobody is willing to call liar, even when someone is very obviously lying. The whole thing is doubly stupid since the fringe conservatives have been demonizing Democrats on national platforms for decades.

Anthony December 29, 2009 · 9:24 am

You might have a Nobel in Economics, but I don’t think I’d ever want you running a business for me….

skeptonomist December 29, 2009 · 9:27 am

“This spread was narrowed thanks to a combination of Fed actions and the expansion of Fannie-Freddie lending.”

For Paul and many other economists, sequence in time apparently proves causation (post hoc ergo propter hoc). The Fed does something, the world does not come to an end, therefore the Fed saved the world (again).

Paul’s attitude that the Fed can do no wrong is also embodied in the application of Taylor’s rule to interest-rate policy. What should the interest rate be? Just what past Fed policy has dictated, according to Taylor’s rule.

J.H. December 29, 2009 · 9:47 am

When I saw the news story about the Treasury giving them unlimited credit I figured they’d be a dumping ground for more “assets”-slush fund style.

And look no oversight as I understand it, plus you notice the big fat +$6 million dollar bonuses the Exec’s got to play along.

Why can’t I get in on this deal? I can fail just as big as anyone else.

America is a country that punishes the honest successful people and rewards dishonest people who are gigantic failures.

If you want to make BIG money in America you can’t just be a failure, you must be a failure of historic proportions-then you are rewarded with obscene amounts of money.

Oh, the insanity, the insanity.

Anon December 29, 2009 · 10:19 am

Practically speaking, what this boils down to is Frannie performing a covert bailout of banks by paying par for impaired assets, then making principal reductions at public expense.

I must’ve missed that day in civics where we learned how spending bills originate in the executive branch.

PatR December 29, 2009 · 10:56 am

But the problem is that doing this perpetuates our over-investment in too many big houses smothered in granite. We criticize the Chinese (correctly) for failing to revalue the yuan, yet we continue to pour far too much money into housing.

We need to take some responsibility and make some changes also, and pouring many hundreds of billions into housing isn’t the right change.

Hephaestus December 29, 2009 · 11:01 am

The Fed is run like a nonprofit, surrendering its yearend surpluses to the general fund. Independence means Bernanke will have room to redesign his institution to apply the purpose for which it was intended, using the right acknowledge new circumstances despite any reactionary misguidance from absentees, whether legislators or shareholders. Now or ever, the purpose of any such institution should not be so controversial: to offset credit cycle shocks, not participate in them.

That Fannie & Freddie reduce risk premia on mortgage products is not controversial. The mode of governance for QGEs is the central matter. Especially those with such direct involvement in credit issue. Could Fannie & Freddie fulfill their purpose without shareholders? I think so. And particularly so, when guarantees are made this explicitly.

Dan Nile December 29, 2009 · 11:21 am

Doesn’t this mean that the US will be forced to put the GSE debt onto the balance sheet?

There is a very big difference between the Fed and the GSEs–the Fed will protect its own solvency, whereas this move looks like the GSEs will serve as the SuperSIV dumping ground for banks to dump their bad assets onto the taxpayer.

Jose Padilla December 29, 2009 · 11:27 am

Isn’t the real question: How much are they paying for these mortgages? Are they simply bailing out the banks by buying their bad debt at full prices?

Don the libertarian Democrat December 29, 2009 · 11:33 am

We’d already done this when we bailed out Citi and the policy became “No More Lehmans” in order to stop the possibility of Debt-deflation. What we need to get rid of are the “Implicit Guarantees” which Investors know are there and invest based on them, while others fool themselves into believing that they don’t exist or need not be honored.

Paul_s December 29, 2009 · 12:37 pm

If this move is intended as stimulus, it’s working for at least one household. We refinanced with an FHA loan and it let us keep our house. Better yet, we’re now on a track to actually OWN that house, unlike the “interest-only” garbage we foolishly bought in the first place.

Lloyd Little December 29, 2009 · 12:47 pm

I must disagree with the comment left on the first comment left on this post. It continues the understanding that the President is doing his best given a Republican Party that just won’t play nice, etc…

This isn’t news. In fact, the election was a two year battle fighting exactly against the Republican Party’s insistence that ruining this country was how they preferred to operate. And the American People decidedly rejected such an attitude with majorities in all elective branches at the Federal level. The American People decidedly rejected the divisiveness that ruined our reputation, wrecked our economy, damaged the lives of thousands of citizens, and put at risk innocents from other countries far away.

Yet, this Administration’s leadership has not followed up on the energy willing to move us away from this incredibly perilous course.

That needs to be kept in mind whenever understanding where we are is attempted.

It needs to be kept in mind that this Administration has not lead at the proper time – can you say Anzio? While instead it has played politics far too often at best.

Thanks!

MTM December 29, 2009 · 12:50 pm

So…..Fannie and Freddie will continue to incur hundreds of billions of dollars in losses, pay their respective CEO’s several million dollars a year( in cash no less) and the taxpayers get to “foot the bill?” Gee… what’s not to like?

The bigger question is this…what is so bad about lower housing prices? We don’t complain when the prices of other items such as computers or cars come down.

Perhaps it is because there is a misguided govt policy trying desperately to prop up home prices at any cost for a variety of reasons. No free lunch though.
Renters should be rioting in the streets….

This will dragthe problem out for a long time.
govt’s answer to everything is simply “kick the can down the road”, cross their fingers and hope it gets better.
In addition, speculators now understand that the “fix is in” in that govt forces are trying to support a bottom in housing
Speculation will continue!.

Might as well do FHA all day long if you are buying a home in that it is essentially an option on the housing market. Put 3.5% down and walk away if the housing prices drop and cash in if prices rise.
What a country! Everybody wins and everythin is free!

Claremont December 29, 2009 · 1:04 pm

I wish the Fed and Treasury good luck in trying to reinflate the housing bubble. They will certainly need it.

strainer December 29, 2009 · 1:07 pm

The US government has thrown around such a large amount of money at the problems that it has temporarily stabilized the economic system. But I think that based on the explosion of govt borrowing all fiat currencies are going to come into question in the next couple of years, and that’s why I think one of the only safe assets to own is gold. That’s the reason I believe gold is one of the best asset classes to invest in currently given its safe haven status and that it is denominated in dollars. And here is a very interesting article on these issues Canada Gold Investing 101 on the top left of the page, which analyzes the relationship between the gold price, the dollar, and gold mining companies as a result of the Federal Reserve’s money printing and micromanagement of the credit markets.

save_the_rustbelt December 29, 2009 · 1:19 pm

So should the execs at Fannie and Freddie get the same pay as the Chair of the Fed?

Or should the chair of the Fed get $6M a year.

alibeamish December 29, 2009 · 1:20 pm

not politically possible:
The new all purpose excuse of Democrats .
FDR did alot of politically impossible things. Civil rights legislation was politically impossible too.
Young people are turning to right wing politicians and libertarians because they seem to believe in fighting for something.

John F. McGowan December 29, 2009 · 1:54 pm

I think the concern is that this is part of a hidden subsidy and bailout for the major banks in which Fannie Mae and Freddie Mac are used to purchase mortgage backed securities or mortgages issued by the “private sector”, mostly meaning giant politically connected banks, at the inflated housing bubble values. Then, Fannie Mae, Freddie Mac, and ultimately the ordinary taxpayer will take the loss.

Dean Baker in particular has written op-eds and reports since the peak of the bubble (around 2005) warning and worrying that Wall Street would dump the bad loans and mortgage backed securities on Fannie Mae and Freddie Mac.

It is worth understanding that conservative, libertarian, and business sources are following their standard playbook tactic of blaming the government when policies initially labeled as “free market” fail catastrophically. In particular, they blame the Federal Reserve, Fannie Mae and Freddie Mac, and the Community Reinvestment Act (CRA) for the current financial fiasco, as absurd as this seems to many, especially on the left.

See. for example, Johan Norberg’s recent book “Financial Fiasco: How America’s Infatuation with Home Ownership and Easy Money Created the Economic Crisis” from the Cato Institute; this book, which is only one of many spewing forth from conservative, libertarian, and business sources, contains an extensive presentation of dozens of government scapegoats for the fiasco.

If the bad mortgage backed securities and/or mortgages are off-loaded on Fannie Mae and Freddie Mac, the subsequent bankruptcy of the two government sponsored enterprises (GSE)’s will seem to confirm the Fannie Mae/Freddie Mac scapegoat heavily promoted by conservative, libertarian, and business sources.

The government has always had, and continues to have, other options to support the economy, both through monetary and fiscal policy moves, other than paying hundreds of billions or trillions of dollars for over-valued mortgage backed securities and/or mortgages.

John

Vox Day December 29, 2009 · 3:35 pm

Dr. Krugman, I fear you’re going to regret implicitly endorsing this covert expansion of the GSE bailout even more than you now regret your historical call for a Fed-created housing bubble.

If you simply would take the time to read Austrian School theory, then you would recognize that this is simply a transparent mechanism to attempt staving off the inevitable debt-deflation. And more importantly, you would understand that this attempt is doomed to failure.

capricorn December 29, 2009 · 5:47 pm

Prof. Krugman, Thanks for a perspective with a little more objectivity than most of the hip-shooters who comment on the economy these days.

BUT this too misses the key points.

Here we are, sticking yet another finger in the Dyke.

Our core problems are 1) that we allowed and encouraged our consumption to far exceed our production, and 2) that we assumed that speculative manipulation could replace real productivity.

The Obama economics team seem to think that the real economy will heal itself. But each additional Taxpayer bailout just weighs the already over-burdened real economy down further.

We urgently need a new policy direction, one that gets the real economy back on its feet, and boosts US productivity to the level where we can cover our past excesses.

Such stop-gap measures as more support for Fannie & Freddie only make sense if we also tackle the real, underlying problems. And the Administration is NOT doing that!

T. Sheppard December 29, 2009 · 11:11 pm

Mr. Krugman this post is right on the money, bravo!

All of you grumbling here about the salaries of the Fannie and Freddie execs are missing the point. Yes maybe they are a little on the high side, but consider this: Right now Fannie and Freddie are buying 80% of the mortgage paper being issued in this country. 80% sports fans. That is 8 out of every 10 mortgages for those of you who attended ivy leauge schools!

The housing market is slowly in recovery, with the economy to only be benefitted by that. Say you whack Fannie and Freddie and they all of the sudden stop buying mortgage paper.

Who is going to buy that paper? Well private investors will, but at what price? What interest rate will it take on mortgages to get private investors to pick up the the slack? Anyone want to guess? 6%, 7%, 8%, 9% 10% Not even wise old Mr. Krugman knows and no one wants to find out. Not in 2010 that is for certain. Just ask your friendly local realtor or mortgage banker what happens to home prices and the volume of home sales when the interest rate on mortgages takes a jump.

Did we forget that the initial wave of defaults in sub-prime mortgages was set off by a jump in rates that spiked payments on all those ARM mortgages back in 2006 and set this whole mess in motion.

Of course we need not continue policies that create another bubble and eventually the Obama team will wean the market off of Fannie and Freddie crack, maybe. I don’t think anyone wants to try to go cold turkey right now. Same reason why the homebuyer tax credit was extended.

The feds have got to see some real indications that the housing market has stabilized and as of yet in many places it has not.

We have got to keep policies in place that allow people to be in a postion to have the opportunity to sell their home and get out at least even or maybe a little down, because if not people will continue to walk away from those homes and the banks will have to foreclose and on and on it will go for years and years.

Right now the mortgages that are being written are excellent paper, so Fannie and Freddie are now purchasing good debt. Debt that will be repaid. Trust me I am involved in the real estate business and the people buying homes now are very solid with excellent credit and attitude about home ownership. Much different than in 2004 and 2005 when anyone drawing breath could get a loan to buy a house.

I think Obama understands that and for that I give him credit and heck I am a middle america republican!

michael pettengill December 30, 2009 · 12:54 am

At least Freddie and Fannie are providing loans to the people rather than screwing them as described in
//www.nytimes.com/2009/12/24/business/24trading.html?em=&pagewanted=all

“The simultaneous selling of securities to customers and shorting them because they believed they were going to default is the most cynical use of credit information that I have ever seen,” said Sylvain R. Raynes, an expert in structured finance at R & R Consulting in New York. “When you buy protection against an event that you have a hand in causing, you are buying fire insurance on someone else’s house and then committing arson.”

daniel December 30, 2009 · 3:38 am

Paul,

Isn’t it politically impossible in part BECAUSE of the Fed’s actions. The Fed is allowing the public to misunderstand the gravity of the situation and the importance of deficit spending.

The balance budget fetish has harmed us for 15 years. Go back to the Clinton Administration. If we had recognized then that there were investments that the government needed to make and only the government would make in the face of a fast changing economy, then perhaps money that went into the stock market would have funded more targeted spending, and instead of the useless bubble, we might have prepared our country for the changes to be wrought by immigration and outsourcing.

John December 30, 2009 · 4:22 am

Unfortunately, forcing mortgage rates so low has the perverse effect of shoveling huge sums of money to all those who own homes (via refinancing) at the expense of all those who do not (by inflating housing prices, thus keeping them locked out; by setting them up for a fall, should they buy now, when rates return to normal and prices decrease accordingly; by all but guaranteeing, should they buy now, that they will never be able to benefit from refinancing).

Surely, there is a better way to prop up the economy than giving huge sums of money to those who have, at such great expense to those who have not.