2008 September 17 Wednesday
Financial Reform Debate Intensifies

Peter J. Wallison, formerly general counsel of the Treasury Department in the Reagan administration, argues that US Treasury Secretary Hank Paulson took over Freddie Mac and Fannie Mac in a way that guarantees further Congressional mischief.

Mr. Paulson has correctly noted that Fannie and Freddie operate on flawed business models -- as government-sponsored enterprises they have conflicting missions, and force the taxpayers to subsidize the risk-taking of for-profit managements. But he argued that, after they have been re-established as operating companies, Congress can decide their future.

This is stunningly naive. Recent statements by Barney Frank (D., Mass.), the chairman of the House Financial Services Committee, and Chuck Schumer (D., N.Y.), a powerful member of the Senate Banking Committee, make clear that Congress will never let them be privatized, broken up, slimmed down, nationalized or any of the other options hopeful reformers are putting forth today. Fannie and Freddie in their current form are just what Congress wants: an inexhaustible source of campaign contributions and funds for favored groups.

But was there a way for Paulson to reduce the future mischief potential of Fannie and Freddie? Wallison says yes.

What should have been done? A receiver, not a conservator, should have been put in charge of Fannie and Freddie. A receiver could have wiped out the common and preferred shares, repudiated unfavorable contracts, created a good bank/bad bank structure for isolating the bad assets, and otherwise taken steps to reduce the losses to taxpayers.

A web site called OpenSecrets.org which tracks campaign donations has a chart that shows Senator Barack Obama was the second largest recipient of campaign donations from Fannie Mae and Freddie Mac from 1989-2008. Senator Christopher Dodd, chairman of the Senate Banking Committee, was the biggest recipient of Fannie/Freddie money. Though in 2008 alone the New York Times finds McCain got more from Fannie and Freddie than Obama did. Neither Dodd nor Obama want to abolish or privatize Fannie and Freddie. Not sure where McCain stands on this question.

Fannie and Freddie have been a way for former high officials in government to hop into the public-private hybrid sector and make a lot of money.

Fannie and Freddie have also been places for big Washington Democrats to go to work in the semi-private sector and pocket millions. The Clinton administration's White House Budget Director Franklin Raines ran Fannie and collected $50 million. Jamie Gorelick — Clinton Justice Department official — worked for Fannie and took home $26 million. Big Democrat Jim Johnson, recently on Obama's VP search committee, has hauled in millions from his Fannie Mae CEO job.

Tyler Cowen says we had incorrect regulation of the financial industry.

In short, there was plenty of regulation — yet much of it made the problem worse. These laws and institutions should have reined in bank risk while encouraging financial transparency, but did not. This deficiency — not a conscientious laissez-faire policy — is where the Bush administration went wrong.

It would be unfair, however, to blame the Republicans alone for these regulatory failures. The Democrats have a long history of uncritically favoring expansion of homeownership, which contributed to the excesses at Fannie Mae and Freddie Mac, the humbled mortgage giants.

Even with the crisis well advanced Democrats in Congress wanted Fannie and Freddie to dig their holes even deeper.

The privatization of Fannie Mae dates back to the Johnson administration, which wanted to get the agency’s debt off its books. But now, of course, the government is on the hook for the agency’s debt. As late as this spring, Congressional Democrats were pushing for weaker capital requirements for the mortgage agencies.

This reminds me of the savings and loan crisis that reached a climax while Ronald Reagan was President. The genesis of the crisis was in the 1970s when inflation drove up interest rates that the S&Ls had to pay and made them insolvent. Well, rather than shut down all those S&Ls Congress, and chiefly though not solely Democrats in Congress, decided to raise the limits on what the savings and loans could do in hopes that by raising their insured deposit limits and letting them into new lines of business that they'd be able to earn their way out of insolvency. Instead these financial institutions dug holes even deeper leading to the Keating Five scandal where John McCain found his character questioned and he became a tireless crusader against private donations to election campaigns.

I think that banks shouldn't be able to buy bond insurance policies. Bank health shouldn't be wrapped up with insurance industry health.

Share |      By Randall Parker at 2008 September 17 11:50 PM  Economics Financial


Comments
Stephen said at September 18, 2008 12:41 AM:

I'm not aware of any other country that actually has an equivalent of F and F. Wonder why non-US financial systems cope well without such allegedly vital organisations?

Ultimately, no politician (of whatever colour) will do anything that even has the tiniest risk of denting house prices.

Robert Hume said at September 18, 2008 8:56 AM:

And Fannie and Freddie and the politicians you mentioned, together with Clinton and Bush insisted on no-doc no-job loans to minorities. And if anyone thought that mortgage requirements should be stiffened in recent years they heard "So you want to deny minorities the right to have their own home and deny them their right to participate in the real-estate boom by which they can become wealthy?" Of course the answer had to be no. So there was no way to stop the con-artists who piled on this unregulated bandwagon.


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