Cafe Hayek

Fannie, Freddie, and Subprime

I'm still not sure how important Fannie and Freddie were to the housing calamity but I continue to do some research. Some say they were not involved in subprime at all, but we now know that was untrue, it's only a question of how much. The amounts were relatively small through 2002, but the real explosion in subprime securitization took place later. The following is from a 2004 HUD study. I have removed the footnotes for readability.

Fannie Mae and Freddie Mac have shown increasing interest in the subprime market
since the latter half of the 1990s. The GSEs entered this market by purchasing securities backed
by non-conforming loans. Freddie Mac, in particular, increased its subprime business through
structured transactions, with Freddie Mac guaranteeing the senior classes of senior/subordinated
securities. The two GSEs also purchase subprime loans on a flow basis. Fannie Mae began
purchasing subprime loans through its Timely Payment Reward Mortgage program in June 1999,
and Freddie Mac rolled out a similar product, Affordable Merit Rate, in May 2000 (described
below). In addition to purchasing subprime loans for borrowers with blemished credit, the GSEs
also purchase another non-conforming loan called an Alternative-A or “Alt-A” mortgage. These
mortgages are made to prime borrowers who do not want to provide full documentation for
loans. The GSEs’ interest in the subprime market has coincided with a maturation of their
traditional market (the conforming conventional mortgage market), and their development of
mortgage scoring systems, which they believe allows them to accurately model credit risk.

Although the GSEs account for only a modest share of the subprime market today, some market
analysts estimate that they could purchase as much as half of the overall subprime market in the
next few years.

Precise information on the GSEs’ purchases of subprime loans is not readily available.
Data can be pieced together from various sources, but this can be a confusing exercise because of
the different types of non-conforming loans (Alt-A and subprime) and the different channels
through which the GSEs purchase these loans (through securitizations and through their “flow-
based” product offerings). Freddie Mac, which has been the more aggressive GSE in the
subprime market, purchased approximately $12 billion in subprime loans during 1999—$7
billion of A-minus and alternative-A loans through its standard flow programs and $5 billion
through structured transactions.153 In 2000, Freddie Mac purchased $18.6 billion of subprime
loans on a flow basis in addition to another $7.7 billion of subprime loans through structured
transactions. Freddie Mac securitized $9 billion in subprime and Alt-A product in 2001 and
$11.1 billion in 2002.

Fannie Mae initiated its Timely Payments product in September 1999, under which
borrowers with slightly damaged credit can qualify for a mortgage with a higher interest rate
than prime borrowers. Under this product, a borrower’s interest rate will be reduced by 100
basis points if the borrower makes 24 consecutive monthly payments without a delinquency.
Fannie Mae has revamped its automated underwriting system (Desktop Underwriter) so loans
that were traditionally referred for manual underwriting are now given four risk classifications,
three of which identify potential subprime (A-minus) loans. Fannie purchased about $600
million of subprime loans on a flow basis in 2000. Fannie Mae securitized around $0.6 billion
in subprime mortgages in 2000, before increasing to $5.0 billion in 2001 and 7.3 billion in
2002. In terms of total subprime activity (both flow and securitization activities), Fannie Mae
purchased $9.2 billion in 2001 and over $15 billion in 2002, the latter figure representing about
10 percent of the market, according to Fannie Mae staff.

Irony isn't a strong enough word

From the New York Times:

Under the photo it says:

Representative Barney Frank was among the politicians charged with creating legislation to recoup the bonus money at A.I.G.

This is the same Barney Frank who has been the champion of Fannie and Freddie, the opponent of keeping too much of an eye on Fannie and Freddie, the champion of their solvency when they were, in fact, insolvent, the champion of bailing them out, the champion of increasing home ownership rates with other people's money. Is it not strange that this man is now involved in trying to stop AIG from paying bonuses with money he has voted for them to have and money that is being spent partly because of policies he relentlessly pursued?

Grassley wants AIG execs to kill themselves. I'd settle for an apology from Frank followed by resignation.

Fannie and Freddie and the future

This New York Times story suggests that Fannie and Freddie are going to stay in the hands of the government, partly because government likes have the tool. I think there's a chance it they will return to their quasi-private form. That's a better tool, a tool you can play with off budget. But in the middle of the article is this remarkable paragraph, the kind of paragraph that gets written with a straight face as if it's just the facts being reported, no big deal:

One reason that Fannie and Freddie will never return to their earlier forms is simple mathematics: to become independent, Fannie Mae and Freddie Mac must repay the taxpayer dollars invested in the companies, plus interest. Even if the firms achieve profitability, it could take them as long as 100 years — or longer — to pay back the government. And almost no one expects the companies to return to profitability anytime soon.

A hundred years or longer? I guess that hasn't exactly played out the way anyone quite intended.

Freddie Mac chief resigns

They had a bad year.

The New York Times reports:

The struggling mortgage lending giant, Freddie Mac, said Monday that its chief executive, David M. Moffett, had resigned effective March 12.

The board, in a statement, said it was working with its regulatory overseer, the Federal Housing Finance Agency, to find a successor.

Freddie Mac, and its larger sibling, Fannie Mae, were both taken over by the federal government in September amid losses because of a decline in the value of their holding, receiving a lifeline of $200 billion.

The resignation came a few days after Freddie Mac said it needed at least $15.2 billion in government aid because it lost nearly $59 billion last year as the foreclosure crisis mushroomed. The company said on Thursday that it lost $25.2 billion, or $4.47 a share, in the fourth quarter, compared with a loss of $3.6 billion, or $3.80 a share, a year earlier.

In a statement, Freddie Mac said that Mr. Moffett indicated that he wanted to return to a role in the financial services sector.

That last sentence is not supposed to be particularly ironic or humorous. But it's also pretty obvious that if you're working for Fannie or Freddie these days you're in your own sector. Not sure what it should be called. Probably the "continue to keep interest rates artificially low in hopes of continue to prop up housing prices" sector. It's related to the financial services sector, but it's quite the same thing.

Government, the Downturn, and Responsibility

These letters in yesterday's Wall Street Journal are worth reading:

"The Weekend Interview with Nouriel Roubini: 'Nationalize' the Banks" (Feb. 21) once again demonstrates that the credibility of economists is inversely related to their level of celebrity and their proximity to political power. To paraphrase Lord Acton: Celebrity corrupts, and political celebrity corrupts absolutely. Mr. Roubini tells us that markets fail and have failed to clear because of excesses, greed and irrational exuberance.

Amazingly, Mr. Roubini makes no mention whatsoever of the government interventionism that is largely the cause of our current crisis. Was the Federal Reserve's policy of holding interest rates below the real rate of interest and thereby causing a credit bubble and debt-fueled consumption a market failure? Or was the market failure that market participants did not read F.A. Hayek's "Monetary Theory and the Trade Cycle" and divine the peril that was not being signaled through the price mechanism? Or does Mr. Roubini consider it a market failure that lenders were coerced by the government to make mortgage loans that never would have been made based on market-driven underwriting standards? Is the failure of unqualified homebuyers to decline the cheap, no-down-payment loans that lenders were coerced to offer them another market failure? Was it market failure that lenders knew they would never have to suffer the consequences of reckless underwriting when they could dump their rotten portfolio on the taxpayers via the government-backed Fannie Mae and Freddie Mac?

Robert Drane
Lakewood Ranch, Fla.

It is a matter of public record how we reached the point where the idea of nationalizing the banks arose. I doubt even the most cunning and unscrupulous member of Congress foresaw the ultimate prize, when under the guise of minority home ownership, they put us on the path to crisis.

Now picture the likelihood that a Sen. Chris Dodd or a Rep. Barney Frank could pressure loans to be made or withheld, and this without public knowledge of where money is being directed. Political contributions would flow from the chosen back to politicians.

It is not enough to control the federal Treasury. By nationalizing the banks, a huge slush fund, safe from prying eyes will be created. Who needs a dictator when we have the U.S. Congress?

Joel Brandes
Chestertown, Md.

Mr. Roubini totally misses the mark about what Alan Greenspan got wrong. The former Federal Reserve chairman spent a career playing the Wizard of Oz, pulling the levers to set the price of money. As the ultimate master of the universe, free markets were not allowed to set interest rates and properly allocate capital. Far from taking Ayn Rand's view of the world to an extreme, his implementation was just the opposite -- he knew better where to set the price of money. Sadly, now that the wizard has been revealed, we have so many willing to accept his explanation on how free markets let us down. No, Mr. Greenspan, you did.

Dale Meyer
Madison, Wis.

They never learn

The stimulus package has a provision for home buyers to get an interest-free loan to help with their down payment. Turns out, the provision was put in place last year. I guess you can never do enough to help people buy a house. When will they learn?

Contracts are Not for Judges to Re-write

My colleague at GMU Law and at the Mercatus Center, Todd Zywicki, explains in today's Wall Street Journal why the increasingly popular idea of letting judges re-write mortgage contracts is a terrible idea -- one likely to perform its own market destabilization.

Mencken Understood the New Deal

No more raw deals.

Good tax policy

Commenter jwilliams writes in response to my post arguing that the reduction in capital gains on housing in 1997 may have been the decisive event that started the rocketing upward of housing prices that created the mortgage mess and subsequent financial collapse:

What conclusions do you draw from this interpretation?

That the government should not have reduced taxes on home capital gains? That the taxes should have been decreased more gradually? That all capital gains taxes should be equal to avoid favoring one investment over the other?

The latter. You don't want to tax-advantage one investment over another or you induce a disproportionate flow of capital into that asset. That's the tragedy of the last ten years that's hidden. Tax policy and what came afterward caused trillions of dollars (not millions, not billions, but trillions) from China and here and elsewhere to go into building new and bigger houses rather than into more productive assets. It was a colossal mistake approved by a Republican Congress and signed by a Democratic president.

The defenders of such policies usually argue that you want more capital to flow into homes because home ownership creates a good society of responsible individuals. Maybe. Maybe not. But such talk is accepted most readily by those who benefit from the policies.

Ever-increasing home ownership is not the American dream. It's the dream of the National Association of Home Builders.

Finally, someone noticed

There are four factors that helped drive up the price of real estate in the United States and create the housing bubble: The GSEs (Fannie and Freddie), the Community Reinvestment Act, expansionary monetary policy starting in 2001, and the 1997 Taxpayer Relief Act that for the first time let people avoid capital gains on home price appreciation without having to rollover the gains into a bigger house.

All of these factors pushed up the demand for real estate. But by how much? Over the last few weeks I have been focusing on the capital gains change because the run-up in housing prices began in either 1997 or 1995 depending on which data you use.

This New York Times article from today is the first one I've seen that focuses on the role of the 1997 tax change in the mortgage mess:

By itself, the change in the tax law did not cause the housing bubble, economists say. Several other factors — a relaxation of lending standards, a failure by regulators to intervene, a sharp decline in interest rates and a collective belief that house prices could never fall — probably played larger roles.

But many economists say that the law had a noticeable impact, allowing home sales to become tax-free windfalls. A recent study of the provision by an economist at the Federal Reserve suggests that the number of homes sold was almost 17 percent higher over the last decade than it would have been without the law.

Vernon L. Smith, a Nobel laureate and economics professor at George Mason University, has said the tax law change was responsible for “fueling the mother of all housing bubbles.”

By favoring real estate, the tax code pushed many Americans to begin thinking of their houses more as an investment than as a place to live. It helped change the national conversation about housing. Not only did real estate look like a can’t-miss investment for much of the last decade, it was also a tax-free one.

The authors do a nice job looking at the politics and some of the economics. But they miss one key point. They did not look at prices, and focused instead on sales. But it is prices where the impact is going to start and it is the increase in prices that made all of the other mistakes possible.

It is an unavoidable fact that when you tax-exempt an asset, it's going to appreciate. The question is how much and what evidence we might look at to confirm the importance of the 1997 tax change. There has been an explosion in ownership in second homes but it's hard to quantify. The National Association of Realtors has data that show a big increase after 2003, when they started collecting the data. But that could be the result of the price appreciation not the cause of it. I can't find reliable data before 2003.

Just look at that picture. If it's accurate, something dramatic happened in 1997 that fueled an explosion in housing prices. I don't think it was irrational exuberance. I think it was a change in a tax policy that suddenly made houses dramatically more attractive as an investment vehicle. The other factors mattered in pushing up demand. And lots of ugliness had to happen along the way. And maybe the timing is just a coincidence. But I doubt it. You would expect making something tax exempt would increase its price. And the price kept going up when Wall St found new ways to let new homeowners borrow in anticipation of higher prices.

A blast from the past

Here is a 1994 article from Business Week on Fannie and Freddie's political fight against getting more involved with low-income lenders. This was very early days. Interesting to see which politicians wanted Fannie and Freddie left alone.

FANNIE MAE'S LINE IN THE SAND

FANNIE MAE, AS savvy politically as it is financially, is fighting a Clinton Administration plan to boost low-income mortgage lending. The Federal National Mortgage Assn., a federally chartered private company that buys mortgages from lenders and bundles them into bonds, has called in a cavalcade of big-time pols to help.

At issue is a program by Fannie to spur lending for affordable housing in urban and rural areas, to low- and moderate-income homebuyers. Fannie chief James Johnson, a former Walter Mondale aide, is upset over pressure from the Housing & Urban Development Dept. to focus on minority and low-income buyers regardless of their location. And HUD has considered making Fannie police bias by lenders, which Johnson sees as unworkable.

Fannie Mae complains that the HUD plan would ignore the urban middle class, potentially prompting their exodus from cities. Johnson has enlisted the mayors of Boston, Chicago, and Oakland as well as Representatives Barney Frank (D-Mass.) and Charles Schumer (D-N.Y.) to lobby against the HUD plan. Their impact has been felt. The word is that HUD thus far has backed off on the idea of Fannie Mae as an antibias enforcer.

EDITED BY LARRY LIGHT & JULIE TILSNER  By Amy Barrett

Dear Prudence

My friend Tibor Machan -- co-founder of Reason magazine and Professor of Philosophy at Chapman University -- has these useful thoughts on the bailout.

My Kingdom for a Troubled Asset!

Being a consummate nerd, when driving I often listen to WTOP radio in Washington; it's an all-news/sports/weather channel.

At :25 and :55 after each hour WTOP runs a business report.  Yesterday at 10:55am the business reporter noted that one company whose stock price was rising on what was generally a down day on Wall Street was Genworth Financial.  The reporter noted that Genworth had announced that it will acquire InterBank fsb -- and, by doing so, Genworth will become eligible to tap into the funds Uncle Sam is making available through its Troubled Assets Relief Program.

I think that I remember the reporter describing InterBank as "a troubled thrift," but I can't recollect with sufficient clarity to vouch for that memory.  But either way, surely InterBank must be troubled, otherwise Uncle Sam would not be trying to save it with bailout funds (!).  So now we have companies (e.g., Genworth Financial) otherwise not sufficiently troubled to be eligible for taxpayer handouts buying up troubled companies (e.g., InterBank) so that the former can get on the government dole.  What perverse incentives are afoot.

Here's the Bloomberg report:

Genworth Financial in Talks to Buy InterBank, Tap Into Program

By James Callan                    

Nov. 16 (Bloomberg) -- Genworth Financial Inc., the insurer spun off by General Electric Co., said it’s in negotiations to acquire InterBank Fsb and with it eligibility for the U.S. Treasury’s $750 billion bailout program.

Genworth is seeking to buy the Maple Grove, Minnesota-based thrift in order to gain recognition as a savings-and-loan holding company. Talks are in progress and terms are being negotiated, Genworth spokesman Al Orendorff said today.           

Genworth Financial would join the more than 50 regional banks offering stakes to the U.S. Troubled Asset Relief Program. The bank is seeking to tap bailout funds after a surge in claims at its mortgage insurance unit and investment losses.    

Last week, Office of Thrift Supervision spokesman Bill Ruberry said Genworth Financial was in talks to buy InterBank and tap the program, a move Genworth said it was “considering.”           

Shares of Richmond, Virginia-based Genworth fell 6 cents to $1.47 on Nov. 14 in New York Stock Exchange trading. It has plunged 94 percent this year.

Where was I in 2005?

Reader Tim Allen asks a very good question. I'm going to quote his entire email and then try to answer his question:

I am a frequent visitor of your blog, Cafe Hayek. I saw your post about the new collection of essays about the financial meltdown. I feel compelled to write to you and Don although up to this point I have restrained myself. I have to admit that I have this unfocused anger about the financial meltdown and I confess has presently coalesced around you. Much like when I am aggravated at a product or service from some random company, I know better than to unload on the customer service person whose only fault is being the next in the queue to answer my phone call.

 

With that in mind, I need to ask of a person with a publication, a popular blog and such access to media outlets like NPR, (not to mention a PhD in economics) how is it that this financial meltdown only gets analyzed by you and your profession ex post facto?

 

I promised myself that I wouldn't bore you with how well I followed this financial crisis between 2003 and now. The no name blogs by averages Joes that I read... How hard it was from 2003 to 2006 to find anyone other than the regular people with no economics PhD that were writing about the housing bubble. And then, when in late 2006 when the housing bubble was self evident, how hard it was to find anyone talking about what the ramifications would be for the banks and financial structure of the world.

 

What really really bugs me is that I was drinking beers with my brother telling him how I didn't think that capitalism, which I truly love, would survive this pending financial imploding back in 2005. So I guess, what I really want to know, is where were you in 2005 and where was everyone in your profession?

You're right, Tim. I didn't see this coming. And I wasn't alone. People a lot smarter than I am didn't see it coming either. So what happened?

I should mention first that the few people who did see it coming were not necessarily any wiser than anyone else. Some of them had predicted nine of the last five recessions. A stopped clock is right twice a day. Even those who claim to have foreseen this mess couldn't make the case well enough to alarm very many other people. And if you want to know if they were really wise or just selling a different story because the market was less crowded on the pessimistic side, you'd have to look at their bank accounts. Did they put their money where their mouth was?

But back to the rest of us. Why were so many people blind about what was going on until it was too late? I'll talk about myself. First, this problem began in the housing sector. I knew very little about housing. I don't know a single economist who specializes in housing the way I know people who specialize in trade or labor economics or health care issues. More importantly, I was oblivious to government's role in housing markets.

Oh, I knew about the deductibility of mortgage interest. I knew there was something called the FHA that helped poor people buy houses. But I knew nothing about Fannie Mae or Freddie Mac. I'd heard of them, but I didn't know what they really did. I didn't know anything about their quasi-public status. I didn't know how HUD leaned on them to get more involved in "affordable housing." I had no idea of the magnitude of Fannie and Freddie's involvement in the mortgage market, generally. I didn't pay close attention to the Taxpayer Relief Act of 1997 that changed the tax treatment of housing. And that's just the beginning.

More disturbing perhaps, is that there is no public record of Fannie and Freddie's involvement in the subprime market. I've seen claims in the New York Times and the Washington Post but they are extremely difficult to verify.

Having said all that, when home ownership went from 64% to an all time high of 69%, I foolishly attributed it to our growing standard of living and Wall St. innovation. I was right about part of it. We do have a growing standard of living (contrary to the claims that the average American isn't sharing in the economy's expansion) and Wall St. innovation did reduce the risk of lending to people who otherwise wouldn't have gotten a loan. But I, like others, didn't see the unsustainability of that rise. And most people thought that if the rise slowed or fell, then some people would lose their houses and others who invested in those mortgages would lose their money. We didn't see the systemic risk.  We didn't pay enough attention to the magnitudes. Prices are unlikely to double in ten years solely because of fundamentals. The explosion of subprime securitization in 2004 and 2005 should have set off alarm bells.

A deeper question that I have not seen adequately answered is why people who specialized in the housing market, people who were paying attention, people who put their life's wealth on the line, were equally oblivious. What were they thinking? That housing prices would keep doubling? Or just keep going up? Were they comforted by the AAA rating of the CDO they had purchased? The credit default swap they had purchased? Should that have been enough? The standard answer that they were greedy is not an answer.

Which brings us to another reason I and others were silent in 2005. Financial markets are incredibly complicated. Even today, ex post, it's hard to know what really happened that spiraled downward so dramatically. There are a lot of culprits. The ratings agencies. Fannie and Freddie. Greed. Innovative products that were too complicated to understand. Tax policy. Monetary policy. Mark-to-market accounting. How do all of these effects interact? The ex post story isn't straightforward. Ex ante is much much harder.

The bottom line is that the ability of economics to anticipate disaster or to understand the full playing out of the complex system known as the economy is very limited. We are pretty good at microeconomics--the incentives created by a particular policy. We are not very good at macroeconomics. And we don't have much to suggest for getting out of the mess we're in. We know the conditions that are necessary--some optimism for the future, functioning credit markets, incentives to invest. But we don't know much about how to create those conditions. At this point,  I think our value as economists lies in helping policy makers avoid mistakes. Not so helpful but better than nothing.

Finally, you might listen to this podcast with Robert Barro. It was taped in August when things weren't going well but very few people thought we'd be where we are today. Barro basically argues that we have a disaster like this once every 50 to 100 years. Maybe that's the best we can hope for. Events that occur that erratically are hard to understand in a systematic way. And maybe if we're lucky, this will just turn out to be a bad recession and not something worse. But nobody knows. Certainly not us economists.

Truer Words Were Never Spoken

Here's George Will in today's Washington Post:

The distribution of a trillion dollars by a political institution -- the federal government -- will be nonpolitical? How could it be? Either markets allocate resources, or government -- meaning politics -- allocates them. Now that distrust of markets is high, Americans are supposed to believe that the institution they trust least -- Congress -- will pony up $1 trillion and then passively recede, never putting its 10 thumbs, like a manic Jack Horner, into the pie? Surely Congress will direct the executive branch to show compassion for this, that and the other industry. And it will mandate "socially responsible" spending -- an infinitely elastic term -- by the favored companies.

Fannie and Freddie Haiku

Fannie and Freddie
Private Gains. Public losses.
Whose idea was that?

Horwitz's Open Letter

Steve Horwitz's "Open Letter to My Friends on the Left" is very well worth reading.

Greenspan Is Guilty As Charged

One of our generation's finest monetary theorists and historians, George Selgin, argues here against David Henderson's and Jeffrey Hummel's recent attempt to acquit Alan Greenspan's monetary policy from contributing to the now-burst housing bubble.

George's case is powerful and well-argued.  I believe that he's correct.

Further Insights from Pietro Poggi-Corradini

The People order, spur, nudge, encourage, politicians to go out and play with the market. The Politicians do. They fiddle, tweak, castrate, pick wings off, etc….and eventually things go terribly wrong. A catastrophe ensues. The People get very angry. They shout and tell the Politicians to fix the mess. "It's your job to fix this!". The Politicians in turn, like three-year olds charged to put grandmas set of crystal glasses back into the cupboard, go busily about their business, hauling over-sized delicate objects above their heads, struggling to hang on to several heavy and mis-shaped precious items. This is the world we live in.

- Pietro Poggi-Corradini

Franklin Delano Bush

Here's a letter I sent on October 20th to the Washington Times:

Dear Editor:

Your equating George W. Bush with FDR is spot-on ("Franklin Delano Bush," October 20).  Both presidents recklessly increased government's role in the economy - a move that proved (in FDR's case) and will prove (in Bush's case) to do nothing but saturate the economy with such uncertainty as to frighten away entrepreneurs and investors.

But popular history will almost surely remember Bush, not as a second FDR, but as a second Herbert Hoover.  The myth will be made that Bush was a staunch free-marketeer who was succeeded in the Oval Office by a charismatic saint whose hyperactive interventions saved the economy (even though precious little evidence of economic salvation will appear in the data).  History will forget Bush's interventions just as it has forgotten Hoover's - as it has forgotten that Hoover signed the largest tariff hike in U.S. history; as it has forgotten that Hoover tried to create jobs by deporting hundreds of thousands of Mexicans; as it has forgotten that Hoover signed the Emergency Relief and Construction Act, the Federal Home Loan Bank Act, and created the Reconstruction Finance Corporation; as it has forgotten that, with the Revenue Act of 1932, Hoover raised the top marginal tax rate on personal incomes from 25 percent to 63 percent (in addition to raising the corporate-tax rate).

History will repeat itself, blaming capitalism for a problem caused and intensified by government interventions.

Sincerely,
Donald J. Boudreaux

By the way, even the Washington Post -- no catacomb of free-market sympathies -- understands that blaming capitalism for today's financial turmoil is absurdly simplistic.

Two Can Play This Game

There's been a rush to blame free markets, even laissez faire libertarianism, for the current financial crisis.  As I -- and Russ -- have said before, there are lots of other potential culprits around.  Hastily concluding that the culprit is the free market might be emotionally gratifying for many folks, but it's an intellectually corrupt conclusion.

Research perhaps will eventually reveal that free markets and deregulation are the main culprits.  Or research perhaps will eventually clear these suspects of most or all such charges.  Time will tell.

In the meantime, anyone wishing to play the childish game of accusing free markets of the financial turmoil should expect something like the following from opponents playing by the same rules:

We now have proof that government is a god that failed -- a poverty-inducing and economically destructive institution that humankind should finally learn must be kept on an extraordinarily tight leash, lest it wreak havoc in the lives and on the fortunes of innocent parties.

The facts are crystal clear.  Since the March 24 promise by the Fed to guarantee $29 billion worth of mortgage securities held by Bear, Stearns, the Dow has fallen 34 percent (as of mid-day on October 28, 2008).  Since the September 8th announcement by the U.S. Treasury Department that it will take over Fannie Mae and Freddie Mac, the Dow has shed 28 percent.  Since the October 3 enactment of Uncle Sam's massive bailout bill, the Dow is down 20 percent.
.....
My priors tell me that all this government intervention is indeed playing a big role in Wall Street's continuing woes.  But at this point, that's all I've really got: priors.

If, though, someone wishes to assert "No!  The problem is caused by deregulation!" then I accuse that person of having only priors -- priors no better or more trustworthy than my own.  And if that person wants to get into a game of post hoc, ergo propter hoc 'theorizing,' then I see no reason why the particular post hoc argument stated in italics above is less compelling than the particular post hoc arguments paraded about now so confidently by the anti-market crowd.

O'Driscoll on Central Banking

Gerald O'Driscoll has a fine piece on the failed promise of central banking.

Garrison on Greenspan

Here's a letter that I sent a few days ago to the Wall Street Journal:

To the Editor:

Alan Greenspan now blames deregulation for today's financial turmoil ("Greenspan Admits Error to Hostile House Panel," October 24).  Whatever deregulation there was, and whatever its merits or demerits, there is one crucial financial instrument - dollars - that throughout was supplied by an utterly unjustifiable state monopoly - the Fed.  Unfortunately, this decidedly unfree-market arrangement draws little attention.

Skepticism is advisable when the former head of a government-created and protected monopoly blames the market for using that monopoly's output unwisely.  Would the demand for mortgage-backed securities have been as frothy as it was if Mr. Greenspan's Fed had not created so much new money?  Would the demand for owner-occupied housing itself have been so intense?  Because money plays a common and vital role in all of these transactions - and because Mr. Greenspan's Fed kept pumping dollars into the economy with no way to know what the 'correct' supply is - you'll pardon my inability to give credence to Mr. Greenspan's latest pronouncements.

Sincerely,
Donald J. Boudreaux

This 2006 essay by Auburn University's Roger Garrison is prescient.

White on the Crisis

Here's Larry White's copius wisdom on the financial crisis - including his correction of a fundamental error committed by Paul Krugman.

Arnold the Wise

Arnold Kling at his best.

David Henderson on Today's Economy

Here's economist David Henderson -- editor of the splendid Concise Encyclopedia of Economics -- on the current financial turmoil.  A sample paragraph:

The best evidence is that the problem was triggered by previous government regulation combined with an unrealistic belief on the part of many people that housing prices could only go up. It is important to understand the cause because, if we do not, we are unlikely to choose good solutions. Indeed, the US federal government has, for the last few months, chosen one bad solution after another.

Hayek's Revenge

University of Illinois law professor -- and Ideoblog's -- Larry Ribstein calls it "Hayek's Revenge."

Covering All Possibilities, From A to B

Here's a letter that I just sent to the Washington Post:

Dear Editor:

You ask "How did world markets come to the brink of collapse?" ("Washington Failed to Catch Up to Wall Street," October 15).  You answer: "Some say regulators failed.  Others claim deregulation left them handcuffed." You wonder: "Who's right?" Perhaps the answer is 'none of the above.'

Contrary to your pose of presenting all relevant possibilities, you miss the main debate entirely. The chief question is to what extent are today's problems caused by market forces, and to what extent by government interference with these forces.  You, though, take the necessity of regulators for granted and ask only why they failed.

If you ran a similar report on the cause of lousy meals served at restaurants whose kitchens are crammed with regulators, you would likely open it with: "Some say regulators failed.  Others claim they were handcuffed. Who's right?"  Perhaps the answer is 'none of the above.'  Maybe, just maybe, the meals will improve only if the regulators clear out of the restaurants altogether and let the chefs and their customers do their thing, unmolested and unsubsidized.

Sincerely,
Donald J. Boudreaux

Jon Macey on Uncle Sam's Interventions

Yale Law School's Jonathan Macey explains clearly, in today's Wall Street Journal, that George Bush's, Congress's, and the SEC's recent interventions into today's panicky market are making this panic not only more intense but justified.  Here's an important passage:

Of course, market manipulation does exist, but federal regulators deserve much of the blame for this form of market abuse. For years the SEC has hampered companies' ability to protect themselves from manipulation by short-sellers. The most effective way for a company to respond to an attempt to manipulate its share prices is simply to repurchase its own shares, simultaneously "squeezing" the short positions and sending a clear signal of financial health to the capital market.

However, companies have long felt vulnerable to being charged by the SEC with manipulation whenever they go into the market to make share repurchases. The SEC finally acknowledged this problem after the collapse of Bear Stearns and Lehman when it stated publicly that "historically, issuers generally have been reluctant to undertake repurchases" when faced with manipulative short-sellers because of the massive amount of uncertainty about whether the SEC would sue them for trying to manipulate the market.

Walter Williams's Lessons From the Bailout

My and Russ's colleague Walter Williams draws important lessons from the bailout.

I talk about the mess and the bailout on Reason.tv

$700 Billion Bad Bet

Paul Jacob speaks common sense about the "$700 Billion Bad Bet."  He's not banking on it.

And Even More on the Bailout

HT to Steve Landsburg.

State-level subsidies

Did you know that states have housing finance agencies to promote affordable housing, too? And guess what? Fannie and Freddie help them. From Freddie Mac:

Mortgage Revenue Bonds

Bond Purchase Activity Supports Community Development

Mortgage Revenue Bonds (MRBs) are tax-exempt bonds that state and local governments issue through housing finance agencies (HFAs) to help fund below-market-interest-rate mortgages for first-time qualifying homebuyers. Eligible borrowers are first-time homebuyers with low to moderate incomes below 115 percent of median family income.

Benefits to Housing Finance Agencies (HFAs)

In purchasing MRBs, Freddie Mac works with HFAs in two ways:

• As a credit enhancement: Originating lenders pool the mortgages into securities guaranteed by either Ginnie Mae or Freddie Mac and sell the securities, rather than the whole loans, to the issuing HFAs.
• As investor: As part of its corporate investment program, Freddie Mac purchases MRBs issued by HFAs.

Does anyone know about the magnitude of these programs. One claim is that across the nation, they have helped a few million people get cheap mortgages. Anyone out there know if the bonds ever default? Or if they might soon? Any idea if the program has expanded or shrunk in the last decade?

Higgs on the Bailout

Here's Bob Higgs on the bailout 'plan.'  I especially like this paragraph:

Sure enough, in the days after the bill’s initial defeat, its managers took the monstrosity that had failed on Monday and made it even uglier. Their purpose, of course, was to buy off the bill’s opponents in Congress by sweetening it with all sorts of more or less unrelated provisions intended to channel benefits to the opponents’ constituents and supporters. In short, in Washington last week, business went on as usual: Congress is the name; corruption is the game.

Yes.  Thank goodness we Americans have mature, responsible, wise, and courageous 'leaders' in government to regulate markets.

Children can be excused for believing in Santa Claus; they are, after all, children.  Adults cannot be excused for believing in the beneficence and wisdom of the state.  This institution's foolishness and predations are visible for all who care to see.  I can respect at least the intelligence of those who defend the state as their means of extracting wealth from others -- that is, for example, I can respect the intelligence of U.S. auto executives who defend the state as their means of extracting the $25 billion recently ponied up by Uncle Sam to help G.M., Ford, and Chrysler.  I can respect their intelligence even as I loathe their ethics.

But I cannot respect the intelligence of adults who continue to insist that empowering strangers sitting beneath a marble dome to take and spend other people's money is wise and sensible.  And my respect for such alleged 'intelligence' dissolves even further when I reflect upon the fact that those persons who insist on trusting the state (because its top officials are elected democratically) see -- or should see -- the disgraceful behavior that these officials each engage in to win their gaudy glory.

Klinging to Sanity, With Spirit!

I love it when Arnold Kling gets angry.

And I wish that he were asked to testify before the self-important, officious, duplicitous, and shameless pooh-bahs on Capitol Hill.

Stan Liebowitz on the Mortgage Meltdown

Stan Liebowitz concludes that the chief culprit in today's mortgage-market meltdown is government.  Here's a key paragraph from the Executive Summary:

This report concludes that, in an attempt to increase home ownership, particularly by minorities and the less affluent, virtually every branch of the government undertook an attack on underwriting standards starting in the early 1990s. Regulators, academic specialists, GSEs, and housing activists universally praised the decline in mortgage-underwriting standards as an “innovation” in mortgage lending. This weakening of underwriting standards succeeded in increasing home ownership and also the price of housing, helping to lead to a housing price bubble. The price bubble, along with relaxed lending standards, allowed speculators to purchase homes without putting their own money at risk.

Regime Uncertainty

What I find most scary about the current market turmoil are the shenanigans it fuels on Capitol Hill and its immediate environs.

Uncle Sam is, I worry, on the verge of creating the same kind of "regime uncertainty" that Bob HIggs effectively argues deepened and prolonged the Great Depression.

More Lazy Fare

Here's a letter that I sent last week to the Baltimore Sun:

Rena Steinzor blames today's financial unrest on "knee-jerk opposition to federal regulation" ("Reviving regulation," Sept. 28”).  Her solution, of course, is greater government involvement in the economy.

But on the very same op-ed page, Cynthia Tucker put part of the blame (rightly so) on George W. Bush: "The White House bragged on programs to make borrowing easy, including an initiative to allow the Federal Housing Administration to insure mortgages for first-time homebuyers without a down payment" ("Minorities a convenient scapegoat for U.S. financial woes").

Clearly, the only knees jerking of late are not those of conservative politicians opposing government intrusion into markets but, rather, of persons such as Prof. Steinzor who lazily assume that laissez faire has been the order of the day.

Sincerely,
Donald J. Boudreaux
George Mason University

Lose the Teleological Mindset

This post is profound.

(HT Bob Higgs)

Laissez Faire to Blame?

With his column in Wednesday's Washington Post, Harold Meyerson joined the chorus of pundits chanting that the turmoil in credit markets signals "the collapse of laissez faire."

Webster's Revised Unabridged Dictionary defines "laissez faire" as

Noninterference; -- an axiom of some political economists, deprecating interference of government by attempts to foster or regulate commerce, manufactures, etc., by bounty or by restriction.

No one who examines the American economy in general, or credit markets in particular, can truthfully conclude that laissez faire has reigned in recent years.  Indeed, were Mr. Meyerson to read George Will's column appearing beside his own in that same edition of the Post, he'd get a partial list of the many government interventions that have paved the path to this crisis.

To blame laissez faire for today's economic crisis is akin to blaming the human body's natural and normal functioning for the illness suffered by someone who's overdosing on heroin.

Arnold and Bill

Bill O' Reilly acts like Arnold Kling (HT: Drudge) and points the finger at Barney Frank. Well not exactly. Arnold would have been more gracious.

Frozen Conventional Wisdom

This report in today's Christian Science Monitor is typical of many such reports of late in taking George W. Bush at his word that credit markets are "frozen" and that, without a bailout, the economy will tumble into the abyss.

But read this report carefully and it's difficult to find evidence in it of any such freezing.  Credit markets have tightened, to be sure, but they emphatically are not frozen.

Here are some of my favorite selections from this report:

Not everyone has felt the squeeze yet. Home buyers with good credit can still get mortgages, although it may require more footwork. The interest-rate gap between commercial bank lending and Treasury bills has eased from record levels a few days ago.

(Note the "yet."  Why presume that people with good credit will eventually be unable to get mortgages and other lines of market-justified credit?)

And

Nationally, only 63 percent of consumers applying for a car loan are being approved compared with 83 percent a year ago, says Art Spinella, president of CNW Marketing Research in Bandon, Ore.

"Only 63 percent...."  This doesn't seem to me to be anything remotely close to evidence that ordinary Americans are being "frozen" out of access to credit.

And today Toyota announced zero-percent financing on 11 of its models.

Government's Role

Here is my piece in the WSJ on government's role in the mess. It's a work in progress. I am working on getting more data to see if the case is sturdy or just suggestive. And of course this is an ex post narrative. I tried to be careful to say that it is part of the story and perhaps the essential part. The people who are saying it ISN'T Fannie and Freddie, or it isn't the CRA or it isn't the Taxpayer Relief Act of 1997 or Greenspan's role in cutting interest rates are probably right. No one of these is THE cause. But I think the combined effects are potentially as compelling once I dig up all the numbers. And I certainly prefer the combined effects to the one cause explanation of greed or markets failed.

For the other side, here's another account by Joseph Stiglitz.

In the meanwhile, I hope to continue posting data as I accumulate it on this issue.

Let's Bail on the Bailout

My friend and co-blogger at Market Correction, Andy Morriss, sent this letter to the Financial Times:

Sirs,

Your editorial on the failed bailout vote in the US House of Representatives claims the bill “could be part of an effective answer” to the financial crisis. Perhaps in the sense that as a 48 year old, out of shape university professor, I “could be” an astronaut. The bailout bill has grown from three pages in Sec. Paulson’s initial “give me $700 billion and I’ll fix it” proposal to the size of a hefty paperback novel. As of Thursday morning the Senate version was 450 pages long.  My chances of a moon walk greatly exceed the chance that this bill will be anything other than a massive resource grab -- those extra 447 pages aren’t value added, they’re favors for special interests, like the attempt by Senate Democrats to shovel millions to the radical group ACORN, or total irrelevancies hitching a ride on the crisis atmosphere, like the provision requiring insurance companies provide more money for mental health treatment.

Andrew P. Morriss
H. Ross & Helen Workman Professor of Law and Business
University of Illinois

Still Hoping Against A Bailout

Here's a letter that I sent yesterday to the New York Times:

Deeply upset that the House of Represetatives voted against the bailout plan, David Brooks writes that "We're living in an age when a vast excess of capital sloshes around the world fueling cycles of bubble and bust. When the capital floods into a sector or economy, it washes away sober business practices, and habits of discipline and self-denial" ("Revolt of the Nihilists," September 30).

So, pray tell, how will a massive government bailout of persons who behaved imprudently - a bailout inevitably injecting hundreds of billions of dollars of additional paper capital into the economy - solve the underlying problem?

As my colleague Richard Wagner points out, markets aren't intoxicated by large flows of capital per se.  Such bubblicious drunkenness results from capital that is politically supplied and directed - just the sort of capital promised by the bailout plan.

Sincerely,
Donald J. Boudreaux

Sensible Voices Against the Bailout

Dan Mitchell wisely and eloquently opposes a bailout.  So, too, does Jeffrey Miron.

Likewise, David Harsanyi speaks good sense on this topic (save for his criticism of the repeal of the Glass-Steagall Act).

And Arnold Kling, of course, is another voice of reason.

Should Government Make Health-Care As 'Affordable' As It's Made Housing?

My friend Nick Calapa sent me the following e-mail:

The one good thing that came out of this whole credit debacle, I now have the perfect pithy response to all the lefties who tell me that the government should take over health care and make it affordable to everyone.  You mean the way they made home ownership affordable to all through Fannie and Freddie?  How did that work out for you?

Go Nick!!

Thomas Sowell on the Bailout

Thomas Sowell's latest is spot-on.

Here's an excerpt:

N. Gregory Mankiw, his {Pres. George W. Bush's] Chairman of the Council of Economic Advisers, warned in February 2004 that expecting a government bailout if things go wrong "creates an incentive for a company to take on risk and enjoy the associated increase in return."

Since risky investments usually pay more than safer investments, the incentive is for a government-supported enterprise to take bigger risks, since they get more profit if the risks pay off and the taxpayers get stuck with the losses if not.

The government does not guarantee Fannie Mae or Freddie Mac, but the widespread assumption has been that the government would step in with a bailout to prevent chaos in financial markets.

Alan Greenspan, then head of the Federal Reserve System, made the same point in testifying before Congress in February 2004. He said: "The Federal Reserve is concerned" that Fannie Mae and Freddie Mac were using this implicit reliance on a government bailout in a crisis to take more risks, in order to "multiply the profitability of subsidized debt."

(HT Walter Williams)

Kling on the housing market and the mess

The latest EconTalk is a conversation with Arnold Kling, blogger extraordinaire and former Freddie Mac economist talking about the evolution of housing markets in the United States. We taped it a few weeks back so we added a postscript on the current situation as well.