Understanding the GSEs
If you want a great example of how conservatives don’t know anything about anything, look no further than Iain Murray’s enthusiastic recommendation of this Wall Street Journal opinion piece pinning the blame for everything on Chris Dodd:
In February 2004, while Republican colleagues warned of the systemic risks posed by Fannie Mae and Freddie Mac, Mr. Dodd pronounced the mortgage market “one of the great success stories of all time.” A year later, the Connecticut Democrat voted against a reform that would have limited the size of Fan and Fred’s mortgage portfolios.
As a heuristic, you might wonder why this piece of finance and business journalism didn’t make it into the WSJ news pages.
Meanwhile, it seems to me that the Republicans were right on the merits of this controversy and that Dodd was wrong. In fact, all before this crisis I generally agreed with the conservative view on the so-called “government-sponsored entities.” As such, I actually understand what that view was! The view was that the implied government guarantee to Fannie and Freddie might cause them to take unduly large risks, and that the very scale of those risks would mean that in the event of a crash we actually would need to bail them out despite the lack of explicit guarantee. Thus, the idea of limiting the size of the Fannie/Freddie portfolios. The point was that if the Fannie/Freddie portfolios could be kept small, then perhaps the GSEs wouldn’t be “too big to fail” and we could afford to avoid bailing them out. And if we did wind up needing to bail them out, we wouldn’t be on the hook for such an enormous amount of money.
These were sensible concerns and I hope that when we come through this current crisis we won’t repeat the mistakes that were made when Fannie and Freddie were privatized in the first place. That said, this has nothing to do with the current crisis in the financial system. In case you, Murray, John McCain, or the WSJ opinion section hasn’t noticed, it’s not as if we’ve managed to get away with not bailing out non-GSE firms. Instead, the magnitude of the crash has been so giant that we’re now partially nationalizing the entire banking system. Fannie and Freddie being somewhat smaller wouldn’t have changed anything. At all. Capping their portfolios was a good idea for avoiding a potential problem that, as it happens, wound up not being relevant because something much worse happened instead. It’s a red herring. You might as well blame the crisis on ethanol subsidies or sugar tariffs or the stupid structure we use to allocate airport runway space or any number of other things that happen to be bad policies but that fixing would in no sense have prevented the current crisis.
52 Responses to “Understanding the GSEs”
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October 17th, 2008 at 10:24 am
it’s worth remembering that ultimately, the market didn’t believe the implicit guarantee: the reason we bailed them out is that they couldn’t roll over paper at an interest rate that would allow them to make a profit.
now, ultimately i think it’s a legitimate argument that the market basically said “you’ve always suggested that there’s an implicit guarantee here, and now’s the time to put up or shut up,” but still.
meanwhile, we see in this insanity the pathetic level of right-wing analysis: the wsj, for example, loves to start with an ideologically correct conclusion and then find an appealing line of anecdote to support it.
October 17th, 2008 at 10:25 am
Matt-
Stuart Taylor makes a litte bit more of a coherent argument in his column in National Journal for greater blame to be place on Fannie and Freddie.
http://www.nationaljournal.com/njmagazine/openingargument.php
As I read it, the argument is essentially that by lowering standards for the mortgages they were willing to buy, Fannie and Freddie allowed the banks to extend more aggressive loans. The large financial institutions, for some reason, took their cues from Fannie and Freddie, and invested in these loans, dramatically underestimating the risk. Unlike a lot of the wingnuts out there discussing this issue, I actually respect Taylor and I think he has a point here. He may be overstating the role of Fannie and Freddie and toeing an annoying “I’m in the center and undecided” line, but Fannie and Freddie were at least part of the problem. As you’ve written before, at bottom, the underlying cause of the crisis is the boom and bust of the housing market. This was certainly in part aided by government policies designed to encourage homeownership, including support for Fannie and Freddie. Now as you, and others have pointed out, this does not explain how people failing to make their mortgage payments managed to almost bring down all of Wall Street. But I think we need to be a little more judicious in our assessments of the problems and potential solutions.
For what its worth…
Greg
October 17th, 2008 at 10:31 am
greg, don’t ever take stuart taylor seriously: he defends the legal logic of bush v. gore. that’s an unacceptable viewpoint from the standard of intellectual integrity.
that said, look, there’s all kinds of contributing factors, but the financial crisis is about over-leveraging. even if the underlying assets were great, 30-1 leveraging is a disaster waiting to happen, and no one put a gun to any investment bank’s head and forced them to do that.
now, obviously, an asset base of shitty assets precipitates the crisis much more readily, but a housing bust (which, after all, we’ve had before: i bought my very first condo in the late ’80s in boston during the course of a several year housing bust – i thought, in fact, i was buying at the bottom and i was wrong) could not have resulted in a crisis of the entire financial system were the leverage not massively excessive.
October 17th, 2008 at 10:39 am
A large number of our financial intellectual “elites” don’t realize — according to their own writing — that 2 (or more!) things can happen at the same time. As bad as the mortgage crisis might be, the leveraging of risk derivatives, without regulation or even public exposure of their extent, is worse and a couple of orders of magnitude larger.
As a result, there are a whole lot of people who’ve had their assets vacuumed and don’t even know it yet. I can understand why the WSJ wouldn’t want this widely known: they might still hope to profit from the public’s ignorance. And they sure wouldn’t want their participation in it bruited about.
October 17th, 2008 at 10:48 am
I read the Stuart Taylor article, and it is very poor. He argues that the GSEs got into the subprime securites market because the private banks were dominating that it and making all the profits from it. Then he turns around and says that because the GSEs jumped into that market, it acted as a seal of approval for private banks so they got into it too. That’s circular reasoning of the worst kind. If the GSEs never bought a single subprime mortgage security, we’d be in the same situation as we are now. I doubt that a single subprime mortgage would have been left unwritten if the GSEs never got into that market.
October 17th, 2008 at 10:49 am
Re Matthew’s comment “In fact, all before this crisis I generally agreed with the conservative view on the so-called “government-sponsored entities.” As such, I actually understand what that view was! The view was that the implied government guarantee to Fannie and Freddie might cause them to take unduly large risks, and that the very scale of those risks would mean that in the event of a crash we actually would need to bail them out despite the lack of explicit guarantee.”
————
Hmmm. I wonder if Matthew has realized yet that the Paulson plan he was endorsing last weeks now has the government guaranteeing an additional $2.2 TRILLION!!! in business
deposits??
Read ‘em and weep, Rubes.
October 17th, 2008 at 10:51 am
As I read it, the argument is essentially that by lowering standards for the mortgages they were willing to buy, Fannie and Freddie allowed the banks to extend more aggressive loans. The large financial institutions, for some reason, took their cues from Fannie and Freddie, and invested in these loans, dramatically underestimating the risk.
http://www.nytimes.com/2008/10/05/business/05fannie.html?_r=2&hp=&oref=slogin&pagewanted=all&oref=slogin
I suggest you read that article, twice or three times so it sinks in. Actually I’m going to e-mail it Taylor, who seems like a hack.
The large institutions “for some reason” didn’t take their cues from Fannie and Freddie, they tried to take their business “for the reason” of making money.
Of course the Democrats aren’t blameless, they usually share a part of it, but Republicans have been running things lately. The Democrats have been unable or unwilling to distribute economic and productivity gains throughout the economy so they are reduced to helping people buy homes cheaper than they might normally be able to.
And don’t you think conservatives, who reportedly value taking responsibility, should think that “large financial institutions” have only themselves to blame?
How were they forced to enter that market???
October 17th, 2008 at 11:00 am
I think Matt gives too much credit to the conservatives on this one. I assume the warnings and legislation mentioned in the WSJ piece refer to s.190, The Federal Housing Enterprise Regulatory Reform Act of 2005. This bill has also been referenced by Peter Wallison twice on the WSJ OpEd page. But conservatives never explain how this bill would have specifically helped avoid the Fannie/Freddie collapse. Upon researching the bill, I found that Mr. Wallison, through the AEI, was a major supporter and wrote a few position papers on s.190.
In Wallison’s own words:
(emphasis mine)
While its true that Republicans sought to reduce the size of the GSEs’ portfolios, they ignore the fact that it didn’t reduce their exposure to credit risk. Obviously, credit risk turned out to be quite a bit more damaging than interest rate risk (to put it mildly). Hence, the Republican attempts to “reform” and “regulate” GSEs in 2004/2005 would not have done anything to slow or prevent the their demise.
October 17th, 2008 at 11:03 am
Your former colleague Ms McArdle blames FMNC for taking risks that the private sector would not, due to its special government chartered status. Of course one need only point out that Fannie and Freddie didn’t actually originate subprime loans at all, and that the riskiest loans were originated by companies that failed years ago, like New Century. Remember New Century?
It is also worth mentioning that though FMNC was government chartered, it was a private corporation run for profit. It was run by executives elected by the board, voted on by share holders. So how is this exactly the government’s fault? If anyone is to blame in this mess, it is Republican Allen Greenspan, for setting interest rates too low during a period of deficit spending and for encouraging ARM loans during a period when they did not make financial sense.
October 17th, 2008 at 11:07 am
This argument is a case of the tail wagging the dog. This was already happening in the mortgage industry and Fannie and Freddie had, until a point, refused to join in. They only started doing this once they had lost so much market share to the mortgage outfits already doing this. So all this proves is the Stuart Taylor has done absolutely no research of the lending timelines over the past decade.
The conservative arguments (well, except for the “Democrats were for deregulation too” claim, which is legitimate) can all be demolished by five minutes of reading Roubini/Calculated Risk/Big Picture/Mish or anyone else who has been right about everything for the past several years.
October 17th, 2008 at 11:07 am
The sub-prime problem would have been contained had certain persons not lobbied the SEC to look the other way with all the insane increases in leverage.
Canada only allowed 20-1, and they aren’t hurting like we are. I guess Harper isn’t very Bush-like.
October 17th, 2008 at 11:12 am
This is the problem with so many of the conservative theories of the financial bubble. There is a germ of truth in all of them, in that the policy problem they identify is often real. But the connection of that flaw to the financial crisis is essentially nonexistent. You point out the germ of truth to one version of the “GSEs did it” story. Even the CRA story has a germ of truth, in that encouraging home lending to underserved communities is a very delicate business. (The story of the FHA and black homeowners is a case in point: Until the 1960s the FHA rarely insured mortgages for black homeowners. It got hammered on that but ended up overshooting in the other direction, and a lot of black families ended up losing their homes to foreclosure.)
The result of all this is that now it is impossible to have a candid discussion of these very real policy problems because the whole topic has become so politicized. If you point out that CRA regulators or the GSEs need to be careful to avoid creating perverse incentives, it looks like you’re endorsing ignorant wingnut theories of the financial crisis.
October 17th, 2008 at 11:14 am
I agree the implicit guarantee was potentially dangerous–but it turns out the market was so screwed up it didn’t matter!
Every goddam firm playing with housing paper acted as though they had an implicit guarantee. They were buying goddam NINJA loans! And they were actually arguing you didn’t have to worry about these loans defaulting because housing prices always go up, so the paper holder can just sell the property at a profit! Magically! And then they compounded their stupidity by leveraging the shit out of these things, which made this house of cards big enough to take down the global finance industry.
In terms of bubbles, the practical difference between Fannie and Freddie and everyone else wasn’t the guarantee on the loans, it was that there was some (but not enough) regulation of the kinds of loans made by Fannie and Freddie, and ZERO for everyone else.
Conservatives were so busy hating Fannie and Freddie for ideological reasons that they totally missed the fact that the rest of the market was already doing exactly the stuff they said they were worried Fannie and Freddie might do!
October 17th, 2008 at 11:16 am
As a heuristic, you might wonder why this piece of finance and business journalism didn’t make it into the WSJ news pages.
That’s a pretty good rule of thumb for anything you read on the WSJ op-ed page. If the piece comments on something reported elsewhere (including the WSJ front page), that’s fine, wingnuts are entitled to their opinion. But given the WSJ news desk’s resources and reputation, you can safely assume that any ‘news’ that appears under the byline of one of their crackpot pundits didn’t pass muster with the people at WSJ who actually do journalism for a living.
October 17th, 2008 at 11:34 am
1) Here’s Matthew’s blog post endorsing Paulson’s latest give-away: http://yglesias.thinkprogress.org/archives/2008/10/recapitalizing.php
2) Here’s the detail that Matthew overlooked:
http://economictimes.indiatimes.com/News/International_Business/US_may_guarantee_nearly_2_trillion_for_banks/rssarticleshow/3596419.cms
“WASHINGTON: The government may guarantee nearly $2 trillion in US banks’ debt and deposit accounts for more than three years in an effort to break the crippling logjam in bank-to-bank lending.
That’s the equivalent of about 20 percent of the national debt, which recently blew past $10 trillion, and roughly 14 percent of US gross domestic product, the economy’s total output of goods and services.
The temporary guarantees for banks by the Federal Deposit Insurance Corp are in addition to the new $250 billion plan announced by the government Tuesday to directly buy shares in US banks. ”
————–
How will they pay off on those UNFUNDED guarantees if the economy tanks? Well, Congress will have to pony up another $2 Trillion , won’t they?
FDIC is talking about levying a deposit insurance fee but ,hey, if the banks had enough capital to back these guarantees, they wouldn’t need the guarantees in the first place.
October 17th, 2008 at 11:40 am
The GSE’s were understood by Greenspan and Wall Street to be the goose that laid the golden egg. While it is generally understood that as bank credit expands and the economy grows that growth spurs ever greater credit expansion. In other words it’s a self reinforcing dynamic. Expanding credit begets more credit. It provides its own liquidity. (back in the post war period the Fed would periodically step in when things got going too fast. Taking away the punch bowl it was called. With Greenspan however there was never any desire to take away the punch bowl. It was party time forever)
What wasn’t understood by most, except the pigmen, was that a strong expansion in non bank issued credit would have the same effect. The real estate bubble really started in the early 90’s with Greenspan’s ultra aggressive rate cutting and an institutionalized push throughout the entire financial world including the Fed and the US government to inflate housing prices. Once prices began rising the incentive to borrow increased and the GSE’s were there to accomodate.
Of course the GSE’s were very old and the system had been there all along but until then it had never occurred to leaders to foster a bubble. As the GSE’s booked hundreds of billions and then trillions of mortgages per year the liquidity flowed through to the broad economy. As the bullish implications of secularized debt became known every manner of debt came to rely on the new Wall Street centered system of credit creation which bypassed banks totally, except for thir crucial role in providing the short term credit to the aggregators and packagers of the secularized debt.
The GSE’s books became behemouths which would have rendered them bankrupt in any downturn at all. By the early 00’s it was apparant that they were out of control. The hapless regulator of them began sounding alarm bells, having to push against the politicians who loved the GSE’s. Eventually batallions of accountants decended on the GSE’s trying to figure out their books, something that was never really completed. At any rate the GSE’s were ordeded to sell off huge chunks of their portfolios, instead of in small chunks as in days of old. This brought another element into the endgame as foreign central banks bought a trillion dollars of GSE mortgage paper. All guaranteed except they didn’t have the capital to guarantee when the disaster struck. That is what the GSE ‘bailout last month was’. Uncle Sam in now going to pay for the losses in the foreign central bank GSE paper holdings.
October 17th, 2008 at 11:40 am
Matthew,
I’m sorry, but your analysis is almost totally incorrect. In fact, as I’ve pointed out in the past, Fannie and Freddie created a whole new market for these troubled loans. Because they were able to secure a great deal of the mortgage market, thanks to their implicit federal backing, you had a number of banks out there that were forced to compete on an uneven playing field–therefore they turned to clients that had, let us say, less than healthy credit. What made this situation exponentially worse is that Fannie and Freddie would turn around and buy those loans from these banks in order to capture more and more of the mortgage market.
It is absolutely correct to say that this wasn’t entirely Fannie and Freddie’s fault, but to forgive them (and individuals like Frank and Dodd) is denying reality. Had they never existed in the first place, this would have been a much smaller problem that would have effected a very small number of banks. But because Fannie and Freddie were on a buying spree, banks just handed out these loans because they knew that they would eventually be bought up and repackaged by these GSEs.
October 17th, 2008 at 11:55 am
I had no idea that Chris Dodd, a member of the minority party in 2004, had the power to prevent the Republican-held Congress from doing anything. Interesting.
October 17th, 2008 at 12:02 pm
Lee,
Completely agree with you. The Republicans did nothing for four years and this is a sin of omission.
Had they pulled a stunt like they did on the drilling (which demonstrated just how little they understand markets as the price of oil was falling over the summer), perhaps they could have weathered the economic political storm that is killing them now.
Personally, I’m glad to see them being blamed for this. This is the price you pay when you abandon your principles (or simply are too stupid to understand just how serious a problem this was).
Perhaps this loss will rescue the party intellectually…but given the folks supporting the party at these Palin rallies, perhaps not. Oh well, if Chuck Hagel gets the nod at State, hopefully they’ll be some room in an Obama administration for disaffected conservative realists.
October 17th, 2008 at 12:14 pm
Dodd was in the minority in 2004.
How does his one vote change everything in
the senate?
Its not like he’s Coburn or Jesse Helms, he’s a Democrat.
October 17th, 2008 at 12:22 pm
catclub,
All you need is one determined Senator to derail legislation in the Senate (when you don’t have 60 votes). While Dodd was the most prominent support of Fan and Fred, there were others…including some Republicans I might add.
I’m not blaming Dodd for all of this, I’m just pointing out that he deserves a great deal of the blame with respect to these twin disasters.
October 17th, 2008 at 12:32 pm
Nobody’s saying that these GSEs originated bad loans – it’s that they bought them. This creates far-reaching incentives throughout the entire industry.
October 17th, 2008 at 12:46 pm
I spent 10 years working for a secondary mortgage lender. Not a small one either, you’ve all heard of them and their brand was synonomous with baseball, apple pie and pickup trucks.
I think we have a chicken and egg problem here.
The way the mortgage market worked was that it was divided into conforming and non-conforming. Conforming is what we called agency paper, meaning it conformed to the limits that the GSEs were allowed to operate under. Namely good credit rating, salary history, and mortgage was under the Jumbo limit.
The private mortgage companies by and large did not compete in the conforming space, because the GSEs were far more efficient at operating there. Because of volume, and because they were backed by the government they could borrow money at a lower rate. So they could pass on a lower rate to the borrower. So banks and even the private mortgage companies would originate the loans, and then just sell them right to the GSEs who would bundle them as mortgage bonds.
There was a lot of money to be made in non-comforming, but the market was smaller than conforming. Now at some point the GSEs were authorized to start playing in this space, I’m sure because they were for-profit companies and they wanted some of these profits.
The problem was that by 2004, the whole market was starting to dry up. There were too many competitors by this point, and then construction started slowing. The MBA(mortgage bankers association) lobbied Congress to knee cap the GSEs. That’s what the Congressional hearings in 2005 were all about. Yes, the GSEs had had some problems with their books, but it was because they were underreporting profits. It wasn’t losses at that point. Still, the argument was made that they were too big and needed to be shrunk. But that wasn’t why the Republicans were arguing it. They were arguing it because the MBA had lobbied them to get the GSEs knee capped so they would have less competition in the market.
We were told by our senior management that their hope in 2005 was that the GSEs would be limited, and this would allow us to bring in more revenue. That’s what the goal was. And the Democrats knew this, and it’s why they opposed the measures. Now I think there were arguments for capping them, or splitting them up. But the whole thing was political right from the start.
But that’s not what caused the mortgage meltdown.
What happened next, was due to the market slowing and these mortgage companies all having a desire to GROW 15-20% annually. Since the GSEs didn’t get capped, they did the next thing on the list you do to grow market, you extend into riskier and riskier product.
That’s why I say it’s a chicken and the egg. The mortgage meltdown wasn’t caused by the GSEs, but perhaps if they had been capped, the increased marketshare available tot he mortgage companies would have kept them happy. But I still blame the mortgage companies, as they are the ones who in an attempt to keep growing, started moving into riskier and riskier parts of the pool.
There’s a lot of moving parts, but the fact was by 2004 the market was starting to slow down, and everybody involved didn’t want that. Not just mortgage companies, but also builders, realtors, etc. It was that last overreach, the last overextending that brought things down. Prior to that, it was mostly sustainable.
October 17th, 2008 at 12:49 pm
The GSEs never originated, they were a secondary lender. They bought from originators and securitized the loans into MBS.
In the non-GSE space there were other secondary lenders, but they also originated product. Countrywide was the largest non-GSE in this space. They originated their own, but also bought from brokers, warehouse lenders and so on.
October 17th, 2008 at 12:59 pm
I agree, these institutions shouldn’t have given out these loans…but I find it amusing that you’ve got folks on the left, who reflexively don’t trust private industry (in some cases for good reason), wondering why these banks would give out these loans when Fan and Fred were more than happy to buy them from them.
Why did people like Chris Dodd continue to push to allow Fan and Fred to operate in this fashion? Can anyone answer that?
I’m sorry folks, but if you’re going to try and excuse the institutions for providing the impetus for these loans to take place, your argument doesn’t have a leg to stand on. The reality is that they were at the center of this debacle, along with Sarbanes-Oxley, outdated regulations, greed, and frankly, arrogance. How very human of us all.
October 17th, 2008 at 1:01 pm
Ed Smithe,
Re: comment 17. could you please provide some data for your assertion that “Fannie and Freddie created a whole new market for these troubled loans.” My understanding is that the exact reverse was true: i.e. that Fannie and Freddie’s market share was actually dropping during the years during which the sub-prime market was exploding. In other words, it wasn’t Fannie and Freddie who were leading the charge into the sub-prime market. Rather, they were following Wall Street’s lead. According to McClatchy:
I would also suggest, pace Matt, that the real problem that conservatives had with Fannie and Freddie was not the moral hazard created by the implicit guarantee, it was the competitive advantage the guarantee bestowed on the GSEs. Wall Street banks wanted to cut into the GSEs market share, so they lobbied their creatures in Congress to reign in the GSEs. Statistics suggest that they got their wish: Fannie and Freddie’s share of loans dropped significantly starting in 2006. Again, McClatchy:
It’s a bit of a chicken-or-the-egg argument, but it seems pretty clear that the GSEs weren’t leading the charge into the sub-prime market.
October 17th, 2008 at 1:04 pm
shorter mercurino: see The Other Steve
October 17th, 2008 at 1:14 pm
I’m a little confused by something, Ed. There’s a lot of testimony that the big Wall Street outfits were going into the repackaging business anyway, and that the GSEs went in to keep up; see, for example, the NYT article cited above. If this testimony is true, then wouldn’t Lehman Bros. et al. have just gone off the cliff anyway, regardless of whatever the GSEs did?
October 17th, 2008 at 1:22 pm
GSE Timewarp:
http://www.nhi.org/online/issues/125/goingsubprime.html
Cute reading there.
October 17th, 2008 at 2:04 pm
mercurino,
You’re correct, Fan and Fred weren’t leading the charge, but as I said, they were the ones underwriting it.
http://money.cnn.com/2008/07/11/news/economy/fannie_freddie.fortune/index.htm?postversion=2008071209
With respect to what conservatives were upset about…it was both the moral hazard and the unfair advantage. Moreover, as we’ve seen (and many conservatives and some democrats warned), the management of these institutions were crooks that knew nothing about the business of mortgages. Their modus operandi was simply to enrich themselves with no regard for the risk that they were subjecting the nation to. On all three counts, I think that we were right. Granted, not every “conservative” could approach this problem empirically, which is one reason why these “conservatives” chose to do nothing about it when they were in power.
Though many people that visit this website are dubious of it, I would also recommend the Wall Street Journals editorial collection on Fan and Fred. While I have found a great deal of fault with their shift to neoconservatism, the WSJ has been absolutely on the mark with respect to these two disasters. Indeed, I can remember taking Metro North from Westchester to the City in 2002 and reading about Fannie and the risks it posed. Before you pass judgment, do yourself a favor and read them…If you’re not convinced after that, at least you’ll have a sense of why conservatives such as myself assign blame to Fan and Fred.
http://online.wsj.com/article/SB121599777668249845.html
October 17th, 2008 at 2:11 pm
Benny,
I think that’s a valid question, though I don’t think it can be answered. All I can say is that Fannie and Freddie’s involvement didn’t help…and it was well within our control to stop them.
I think we’re all in agreement though that this goes beyond Fannie and Freddie. Indeed, there were significant problems with the regulations (as in lack thereof). With respect to short-selling for example, you had a situation where individuals were not playing by the rules because no one was enforcing them. This, in part, led to a run on these institutions which killed folks like Lehman Brothers.
When you look at all of the factors (some larger than others) the whole thing was a perfect storm just waiting to happen.
October 17th, 2008 at 2:12 pm
The fact of the matter is that MY is right that GSE firms are completely incidental to this problem. The conservative argument here fundamentally relies on the assumption that dangerous, unsustainable asset bubbles do not emerge in capitalist markets. WTF!!?? Of course they do. Only a complete moron would dispute this. The question we need to concern ourselves with is, “what happens when an unsustainable bubble emerges?”. The answer is that we need to insure that the regulatory apparatus exists to insure that privileged institutions like banks are not allowed to invest long in risky, bubble-vulnerable markets without appropriate capital backing. That regulatory apparatus failed because we allowed dubious measures of credit rating to substitute for sound judgement. Also, absurd practices like everyone insuring one another were supposed to protect each other from easily predictable events like a market downturn. I don’t even think the problem of banks being too large was the problem here- everyone was simply too dependent on everyone else’s risk exposure and most of them had the same damn exposure in the real estate market. It’s not as if this is the first time we’ve seen a real estate bubble, or even an economically disastrous one.
October 17th, 2008 at 2:23 pm
mpowell,
Perhaps there are a collection of “conservatives” out there that don’t believe that “dangerous, unsustainable asset bubbles do not emerge in capitalist markets,” but I am not one of them. Markets are made of human beings, human beings are prone to mistakes…and sometimes these mistakes take on a herd mentality–leading to these types of bubbles.
But let’s not pretend that these two behemoths were “incidental” to the problems that we face. Of the 12 trillion dollars of mortgages that are out there, Fannie and Freddie hold 5 trillion dollars of them. Size alone makes their presence significant by any objective measure.
Factor in their business practices, their management, their risks, and their downfall and you have a significant reason why this all went to hell. Again, I am not arguing that they are the end all, be all…But to say that they don’t matter is simply ludicrous and sets us up for this to happen again down the road. Maybe this time I’ll actually wait for things to hit the bottom before I buy in.
October 17th, 2008 at 3:35 pm
Ed, I think my argument would be that there are any number of things that could have been or could have happened that would have led us down a different path. Many of those things should have been done for their own reasons. I agree with MY on that one. But if our financial sector can be built to withstand a bubble, then we are much better off. If we cannot build a financial sector to withstand an asset bubble, we will never succeed at moderating our business cycles. So arguing about the precise cause of this or that asset bubble is pissing in the wind when the real problem is a financial sector that collapses along with any particular asset bubble.
The frustrating thing about this situation, is that from a personal perspective, I correctly identified the relevant asset bubble and avoided it. But a much wider pool of investments was heavily negatively affected because of our poorly built financial system.
October 17th, 2008 at 3:36 pm
Ed Smithe:
But let’s not pretend that these two behemoths were “incidental” to the problems that we face. Of the 12 trillion dollars of mortgages that are out there, Fannie and Freddie hold 5 trillion dollars of them. Size alone makes their presence significant by any objective measure.
What a lame-ass argument. Conservatives really have sunk to sorry depths.
Their market share actually fell as the bubble grew to ever more dangerous levels, dropping from 50.1 percent in 2002 to just 34.8 percent at the peak of the bubble in 2006.
Fannie and Freddie deserve blame for failing to recognize the bubble (this is their job), but clearly they were not the primary cause.
http://www.prospect.org/csnc/blogs/beat_the_press_archive?month=10&year=2008&base_name=mccains_fanniefreddie_accusati
Mr. Mozilo, who did not return telephone calls seeking comment, told Mr. Mudd that Countrywide had other options. For example, Wall Street had recently jumped into the market for risky mortgages. Firms like Bear Stearns, Lehman Brothers and Goldman Sachs had started bundling home loans and selling them to investors — bypassing Fannie and dealing with Countrywide directly.
“You’re becoming irrelevant,” Mr. Mozilo told Mr. Mudd, according to two people with knowledge of the meeting who requested anonymity because the talks were confidential. In the previous year, Fannie had already lost 56 percent of its loan-reselling business to Wall Street and other competitors.
http://www.nytimes.com/2008/10/05/business/05fannie.html?_r=1&hp=&oref=slogin&pagewanted=all
The other Steve @ 23 sounds right. The market was drying up, competition was stiff, players took on more risk and were heavily leveraged. When things went south, they went bad quickly.
The problem wasn’t the GSEs, it was conservative ideology and its irrational hositilty to democratic governmental regulation of irrational markets and overleveraging. Conservative ideology has taken a heavy hit these last couple months even if you are too effing stupid to see it. Go hassle some other blog.
October 17th, 2008 at 4:48 pm
Christ, posts like that are why I’m starting to favor blogs without comment sections. Somebody presents a differing opinion, and you take it personally.
‘Hassle some other blog’? What, there’s no room for any opposing viewpoint on Matt’s blog?
October 17th, 2008 at 5:20 pm
Everybody who was anybody in politics and business was at fault. Republicans are attacking Fannie Mae because that’s where Democrats went to get rich, not because it was the sole cause of the housing bubble. George W. Bush’s attacks in 2002-2004 on down payments as the “chief barrier” to minority homeownership, which he wanted to boost by 5.5 million homes, was at least as culpable as Pannie Mae. And it wasn’t just lending to minorities — debauching traditional credit standards in the names of increasing minority homeownership was a convenient excuse for debauching credit standards for everybody, which is what most of the ruling class wanted.
If you want to understand the roots of the mortgage meltdown, read UT-Dallas economist Stan J. Liebowitz’s “Anatomy of a Train Wreck”
PDF Download PDF File (29 pages)
http://www.independent.org/pdf/policy_reports/2008-10-03-trainwreck.pdf
Why did the mortgage market melt down so badly? Why were there so many defaults when the economy was not particularly weak? Why were the securities based upon these mortgages not considered anywhere as risky as they actually turned out to be?
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.
October 17th, 2008 at 9:43 pm
“What a lame-ass argument. Conservatives really have sunk to sorry depths.”
If you cared to read my other posts Peter, you’d find that this was only one of many facts that disprove your analysis. Moreover I don’t see you tackling the reality that Fan and Fred are responsible for nearly 50% of the ENTIRE MORTGAGE MARKET. As I said before, and I’ll say once again for your benefit:
I AM NOT ARGUING THAT FAN AND FRED ARE SOLELY RESPONSIBLE FOR THIS MESS. BUT TO ARGUE THAT THEY WERE INCONSEQUENTIAL IS ABSURD.
Also, you might want look at your quote. “Fannie had already lost 56 percent of its loan-reselling business to Wall Street and other competitors.” Note “loan-reselling.” That doesn’t include all of the loans that they were BUYING from these banks, including Countrywide. Even the New York Times can be wrong from time to time. Per my earlier observation, you might want to take a look at the WSJ to get the other side of the argument.
October 17th, 2008 at 9:50 pm
Andrew,
I agree that it can be rather frustrating when one gets these personal and incredibly poorly thought out comments in response. But I am very thankful that Matthew has provided us with a forum in which to hash this stuff out. More often than not, I’ve found individuals of both the left and right interested in a thoughtful debate of these issues. More often than not I’ve been able to find a degree of agreement between both sides. That is a sign of progress given the destructive emotions that have torn apart both parties (and our political system).
Those of us that give a shit about facts and about keeping the emotions to a minimum need to work to purge our respective parties of these simpletons. They are of no benefit to the future of our nation…indeed they have created problem after problem that will need to be solved. I’m beginning with the neocons on my end…I would hope that the left would find their brand of neocons and purge them with me.
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