Center for a Stateless Society
A Left Market Anarchist Think Tank & Media Center
After Greed, Comes Fear

After Greed, Comes Fear and Fannie’s Follies, Freddie’s Foibles were originally posted to the Art of the Possible blog by Angelica aka Battlepanda.

There have been so many defaults on mortgages and the housing market is in such freefall that the chief investment analyst at Johnson Illington told NPR that for now at least, nobody want’s to touch them.

JOHNSON: If there are no buyers and you can’t sell it, it’s probably worth nothing…when you can’t sell a security, it’s really worthless.

When will they start being worth something again? Depends on when we find the bottom on the housing market, Johnson said. Meanwhile, legitimate borrowers are finding it hard to secure credit. David Wessel, the economics editor of the Wall Street Journal said in an earlier segment of the same show that bankers have become skittish. “When good credit can’t borrow, that is the definition of a credit crisis,” he said.

It wasn’t that long ago when lenders were tripping over themselves to throw money at any schmuck with a piece of real estate. Now they can’t lend money to people who are much better chances. After greed, comes fear.

The Market is often conceptualized as a ur-entity that takes a whole bunch of individuals, who are irrational and only has partial information, into a omniscient machine that prices everything correctly. In the housing market debacle, we see something that is almost the opposite. As they moved through the market, the sub-prime mortgages became more and more opaque, as a result they were incorrectly priced. All the information that might be available to a local bank assessing lenders on a one-on-one basis disappeared as large number of mortgages were bundled as securities and then are sold off far away. The market having severed the link between lenders handing out the loans and the individual(s) who ultimately is left holding the bag as the loan goes bad.

It is not for nothing that the charging bull and the rearing bear are the enduring symbols for the two faces of the Market. Right now, the government is trying to coax the bear back to the cave with all manners of monetary and fiscal tricks.

Maybe it should have been  quicker with the brindle of regulation on the bull instead before it charged out of control.

This entry was posted on Wednesday, March 12th, 2008.

Fannie’s Follies, Freddie’s Foibles

In my post, After Greed, Comes Fear, I excoriated the role of the unregulated market in the current sub-prime mess we’re in. Quasibill cried foul, pointing out quite rightly that the whole concept of mortgage-backed securities started off with Fannie Mae, Freddie Mac and all the rest of those cutely acronym-portmanteau-ed government-sponsored enterprises. To quote ‘Bill directly, “to lay this turd at the feet of “unregulated markets” has the causation entirely backwards.”

My response? I both agree with ‘Bill, and I stand by my post. It is possible for there to be both simultaneously too much government influence AND too little regulation. Read on…

Too often, when libertarians and liberals argue, the conversation gets flattened into a single axis with a totally unregulated market on one side and complete state control on the other. Each participant pick the point on the spectrum that they reckon is optimal, dig in their heels and start playing tug.

However, the reality is considerably more complicated, with all sorts of permutations and combinations of public and private. In addition, a situation with relatively high levels of regulation can have positive or negative outcomes depending on the quality of the regulation. Situation with relatively high levels of market freedom can also have positive or negative outcomes depending on all sorts of things from culture to extant levels of infrastructure to external factors such as what other countries are doing.

Kevin got at this oft-ignore complexity very effectively with his post, Libertarian Self-marginalization. Many of those he terms “vulgar libertarians” find themselves defending all sorts of unsavory institutions such as sweatshops or big-pharma because, argues Kevin, they are ignoring the government distortions that underlies the market that produces those results. They are too busy tugging.

In the case of Fanny and Freddie, what we have is an unholy hybrid of the public and the private that should never had been allowed to live. Bill Mann of the Motley Fool put it really well: “The duality of Fannie and Freddie as publicly traded ventures and government-backed entities is the real conflict.” Any time you have a situation where the profits are private and the risks are public, you can bet that it is a matter of time before the whole thing start stinking to high heaven. And so it proved.

I recommend Mann’s article What does Fannie Mae do highly. It was written back in 2004, but recent events have ensured that it remains compelling. (Of course, Fannie haven’t enjoyed AAA ratings for a while now.)

Fannie Mae doesn’t just hold onto all of these mortgages, though. It will take your loan and package it up with hundreds of others and market them as mortgage-backed securities (MBS) that it then sells to investors (for example, insurance companies, pension funds, or even mortgage REITS like Annaly Mortgage (NYSE: NLY)). Fannie Mae provides a guarantee to these investors that they will receive timely principal and interest payments, no matter what happens with the underlying mortgages. If there are large numbers of defaults, Fannie Mae will have to make the investors whole. If there is a massive crash and defaults overwhelm Fannie Mae, it has an ace in the whole: your tax dollars. Even though the company’s debt offerings clearly state otherwise, the financial markets believe that Fannie Mae’s status as a government-sponsored enterprise implies that the government will provide full faith and credit for Fannie’s debt. It is for this reason that Fannie Mae maintains a AAA credit rating, even though at a 78:1 debt-to-equity ratio it is levered many times what is allowed international banks. (Debt is defined as mortgages on its books plus the value of its guarantees.)

Fannie is exempt from regulation by the Securities and Exchange Commission (though Fannie Mae has in the last few years begun filing 10-Ks and 10-Qs), it is also exempt from state and local taxes. The U.S. president gets to appoint several board members, and the U.S. Treasury Department approves Fannie Mae’s debt issuance. And it has approved and approved and approved. Fannie Mae and Freddie Mac have virtually unlimited access to capital, at funding costs that are below the rates otherwise available on the market. As Fannie and Freddie have approached saturation in their core businesses, they’ve branched out, basically by taking on more risk. Fannie and Freddie have been arguing against the need for statutorily required mortgage insurance for loans above 80% of the value of the home, the bailiwick of private mortgage insurance providers like MGIC (NYSE: MTG), Radian Group (NYSE: RDN), and PMI Group (NYSE: PMI). Why would they do this? Because Fannie and Freddie want to cut out the expense of paying the PMI providers, even though it increases the risk of their overall portfolio.

You may, between the last two paragraphs, already be able to discern how it is that avarice at the top could maul Fannie Mae. It has a AAA credit rating, despite the fact that its debt levels in no way warrant such a rating, and it has a nearly limitless channel to capital, at interest rates that are below market. Add to these elements the fact that Fannie Mae is not a governmental operation, but a for-profit corporation, and you have the recipe for — well, for what’s going on right now. Why worry about risks when you have the implied backing of the federal government? Why worry about capital structure when no matter what your cost of debt is fixed at a below market rate?

Fannie and Freddie are both poorly-regulated and not part of a free market. The same goes for other public/private monstrosities such as the Medicare prescription drugs coverage plan and any number of poorly thought out privatizations schemes.

This entry was posted on Thursday, March 13th, 2008.