Freddie Gets Favored

Upon the news of a federal bailout of quasi-public mortgage lenders Fannie Mae and Freddie Mac, comrade Dean Baker nails the long and short of it:

We had to keep Fannie and Freddie in business, but we could have done this by putting conditions on the bailout. The government uses conditions all the time when it offers help to low and moderate income people. Unemployment insurance, TANF, food stamps, and even student loans come with all sorts of conditions.

It is only when it comes to giving money to extremely rich people that we find it impossible to impose conditions. Again, we could have told Fannie and Freddie that no executives will get more than $2 million a year in total compensation. We could have told their shareholders that they are out of luck, because that is what is supposed to happen when you invest in a bankrupt company.

Instead, we told the people who work as truck drivers, school teachers, and fire fighters that they will have to pay more in taxes to help some of the richest people in the country escape the consequences of their own stupidity. While kicking the poor is always fun for politicians, neither the Bush administration nor Congress are prepared to tell the very rich that they are on their own.

But let's step back a little bit and explain why Brother Baker, as usual, is so wise.

You might have heard that the mortgage crisis has something to do with the fallout from "securitizing" home loans: in other words, bundling a bunch of loans together as investments, in which one could buy shares.. But securitization itself is not a bad or dangerous thing; originally, it was the opposite—it was one of the wise progressive policies that made the democratization of homeownership a virtuous circle that made the entire nation, and especially ordinary Americans, better off.

Here's how I described it over a year ago, back when the foreclosure crisis first became obvious (foreclosures have gone up 55 percent since then):

FDR said protecting homeowners from "inequitable enforced liquidation at a time of general distress is a proper concern of the government." The situation, now as then, cried out for collective action coordinated by government, because it is a collective problem—protecting home values: a virtuous circle, helping everyone.

The HOLC [Home Owners' Loan Corporation] also refinanced mortgages, mandating unprecedentedly low interest rates, and also unprecedentedly long repayment schedules. That set into motion a policy cascade that soon far transcended merely the needs of those in financial hardship and spread to the entire middle class—indeed, helped build the middle class.

The Federal Housing Administration was established in 1934 to insure mortgages, mandated at favorable terms; in 1938 the Federal National Mortgage Association (Fannie Mae) was established to create a secondary market for mortgage—a radically different secondary market than the one created by Wall Street investment banks in the 1990s because it served both the interests of creditors (by freeing up liquidity for loans) and borrowers (because their creditors required less liquidity from them upfront in order to ensure a profit). Then, following World War II, the Veterans Administration offered even more favorable terms for the men who had just defeated fascism.

Previous to this decades-long process, the typical mortgage required a down payment of half the home's value and came due in 10 years; after, a mortgage involved a down payment of 10 percent, was financed at 4 percent spread out over 30 years—and mortgage payments were tax deductible. The homeownership rate was 40 percent before the war; by 1965, it was almost 65 percent. The salubrious housing policy environment had helped boost consumer spending; the upshot was the greatest sustained economic boom in the history of mankind, and the largest middle class the world has ever known.

The reason that securitization then was a very different thing than securitization now is that these reforms freed up capital to help the financial sector in exchange for the financial sector agreeing to enlightened regulations. The new mortgage-backed securities now exist for exactly the opposite reason: to provide banks with investment vehicles that are radically less regulated—a vicious circle, taking away mortgage-issuers' incentives to loan responsibly, because they can sell the securities whether the underlying loans are sound or not. The climate of deregulation than swept over Fannie and Freddie, too, making them just one more shell in the game, instead of what they were designed to be: capitalist institutions that also acted in the broad public interest.

The fact that they have to be bailed out is a function of how big they have become. The reason they became big was the enlightened bargain that created them in the first place: a government-near monopoly, in exchange for falling under enlightened regulations. Now we've removed the regulations—and the institutions prove "too big to fail."

Bailing them out could have become a progressive opportunity: As Dean Baker said, we could have demanded concessions in return for the cash. Instead, we're just shoveling rich bankers the cash.
It's a neat trick: the purest example extant of socialism for the rich.