Government Takeover of Fannie and Freddie

Don't underestimate the importance of this news story. As technical as it sounds, the US Treasury Department's seizure of the "Government Sponsored Entitities" (GSEs) Fannie Mae and Freddie Mac (for a basic primer on these institutions, see here) is important and has profound implications:

According to the Times, "It is not possible to calculate the cost of any government bailout, but the huge potential liabilities of the companies could cost taxpayers tens of billions of dollars and make any rescue among the largest in the nation’s history."

What's worse, we can't say we weren't warned.

This is perhaps the most disturbing aspect of this story. For years, various experts have told anyone who would listen that Fannie and Freddie were in urgent need of reform.

Alan Greenspan was telling anyone who would listen that trouble was coming:

"The strong belief of investors in the implicit government backing of the GSEs
does not by itself create problems of safety and soundness for the GSEs but
it does create systemic risks for the U.S. financial system as the GSEs
become very large," he said.

A study by Federal Reserve economists concluded in 2006:

there is reason to be seriously concerned about potential future social costs associated with the systemic risk emanating from Fannie Mae and Freddie Mac and that this risk largely arises from the institutions’ highly leveraged investment portfolios. We also find the social benefits of these portfolios to be minimal to non-existent. From these considerations, we conclude that a large reduction in the size of these portfolios would be socially desirable.

Some in Congress, however, was having none of it.

Here's Congressman Reuben Hinojosa:

I continue to support the level of Fannie Mae’s portfolio of loans. I disagreed
one hundred percent with former Federal Reserve Chairman Alan Greenspan’s
recommended that Fannie Mae’s portfolio be reduced from its current level to one
hundred billion dollars worth of loans. Such a proposal would have negatively
impacted Fannie Mae’s ability to meet its mission and would have harmed my
constituents.

Whoops.

And Representative Paul Kanjorski:

I am also heartened that Fannie Mae, according to its regulator, is cooperating and working to address these issues in a responsible manner. I am also pleased that although serious, these problems do not appear to pose a systemic risk according to those most knowledgeable of the facts in these matters.

I don't mean to single these two Members of Congress out. There were plenty of Members who turned a blind eye to need to rein in Freddie and Fannie.

So, Congress failed to act despite being warned by the most prominent financial experts in the nation. The taxpayers will pick up the tab. When Members of Congress ignore people like Alan Greenspan and housing finance experts, we need to ask "why?"

Amazingly, these entities were allowed to lobby even though they enjoyed explicit and implicit government subsidies. They spent millions on lavish fundraisers, employed many lobbyists both in house and the best K Street had to offer. This may serve as a partial explanation. Further, rather than being run by experience bankers, Fannie was run for many years by former politicos such as James Johnson, a former aid to Walter Mondale. Fannie hired many top staff from both parties for top jobs that any sane financial institution would have reserved for MBAs. They were political animals, yet they played with real money - taxpayers' money it turns out.

This why the Shadow Financial Committee, a non-partisan group of academics and other experts convened by the American Enterprise Instiute recommended back in 2005:

Congress should adopt a number of additional provisions that will reduce the impression among investors that Fannie and Freddie are backed by the government. Thus, Congress should repeal their exemption from state and local taxes, their so-called line of credit at the Treasury, the authority for national banks to make unlimited investments in their securities, and the fact that their securities may be used to collateralize Treasury's deposits in banks. In addition, as appropriate for organizations that receive a government subsidy, the GSEs should be prohibited from making political contributions and their lobbying activities should be limited.

These quasi private, private government entities, which allow people to real private sector like benefits while exercising government like power have been disasters. Why Fannie and Freddie failed, and why Members of Congress blocked reform legislation, should be thoroughly investigated. We could find a story that would make the whole Jack Abraham story appear to be trivial.

A Friday Thought

Comes from www.dailyliteraryquote.com:

If your everyday life seems poor, don't blame it; admit to yourself that you are not enough of a poet to call forth its riches; because for the creator there is no poverty and no indifferent place.

-Rainer Maria Rilke

The Conventions Are Over...

The Republican Convention ended last night, marking the end of the 2008 cycle of conventions.

A few thoughts and observations on political conventions generally.

-Each party only stages one every four years. They're not like reality shows or police science dramas, which seem to dominate the air waves. Watching as much of each as time allows, therefore, seems to be a small commitment for someone who is planning to case a ballot that will, in turn, impact the lives of their countrymen for the next four years and beyond.

-The television coverage of this years' conventions were revealing. The stations that have some sort of moral obligations to cover them (because they broadcast on public airwaves), e.g., ABC, NBC and CBS, carried only the bare minimum, while those who pretty much pay their own freight such as MSNBC, CSPAN, CNN and other cable channels provided more comprehensive coverage. That ABC, NBC and CBS have mostly abandoned their commitment to news has, of course, been obviuos for some time, but this is the most blatant example to date.

-It can be argued that this reflects the decline of a political convention from a place where news really happened, i.e. candidates were actually selected and have become political pageants instead. Still, this is the only time most voters will actually be exposed to the parties' message, unfiltered by the talking heads, for more than short sound bites. This alone means they are still a meaningful part of the political process.

In short, I hope you watched at least as much of them as time permitted. At the very least, you'll know the candidates' basic stories, the issues that matter most to them, and have some sense of what the differences are between the parties and what is at stake in this election.

Sadly, that is a lot more than most voters will have when they go to the polls this November.

Websites for Government Budget and Economics Information

Two good places to learn more about the fiscal and economic changes facing the US Government are the Congressional Budget Office's blog and the website of the Council of Economic Advisers. Bot contain reports, speeches and other useful economic analysis on a variety of economic topics written in a clear and professional manner.

The CBO Blog essentially summarizes the office's testimony and reports. It's a "Cliff's Notes" version of their work and written in pretty plain English. For example, here's a recent post on the problems facing Social Security:

the number of Social Security beneficiaries will grow considerably as the baby boomers become eligible for retirement benefits. Absent legislative changes, spending for the program will therefore climb substantially and exceed the program’s revenues. CBO projects that the 75-year actuarial imbalance in the program amounts to 0.38 percent of GDP, or 1.06 percent of taxable payroll.

The CEA publishes an annual report that contains chapters on a variety of topics. The 2008 edition contains chapters on housing, energy, tax policy and infrastructure, among others. If you want a "plain English" summary of the government's policies and challenges in those areas, it's an excellent place to start.

A Dose of Reality...

As usual, Robert Samuelson gives us some perspective on where we are economically. Using just released census data, he concludes:

For most Americans, living standards are increasing, albeit slowly, over any meaningful period. But rising health spending is eroding take-home pay, and immigrants are boosting both poverty and the lack of health insurance. Unless we control health spending and immigration, the economic report card will continue to disappoint. Unfortunately, neither Obama nor McCain seriously addresses these problems.

To clarify, I am not endorsing specific courses of action here (especially regarding immigration), but Samuelson's article is worth reading, although I'm not clear what he wants to do about immigration exactly when he talk about "controlling" it. He seems to be saying that illegal immigrants are skewing the numbers (i.e. making it look like our problems with wages and health care coverage are worse than they are because they're due to an influx of low wage workers, and don't accurately portray what's happening to the rest of us).

Meanwhile, looking at the same new census data, Brian Wesbury notes that good news:

Contrary to the often-repeated doom and gloom portrayal of the US economy – where workers are always working “harder and harder for less and less” – the report showed incomes have been rising, poverty remains low, and inequality shrunk dramatically in 2007.

Greg Mankiw notes the that the census data, even as positive as it is, paints a more negative picture of the economy than warranted.

If you're reading Samuelson, Wesbury, and Mankiw, you have a pretty good read on our economic situation.

An Inside the Beltway Mentality

Sometimes you may hear of a "beltway mentality."

It refers to the tendency of those of us who live in Washington, DC and work in "politics" to lose perspective on how other Americans see things when it comes to government, politics and Washington.

It's a phrase often overused by politicians trying to paint themselves as outsiders in election years when polls show people prefer "change" to "experience." Those without such mindsets are supposedly much more attuned to what the voters are thinking and desire. Despite the overuse, it's a very real phenomanon.

When I consider what we get wrapped up in and think is the most important thing in the world, I stop and ask whether any of my relatives who live outside the beltway are even aware of it.

Usually the answer is "no." It's not because they're simply not "up" on the news. Usually its because in the grand scheme of real life, much of what happens here isn't nearly as important as we think.

Intesting Choices

Our hometown paper, The Washington Post, asked some well known policy experts to recommend a book to readers to help them understand the current economic scence.

One expert is current Congressional Budget Office Director, Peter Orszag. Orszag recommends Robert Shiller's The Subprime Solution because:

In this most recent book, [Shiller] brings his combination of rigorous
economic analysis and psychological insight to our current economic predicament,
not only analyzing its causes but also offering possible solutions that could
help to inhibit bubbles in the future. More important than the specific
suggestions is his willingness to move beyond the Panglossian constraints of
conventional economics. We need a bit less 'Economics 101' thinking in
public policy and much more 'Psychology 101,' and Bob Shiller shows us how
in this book.

A second expert in Greg Mankiw, a Harvard Econ professor who is a former chairman of the Council of Economics Advisors and the author of the world's leading econ 101 type college textbook. Mankiw recommends Milton Friedman's Capitalism and Freedom, a basic defense of free market economic principles. because:

I read this book first as a student at Princeton 30 years ago and again more
recently when I assigned it for a freshman seminar at Harvard. Friedman's
insights into how the economy works and his classically liberal perspective on
the role of government are timeless. In this difficult economic time, it is
important to keep first principles firmly in mind.

Here you have in a microcosm the debate between two schools of economists. One, represented by Shiller and Orszag (and Obama advisors such as Austin Gollsbee) critique traditional free market economics for not taking other considerations, such as the psychology of crowds, etc. into account. They tend to believe that there is a larger role for government to play than traditionally recognized by classical economics. The latter, characterized by Mankiw and many others (specifically those advising McCain) generally believe that free markets are very efficient, and that even if imperfect will provide better outcomes than government programs.

Note: the above is a gross oversimplification, but I think this debate between those who believe in sticking to "first principles" and those who urge us to "move beyond the Panglossian constraints of conventional economics" still represents a high level overview of the two basic ways that economists and the two political parties approach economics and government policy.

Promises, Promises

One concern I have this year is the seeming disconnect between candidates' positions on the stump and what they really intend to do when elected. Of course, not every candidate can keep their promises once elected, but its usually understood that a candidate will at least try to accomplish what she says she will when she asks for your vote.

This year, however, we seem to almost be giving up on that notion. The most startling example came when Senator Obama called for renogotiating NAFTA during the primary. Later, however, he pulled back from that startling statement:

Obama also appears to be backing off somewhat from his heated rhetoric from the primary campaign. He suggested in an interview with Fortune this week that he doesn't want to unilaterally renegotiate NAFTA, adding that "[s]ometimes during campaigns the rhetoric gets overheated and amplified."

In short, should we just assume that candidates can abandon anything they say during the campaign as "overheated rhetotic"?

Now, Congressional Quarterly columnist John Cranford notes that there is a disconnect between the promises and the revenue increases that will likely cause the Obama administration to drop at least some of its promises:

Obama’s call for spending $50 billion right away on individual energy credits and on aid to state and local governments to give a further boost to the weak economy — money that would need to be borrowed if it were to have any stimulative effect — doesn’t even count in this equation. No, the culprits are his call for $65 billion a year (or even more) to provide near-universal health care and his promise to boost domestic spending right, left and center. And there’s little evidence that Obama has a plan to pay for all this. Just last week, he reversed course and threw $2 billion to NASA to counter complaints that he would harm the space program, which he previously proposed trimming to finance enhancements to education.

On top of the spending proposals, Obama’s tax plan by itself would raise the federal debt by $3.5 trillion — or by roughly a third — over the next decade, according to the nonpartisan Tax Policy Center run by the Urban Institute and the Brookings Institution. And that calculation takes into account his proposal to increase taxes on those he calls rich.

No need to worry though, because we're not really going to actually do what we promise:

None of this means, of course, that Obama’s proposals won’t resonate with voters who feel the pain of foreclosures and falling home prices, or who think the economic policies of the past eight years have failed them. After all, his call for a more progressive tax code and for increased spending on domestic priorities are Democratic Party staples. And surely some of these ideas will survive if he wins the keys to the White House. The question is, which ones?

SOME of the ideas will survive? Well, that's reassuring.

Businessweek makes the same point:

Politics, the weak economy, and the reality of the ballooning federal budget will all limit the next President's room for maneuver. McCain's low-tax strategy could well be chewed up in a Congress that is likely to be even more Democratic than it is today. Obama's lofty plans could be undone by the hefty costs of his health-care plan and other programs. Even some Democrats may not stomach the huge expense and vast complexity of Obama's proposals.

In every election there is a big gap between what the candidates promise and what they can actually deliver...This year that gap between promise and reality may be even larger than usual.

I don't want to beat up on Obama, though. Cranford will take a similar look at Senator McCain's proposals next week, and I'll be sure to link to it as well. The important thing, though, is that we listen to what's being proposed and then hold the candidates accountable if elected. Or, at least make them explain the need to change course.