21 JUL 08 / "Bailing Out Fannie & Freddie"

News broke last week that Congress was prepared to act in concert with the Bush administration to allow the Federal Reserve and Department of the Treasury to cover billions of dollars in losses at Fannie Mae and Freddie Mac, the pseudo public organizations that securitize mortgages, by buying newly issued stock in the two companies. If the legislation becomes law, Fannie and Freddie will have expanded loans, expanded debt, and the guarantee of the federal government.

Whatever happened to the principle of "laissez faire"? Adam Smith's concept of free market capitalism has been under attack in the United States since the New Deal. The federal government has a role to play in the national economy, but it shouldn't be that of insurer of last resort against failure. Government intervention of the New Deal in the 1930's actually prolonged the depression. Only in socialist countries does government normally play such an interventionist role in the economy.

President Bush and the Congress are succumbing to the political pressures of a presidential election year. Their rationale is that Fannie and Freddie are "too big to fail." Over the past 12 months the two companies have lost $11 billion combined. Fannie and Freddie constitute what is known as the secondary housing market. The companies' stock prices have fallen dramatically in response to the turbulent housing market and the high foreclosure rate.

Failure in the financial markets cannot be avoided. It is a naturally occurring phenomenon, and voters should understand that the federal government could fail because it is carrying too much public debt. It's a threat to our national security. It would be better to take the hit now and enjoy a faster recovery. Avoid the hit and prolong the current economic downturn. Market fluctuations and aberrations are part of the game and must be accepted as such. What message does the bailout send to investors? The must figure then can act imprudently and somehow the government will act to mitigate their risk.

The recent actions on behalf of Bear Stearns and the potential $300 billion designated for the Federal Housing Administration have the immediate effect of calming the financial markets. However, the apparent short-term fix creates a long-term problem. Politically popular in the short-term, it constitutes bad policy in the long-term and will have ramifications. Taken together, these expenditures are the largest bailout since the 1930's. It significantly increases the national debt and puts additional pressure on the dollar. Some economists are alarmed at the prospect of an increasingly powerful Federal Reserve.

In this presidential election year, neither the Republicans nor the Democrats want to be perceived by voters as having done nothing to improve the economy; but so much is beyond the control of politicians. The urge to do too much is irresistable when voters blame you for what's wrong. The price of oil is due to demand and supply. Ultimately, supply will increase to meet demand. The high price assures that oil companies will do all they can to increase supply.

Together, Fannie Mae and Freddie Mac own or guarantee about $5 trillion in mortgage debt, approximately half of the total amount of mortgage debt in the United States. The problem is propping up Fannie Mae and Freddie Mac comes at a significant cost to the federal government and taxpayers, as always, are left holding the bag.

The Federal Reserve and the Treasury Department have been acting for months to prevent a full blown financial crisis, but the role of the federal government is not to insert itself to stave off disaster. Financial markets have natural tendencies. If the tendency is for a market to collapse and for financial institutions to fail, then that is what should be allowed to happen. The federal government, with these bailout actions, may be buttressing the economy in the short-term, but in the long-term it sends the wrong message. The danger is that taxpayers might end up holding the bag for the billions of dollars in losses at Fannie and Freddie.