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Socializing Losses

In another installment of the demise of free-market optimism, the US House of Representatives has passed the package effectively giving the green light to the government to protect the two mortgage giants, Fannie Mae and Freddy Mac.

Both these monuments of the mortgage landscape guarantee something in the order of $5.2 trillion of America’s $12 trillion market.  The package raised the national debt limit to $10.6 trillion.  Refinancing for mortgages is also provided, upwards of $300 billion. A measure where some $4 billion worth of local government grants for the purchase and refurbishment of foreclosed properties has also been slipped in.

The package, authored primarily by Representative Barney Frank, Democrat of Massachusetts, has successfully seduced George W. Bush.  Despite initial rumblings of dissatisfaction, the President had to relent.  He had been cornered, looking mean spirited for threatening to veto a package for its $4 billion block grant program.  All fine to help Wall Street, not ‘ordinary’ Americans struggling on the mortgage belt.

But both Fannie and Freddie are curious anomalies in the free market system.  While they operate as private companies with stocks, they have that curious title of ‘government-sponsored enterprises.’  They purchase loans from lending institutions and package them as bonds, thereby selling them to investment firms (for instance, pension funds).

The nature of their constitutions, it must be said, seems to give them a direct link to government assistance in the event of crisis.  As Paul Krugman of the New York Times points out, this system tolerates a pernicious practice: ‘profits are privatized but losses are socialized’.

The package is being labeled as revolutionary as the Home Owners’ Loan Corporation of the 1930s, a New Deal creation that was designed to soften the brutal Great Depression foreclosures.

But this package is getting more opposition than previous bailout and subsidizing measures that have provided a blank check for economic imprudence and incompetence.  During the Reagan administration, it became clear that, on the one hand, supply side economics and private buccaneering would be encouraged; on the other hand, if that buccaneering should fail, the state would happily extend the purse.

This package, which is bound to pass both houses, may be different in so far as it targets Fannie and Freddie mortgage holders, not the pirating exploits of Wall Street.  But the argument is the same, whether one is shoring up the foolish ventures of a well-moneyed executive, or the foolish decisions of a small home owner: preventing economic slide.  To not rescue such institutions as Mac and Mae would see half a million house owners on the streets.  Mortgage prices will be driven up as a result.

The package has proven revealing in how it has split the Republican Party.  Consensus in the minority party of both houses has dissolved (some 45 Republicans joined 227 Democrats in passing the bill).  House Republican leader John Boehner of Ohio was baffled at this mobilization of the treasury to bailout bad loans. The fiscally responsible Republican, or so one is supposed to think, is bucking the trend of the fiscally irresponsible glutton.

Opponents of the package cannot be dismissed lightly.  Whether you agree with the ‘sink or swim’ attitude of the finance measure, a dogma that is of only limited utility these days, the package was never asked for by the two giants.  It comes as a rather costly, unsolicited gift.

Some columnists insist on a sober assessment – Krugman insists that a government rescue may be needed but only to patch over problems which have otherwise been ‘overblown’. In the second place, these giants had little, if almost nothing to do with the high-risk speculation that engulfed the American housing market after the 1990s.  Nor can they actually engage in subprime lending.

In short, Fannie and Freddie were actually regulated to begin with.  The scale of the market meltdown has simply proven so extensive, that Fannie-Freddie regulated mortgages have not been enough to insulate the market and its desperate borrowers. Nor have these giants assured a deep enough capitalization.

Many will wish that the Treasury’s authority will never be used – but this precedent is yet another aimed nail into the coffin of free market buccaneers.

BINOY KAMPMARK was a Commonwealth Scholar at Selwyn Collge, University of Cambridge.  He can be reached at bkampmark@gmail.com

 

 

 

 

 

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Binoy Kampmark was a Commonwealth Scholar at Selwyn College, Cambridge. He lectures at RMIT University, Melbourne. Email: bkampmark@gmail.com

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