Streetwise Professor

Reading this article about Fannie Mae and Freddie Mac reminds me of a horror film cliche: the return of the monster from the dead.  Godzilla.  Frankenstein.  Dracula:

In the last six weeks alone, the Obama administration has essentially transformed Fannie Mae and Freddie Mac into arms of the federal government. Regulators have ordered the companies to oversee a vast new mortgage modification program, to buy greater numbers of loans, to refinance millions of at-risk homeowners and to loosen internal policies so they can work with more questionable borrowers.

These are companies that should have been euthanized.  No, let me correct that.  They should have been terminated with extreme prejudice.  Instead they are being revived, and pushed into doing the kinds of things that created the financial crisis in the first place.  (Not that I am putting the entire onus of the financial crisis on F&F, just that buying huge quantities of loans, loosening standards to permit working with questionable borrowers, etc. were the kinds of banking practice that lay at the root of the crisis.)  As I said in Neo Soviet Economics, the housing market and housing finance need to contract.  Substantially.  But instead, driven by political considerations, we are reinforcing failure, and repeating the mistakes that got us here in the first place.  

Not that this should be a surprise.  These programs and practices arose in the first place in large part because there was political support for them.  The main political supporters have increased in power, and the opponents have declined in power.  So, here we go again.

And the usual suspects are there, front and center:

Moreover, the takeover has provided legislators with a long-sought ability to influence the mortgage marketplace directly and pursue social goals like low-income housing.

“There is a commitment to restructure these companies, and we are going to want to retain a hand in the things that matter, like affordable housing and making sure that the housing economy doesn’t become a threat to the entire economy again,” said Representative  Barney Frank, Democrat of Massachusetts and chairman of the House Financial Services Committee. “Some of what these companies did will be returned to the private sector, and some of it is going to remain with a public entity.”

I like the way good ol’ Barney includes two mutually incompatible goals in the same clause: “affordable housing and making sure the housing economy doesn’t become a threat to the entire economy.”  Given that the policies intended to make “housing affordable” also made a great contribution to the threat to the entire economy, just how does one do that?  (And, by the way, these affordable housing policies induced people to buy houses they couldn’t afford and now need government assistance–from F&F–to stay in.  What a country!)  Somebody once said that genius is the ability to hold two mutually incompatible thoughts in mind at the same time.  By that standard, Barney Frank is Einstein.  (Anybody know who uttered that quote?)

Warnings about the extremely dangerous implications of politicized lending are starting to be voiced, but by the politically marginal:

Most important, by taking over the companies, lawmakers have gained a lever over the housing market and national economy that many — particularly Democrats — are loath to discard, legislators say.

“Once government gets a new tool, it’s virtually impossible to take it away,” said Representative Scott Garrett, a Republican of New Jersey and member of the Financial Services banking subcommittee. “And Fannie and Freddie are now tools of the government.”

. . . .

Republican lawmakers — many of whom believe the federal government should not be involved in the mortgage business at all — have signaled they will try to end the government’s involvement with Fannie and Freddie, even as they acknowledge that effort is likely to fail.

And lawmakers of all stripes are quietly voicing worries that government involvement in the mortgage industry could lead to the very problems that caused the current crisis.

“When you use mortgage companies for political purposes, such as helping low-income borrowers or expanding homeownership, you make bad economic decisions,” said Mr. Garrett, the Republican congressman. “And bad economic decisions are why we’re in this trouble right now.”

Damn right.  Not that it matters.  Not with Barney-the-dinosaur (but not the purple one) in charge.

The expansion of government authority over other financial institutions, such as Citi, and perhaps other large banks, will only exacerbate these problems.  Look to the UK, and you see the government making Northern Rock dance to its tune, and like Fannie and Freddie, return to the bad habits that put it in government hands in the first place.  

What’s more, this politicization of these large financial institutions makes their continued reliance on the government inevitable.  Soft budget constraints are addictive.  More bad loans will pile up, making these firms even less able to survive in the marketplace without government assistance.  Such assistance is like a Roach Motel–you can get in, but you can’t get out.  

But to Barney and the gang, this probably looks like a feature, not a bug.