Rewarding the Bubble's Enablers
Why the Bail Out of Freddie Mac and Fanny Mae is Bad Economic Policy
Rewarding the Bubble's Enablers
Counterpunch Special Report (July 15 2008)
I am writing this article about Fannie Mae and Freddie Mac while sitting in the Queens Botanical Garden. This was not my plan today. The central air conditioning in my apartment broke down six weeks ago and still has not been fixed. (It's a nice condominium building, but accidents happen.) It is over ninety degrees outside, and nearly 100 as a result of the greenhouse effect in my apartment. Yesterday I took refuge in the Forest Hills Public Library, but it is closed on Sunday. One of the few libraries near public transport that normally is open on Sunday is in Flushing. So I went there to write the final draft describing the past week's financial turmoil.
Unfortunately, when I got to the Flushing library, a lady explained that because of the city's budget cuts, the library no longer would be open on Sundays. Already before noon, when it was supposed to open, a large number of Chinese were waiting to get in, expecting to use the books and computer terminals. There was no sign explaining the situation in Chinese, and they continued to wait as I went down Main Street to the Botanical Garden.
At first glance this might not seem to have much to do with the turmoil of the last few days over the fate of Fannie Mae and Freddie Mac or the real estate markets they have helped inflate over the past decade. But my experience today has everything to do with this topic. These two semi-public mortgage-packaging companies dominate the nation's mortgage market and have supported real estate prices by steering over $5 trillion to enable homebuyers to bid higher and higher prices for homes, earning billions of dollars of bonuses, profits and interest for the bankers, mortgage brokers and Wall Street debt packagers who are the financial beneficiaries of the real estate bubble.
And that is what really is at stake. If cities such as New York do not cut back public services, they would have to do what they and nearly all American cities and municipalities traditionally have done: finance most of their public budgets by taxing property. But to do that in today's market would leave homeowners - and commercial building owners as well - with less revenue to pay their mortgages. Already this year over a million debtors have defaulted on their home mortgages, and enough have now fallen behind to suggest that Treasury Secretary Paulson's warning that two million mortgage defaults for 2008 may be a million too low.
So that is the tradeoff: If cities are to maintain their customary level of public services, they will have to tax property at the traditional rate. But this would mean that housing prices would be less. The revenue paid in taxes would not be available to pay bankers to capitalize into interest payments on higher mortgage loans to buy homes at higher and higher prices. Given a choice between more affordable housing and better public service on the one hand, or "wealth creation" in the form of higher-priced housing (along with its higher carrying charges), Americans have voted overwhelmingly for the latter - that is, for housing so priced it forces buyers deeply into debt, paying bankers.
To me, this seems crazy, but then I'm an economist and we're notoriously unable to explain why people vote against what seems to be their self-interest. In any case, this seeming craziness is what the plunging prices for stock in Fannie Mae and Freddie Mac last week was all about. One politician after another was televised pontificating about the need to keep real estate at unaffordably high prices rather than falling back to more affordable levels. Nobody mentioned the option of cities and states avoiding public service cuts by taxing the real estate - mainly the land's site value - that has soared since 2000. Nobody discussed how an economy would look with lower housing prices and less mortgage debt. All they could say was the need to preserve the value of bonds and packaged bank mortgages held by financial institutions. These are the securities held by the economy's wealthiest ten percent of the population. They take the form mainly of loans to indebt the bottom ninety percent. The economy as a whole may have no net saving, but the top ten percent save - in the form of loans to the bottom ninety percent. And they don't want the value of these loans to be cut back.
Debt write-downs and lower property prices would be good for most of the economy, but are anathema to Wall Street. Bear Stearns already has gone under as a result of its business model based on packaging junk mortgages, and last week it looked like Lehman Brothers was going down the same road. It amazes me that the election is not being fought over this economic issue, but I guess that's why I'm still in Dennis Kucinich's camp rather than elsewhere.
The policy question
For millions of homeowners watching the price of their homes fall below the mortgages they owe, the question is whether to pay or default. Many have no choice. They have Adjustable Rate Mortgages (ARMs) that are resetting at sharply higher interest rates and require amortization payments far beyond what the debtor is able to pay.
The looming defaults threaten financial institutions holding mortgages on such properties, moving up the economic pyramid to reach investors and creditors at the top. Somebody must take a loss. But who? Big fish or little fish?
For lawmakers there are two possible policy responses. The first and seemingly most logical response would be to re-set bad debts at levels that can be paid. This write-down would be in keeping with the direction of legislation since the 13th century to favor debtors more than creditors. After all, bankruptcy laws have replaced debtors' prisons, enabling debtors to make a full start. Truth-in-lending laws, anti-usury laws and similar legislation have sought to balance what people earn and what they can afford to pay for housing and other debts. This is the balance that would be restored by writing down bad debts - or to put it another way, writing off bad loans.
This is not the path that Congress is taking. Instead of bringing debts within the ability to pay, its banking and real estate committees are trying to find a way to re-inflate housing prices. The hope is to enable existing mortgage debtors who have defaulted, or are on the brink of doing so, to get into a position to sell out or to borrow the money due on even easier terms from the Federal Housing Administration (FHA). This would leave government agencies rather than Wall Street holding junk mortgages. It would give security not to home owners and mortgage debtors but to the lenders and speculators holding the $5 trillion in mortgages guaranteed by the Federal National Mortgage Association (FNMA, "Fannie Mae") and the Federal Home Loan Mortgage Corp. ("Freddie Mac"), as well as the default-insurance companies on the hook and whose IOUs have now sunk to junk status themselves.
What is the point of buying insurance against mortgage defaults, after all, if the insurance reserves are miniscule in comparison to the likely default volume? The monoline insurance companies (firms whose only business is to write default insurance) have made their money writing policies, not paying out. Their executives have already taken the money and run. Yet it is for their wealthy financial clients that Congressional hearts are bleeding, not for the victims of subprime mortgage fraud and the associated Wall Street fraud in packaging junk mortgages and selling them to institutional investors at home and abroad.
The question is, how can an economy survive with millions of homeowners defaulting and wealth ownership polarizing between creditors and debtors. This is what plunged the world into depression in the 1930s, and long before that, reduced the Roman Empire to debt bondage and serfdom.
Is it all happening again today? Or can things simply return to normal with today's debts be paid off by borrowing yet more money and running yet further into debt, in what is known as the "magic of compound interest"?
The Democratic congress pushes for American families to pay higher home prices
Congressional banking committee heads are simply behaving as politicians traditionally do by giving priority to their major campaign contributors in the financial and real estate sectors. Led by Democratic senators Charles Schumer from Wall Street and Christopher Dodd from Connecticut's insurance industry, and supported by Congressman Barney Frank from the real estate sector, Congress is seeking to bail out the bubble's sponsors, not its victims. The plan is to re-inflate the housing bubble at least long enough for the largest banks and other financial speculators to dump their riskiest holdings. Book values on these mortgages - and the real estate that backs them - are purely fictitious, despite the AAA whitewash from bond-rating agencies which themselves are now under investigation for the fatal Arthur Anderson-style conflict of interest between their research and sales arms.
Dealing as they do with real estate, and hence with local urban politics where most of the property values and maneuvering occur, Fannie Mae and Freddie Mac are largely Democratic creations. James A Johnson ran Fannie for most of the 1990s and was its main lobbyist. Until June he headed Barack Obama's vice-presidential search team, but resigned when it was revealed that he got mortgages on unrealistically favorable terms from Angelo Mozilo's notorious Countrywide Financial. Fannie Mae's former head, Franklin D Raines, was President Clinton's budget chief. He was forced to step down when serious accounting problems were discovered. Other Fannie apparatchiks include Jamie Gorelick, former Clinton deputy attorney general, and Thomas E Donilon, Clinton chief of staff to the secretary of state.
To be sure, political opportunism leads Fannie and Freddie to cover all the bases, becoming known for hiring relatives of powerful politicians wherever they may be in a position to help. But at least this time the problem is not George Bush's fault. The Wall Street Journal seems closer to reason than the Democratic Congress. Over the weekend its editorial clarified what socialists since Marx have been saying: "What taxpayers need to understand is that Fannie and Freddie already practice socialism, albeit of the dishonest kind. Their profit is privatized but their risk is socialized."{1} Calling Fannie and Freddie "high-risk monsters", the newspaper noted that "Wall Street and the homebuilders also cashed in on the subsidized business, and also paid back Congress in cash and carry". It concluded by questioning whether these government-sponsored enterprises (GSEs) were justified at all. "Apart from outright failure, the worst scenario would be a capital injection that left the companies free to commit the same mayhem all over again two or ten years from now".
In a separate article the Journal noted that, "On a fair-value basis, the company [Freddie Mac] had negative net worth of nearly $17 billion" {2}. The problem is that there is no "market" - that is, no supply of equally gullible buyers - to take on these bad loans, except at distress prices. Through short-term greed and incompetence, the home-debt industry has pawned off highly debt-leveraged mortgage loans drawn up from fraudsters. They can't be called crooks exactly, because instead of being indicted, they have been rewarded with tens of millions of dollars in bonuses for making so much money as debt innovators for the finance, insurance and real estate sectors.
Their place is to be taken by the government as bad-debt buyer of last resort. I suppose this might be called Finance Socialism - the stage at which it becomes necessary to rescue Finance Capitalism, at least its largest institutions ("too large to fail") at the top of the economic pyramid. Or it might be called "real estate finance capitalism". But in Washington-talk it is euphemized in the Democratic Party's usual populist garb as "democratizing property" and "increasing homeownership", by which is meant indebting a rising share of the population to the point where carrying their mortgage absorbs most of their disposable personal income.
Can a new real estate bubble be inflated?
The fact remains that like every financial bubble in history starting with England's South Sea Bubble and France's Mississippi Bubble in the 1710s nearly three centuries ago, today's bubble has been sponsored by the government. Forget the "madness of crowds" free-market propaganda. Insiders and enabling politicians always try to blame the victim. The reality is that Fannie, Freddie and the FHA gave a patina of confidence to irresponsible lending and outright fraud. This confidence game led them to guarantee some $5.3 trillion of mortgages, and to keep $1.6 trillion more on their own books to back the bonds they issued to institutional investors. Their strategy has been to issue bonds paying fairly low interest rates, and use the proceeds to buy mortgages yielding somewhat higher rates. This kind of interest-rate arbitrage is what the S&Ls did in the 1980s - a relevant parallel, as I will discuss below.
The myth is that Fannie's and Freddie's role is simply to spread homeownership by making it affordable for more of the population. Fannie Mae was established in the Depression, in 1938 as part of Roosevelt's New Deal, and privatized in 1968. Freddie Mac was established two years later, in 1970, to buy up S&L mortgages and give "liquidity" to their mortgages, by developing markets beyond the banks and S&Ls that originated these loans. But this turned out to be the "original sin", so to speak. Non-bank investors were obliged to place their trust in the mortgage originators - banks, S&Ls and mortgage brokers, whose ranks are filled with fraudsters and crooks.
Whatever we may call it, their dream is to bring back the seeming golden age sponsored by Alan Greenspan at the Federal Reserve. It was a decade of quick mortgage billionaires writing fictitiously high mortgages and selling them off to pension funds and to German and English bankers eager to seek a few extra fractions of a percentage point in current income so as to justify a big bonus by claiming to outperform more reality-based money managers.
All this is as American as apple pie. Altruistic political talk aside, the reason why the finance, insurance and real estate (FIRE) sectors have lobbied so hard for Fannie and Freddie is that their financial function has been to make housing increasingly unaffordable. They have inflated asset prices with credit that has indebted homeowners to a degree unprecedented in history. This is why the real estate bubble has burst, after all. Yet Congress now acts as if the only way to resolve the debt problem is to create yet more debt, to inflate real estate prices all the more by arranging yet more credit to bid up the prices that homebuyers must pay. The plan is thus to pretend that the Bubble Economy's financial unreality may be made real by Finance Socialism.
Can the plan work? The reason why Fannie and Freddie have been able to borrow at lower rates than their rivals is because their public sponsorship led investors to believe that there was an implicit public guarantee not to let them fail. And in view of the fact that these two agencies account for some $5 trillion in mortgages - nearly half the nearly $12 trillion US home mortgage market - they do indeed seem to be "too big to fail". The face value of mortgages they have guaranteed is nearly as large as the entire US federal debt held by the public. This means that the nominal federal debt would double if they went under. But at least the government can always print money, while the real estate backing the mortgages guaranteed by Fannie and Freddie (or held in their own accounts) is plunging in price into the dreaded Negative Equity territory.
But on their shoulders ride the hope of re-inflating housing prices to bail out the financial managers who sought to make money by debt creation rather than tangible capital formation. So the question is whether housing prices can be raised to a level that oblige families to run into even more debt than they now are carrying - with even lower down payments, subsidized at public expense.
In this case the subsidy would not really be for homeowners at all, but for the financial system's mortgage holders. The aim would not be to make housing more affordable, but less so, because the debts would be larger!
Most investors view the situation as being more political than strictly economic. One hears again and again these days about the "implicit" government guarantee to make good on the bonds Fannie and Fred issued to fund these junk mortgages. Its constant repetition reflects the anxiety that bondholders feel about how sound their bond holdings really are. (The stocks of Fannie and Freddie have now plunged to less than ten percent of their former highs. Investors obviously expect their equity to be wiped out, a la Bear Stearns.)
The word "implicit" means "not explicit". There is a tantalizing hint of what might be, but does not yet exist in a legal sense. Financial free lunchers on Real Estate Finance Capitalism claim to be innocent victims of an "unexpected" bad turn in the market. (Bad news always is "unexpected" as far as financial spokesmen and media reporters are concerned, just as Claude Rains was "shocked, shocked" to find that there was gambling going on at Rick's Cafe.)
The distinction between implicit and explicit may be too philosophical for most money managers who work in the financial institutions that have bought Fannie Mae and Freddie Mac bonds and packages of junk mortgages. Most of these apparatchiks don't need much of an education. All they need is greed, and that can't be taught. It is an addiction - and on Wall Street it lives in the short run, from one annual bonus to the next.
Wall Street bonuses are based on how well one "performs" relative to the norm - a Treasury bond's rate of return, or the average mutual fund or money market fund. Anyone can out-perform these averages simply by buying the most risky and hence highest-yielding bonds around.
Predator vs victim - who will Congress support?
On the subway to my hoped-for cool spot in Queens, I opened today's Sunday New York Times to find an article by the always informative Gretchen Morgenson about a Countrywide Financial customer saddled with an adjustable-rate mortgage re-setting at a rate beyond his means to pay. The mortgagee got so frustrated with non-responses to his earlier attempts at communication that he sent an e-mail message to a block of Countrywide addresses asking to renegotiate his mortgage on more affordable terms so as to avoid default. This is what Henry Paulson has been urging "responsible" lenders to do - and Countrywide is responsible for some $1.5 trillion in mortgage loans, most of them subprime.
The e-mail actually got to Countrywide co-founder and CEO Angelo Mozilo, cited above for having given GNMA head and erstwhile Obama advisor a mortgage on remarkably affordable terms. Mr Mozilo is the Darth Vader of the global mortgage market, and the person probably more responsible than any other for wrecking more lives financially than any other man on the planet, including Ken Lay and Michael Milken. Until the movie biography arrives, we will have to do with Ms Morgenson's article. {3}
Mr Mozilo actually responded. He found the request to lower his company's mortgage demands "Disgusting". The very thought of debtors not living up to written contracts they had signed - contracts which turned out to be bait-and-switch deals signed under duress - seemed to threaten the institution of private property itself. After all, had not the mortgage agreed to "adjust" his teaser interest rate upward to a more real-world rate of extracting his income?
A Countrywide "workout advisor" on the company's "home retention team" tried to be more helpful. She suggested that "Maybe you can eat less", when the mortgagee told her that all he could afford was $10 a day after paying his mortgage.
Perhaps my mind was wandering too far, but I was reminded of Sumerian and Babylonian language for creditors. Contracts said that they would get to "eat" the interest on debts owed by cultivators and debtors. Bronze Age contracts from Hammurapi's time (about 1750 BC) typically called for rural debtors to pay their debts in grain (which exchanged on a par with silver, one liter of grain per shekel of silver), weighed out at harvest time on the threshing floor. Post-classical economic theory is based on the principle of diminishing marginal utility. According to this theory, the pleasure of consuming more of any given commodity diminishes with each additional unit that is consumed. This seemed to suggest that as people got wealthier, they would become less greedy, leaving the path open for the poorest consumers to "catch up". It was a happy picture of economies leading naturally and almost automatically to a more equal distribution of wealth.
Of course, it was utter fiction. But it was a "successful error" that won for the marginal utility school such enormous financial subsidies for economics departments teaching this distraction that it drove classical economics off the board with its discussion of unearned increments, free lunches and the polarization of wealth by rentiers (a word that today is almost as anachronistic as "usurer").
Obviously, these marginal utility theorists never heard of the wealth addiction that Aristotle and other ancient observers described. How much can a creditor "eat" in practice? The answer is, "everything"! That is what wealth addiction is all about.
It is implicit in the mathematics of the "magic of compound interest". This is the magic that has causing the real estate crisis plunging Fannie Mae, Freddie Mac and Lehman Brothers. to the brink of insolvency.
A replay of the federal S&L insurance crisis: Bailing out the risk-takers, not their victims
Junk bonds issued by corporate raiders were the highest-yielding bonds in the 1980s - before they brought down the S&Ls. Since the Federal Reserve flooded the economy with credit after the dot.com bubble burst in 2000, junk mortgages have been the highest-yielding securities. Meanwhile at the Federal Reserve, Chairman Alan Greenspan deregulated the banking system to let the usual array of financial crooks express the "animal spirits" that he believed were the driving force in his Ayn Rand fantasy world.
The result is a replay of the S&L collapse two decades ago - a financial "golden oldie", so to speak. The S&L bailout is relevant today because proposals to bail out Fannie Mae and Freddie Mac bondholders are distressingly like the bailout of S&L depositors in crooked S&Ls back in the 1980s. Only a handful of S&Ls went under - and they were the notorious risk-takers. Their depositors were not neighborhood moms and pops. They were large institutional savers, who didn't care about risk or crooked behavior, because there was a government guarantee by FSLIC: the Federal Savings and Loan Insurance Corporation. And that bailed out the large depositors.
Fast forward to today. Fannie Mae was shown many months ago to have been cooking the books. But large speculators didn't care. Although there was no official government guarantee, there was an "implicit" protection for risk-takers. Financial insurance firms sharply raised the default-insurance premiums for these two government-sponsored mortgage agencies. But investors still were able to make a few basis points more than normal by buying their bonds.
Should they be bailed out? And if the government does not do so, would this mean that Fannie Mae goes under and the US mortgage market plunges?
Do we really want a new bubble? Or re-industrialization?
Let's take a step back and look at the function that Fannie and Freddie have played in today's Bubble Economy.
Who would one expect the Fed as "board of directors" for the commercial banking system, the Federal Housing Agency (FHA), Fannie Mae and Freddie Mac as creatures of the real estate sector, to support? Ostensibly created to serve "the people", ninety percent of whom are debtors, these institutions actually back the ten percent of the population who are creditors.
This year already has seen a million foreclosures and the junk mortgage collapse is worsening. Home prices are plunging as interest rates on the euphemistically named adjustable rate mortgages (ARMs) "adjust" in the only direction they ever were intended: jumping up from teaser rates to distress levels. It is more difficult to borrow in today's market. The economy has reached its debt limit and is entering its insolvency phase.
We are not in a cycle but the end of an era. The old world of debt pyramiding to a fraudulent degree cannot be restored, despite the repeal [of the] Glass-Steagall Act in 1999 that unleashed financial conflicts of interest when the Clinton Administration backed Treasury Secretary Robert Rubin and financial lobbyist Greenspan in claiming that financial markets would be self-regulating and law-abiding. The real estate bubble was made possible by the unique degree to which America's population emerged from World War II relatively debt free. Each recovery has taken off from a higher debt level. This is something like trying to drive a car with the brakes pressed tighter and tighter to the floor each time there is a stoplight (recession). We have now reached the debt limit, and the economy is stuck. The class war is back in business, with a vengeance. Instead of it being the familiar old class war between industrial employers and their work force, this one reverts to the old pre-industrial class war of creditors versus debtors. Its guiding principle is "Big Fish Eat Little Fish", mainly by the debt dynamic that crowds out the promised economy of free choice.
This is being portrayed as a post-industrial economy, but it is a much older story. No economy in history ever has been able to pay off its debts. That is the essence of the "magic of compound interest". Debts grow inexorably, making creditors rich but impoverishing the economy in the process, thereby destroying its ability to pay. Recognizing this financial dynamic most societies have chosen the logical response. From Sumer in the third millennium BC and Babylonia the second millennium through Greece and Rome in the first millennium BC, and then from feudal Europe to the Inter-Ally war debts and reparations tangle that wrecked international finance after World War I, the response has been to bring debts back within the ability to pay.
This can be done only by wiping out debts that cannot be paid. The alternative is debt peonage. Throughout most of history, countries have found again and again that bankruptcy - wiping out the debts - is the way to free economies. The idea is to free them from a situation where the economic surplus is diverted away from new tangible investment to pay bankers. The classical idea of free markets is to avoid privatizing monopolies, such as the unique privilege of commercial bankers to create bank-credit and charge interest on it.
Current proposals would replace bad debts that are not publicly insured (except by an "implicit" guarantee that relevant legislators have bought into) with new debts, and new suckers are to be left holding the bag. Bahrainis and Saudis in particular are being courted.
But most of all, there is a public campaign being waged by the FIRE sector (Finance, Insurance and Real Estate) to convince the American public that, in the infamous words of Margaret Thatcher, TINA, "there is no alternative". (See for instance the Wall Street Journal's excellent coverage of the Fannie Mae/mortgage crisis on July 11 2002, page A12.) When one hears this, it means that political censorship is being mobilized to flood the popular media with the intellectual equivalent of sterile fruit flies being released to stop the spread of a threat. All one hears is a barrage of claims that the government must preserve the financial fictions of Fannie Mae and Freddie Mac in order to "save the market".
But what is "the market" that is to be "saved"? To Wall Street and its Congressional advocates, it is the mass of bad debts growing at compound "magic" rates of interest, beyond the ability of debtors to pay. If the debtors cannot pay, then the Government - "taxpayers" are to pick up the check to Wall Street. Meanwhile, more tax breaks are to be given to leave the finance, insurance and real estate sectors with enough money to "earn back" their losses, by extracting yet more rent and interest from the industrial economy's consumers and wage-earners.
The usual hypocrisy is being brought to bear claiming that all this is necessary to "save the middle class", even as what is being saved are its debts, not its assets. Something must give - and the upper ten percent of the population wants to make sure that it is not its own economic position, but that of the bottom ninety percent. The "way of life" that is being saved is not that of home ownership, but debt peonage to support the concentration of wealth at the top of the economic pyramid.
My modest proposal
Shareholders of Fannie Mae and Freddie Mac probably will be wiped out, as were S&L shareholders in the bailout of S&L depositors in the 1980s. There's a simple way to save Fannie Mae's and Freddie Mac's public functions, if they indeed are deemed necessary to keep supporting the debt market. This can be done without bailing out the speculators who bought the mortgages it packaged.
First of all, not all the mortgages that these two agencies have bought or guaranteed are junk. Most are genuine and are being paid. The poor are honest, after all, and think that they should pay as a matter of honor even if it is not in their economic interest to do so when their homes fall into negative equity. Let these mortgages continue to back the existing Fannie Mae and Freddie Mac bonds to the degree that they actually receive mortgage debt service. If there is a shortfall, let bondholders take the usual haircut that is supposed to go hand in hand with risk. That is why these mortgages had such high rates of interest, after all. The loss would be proportional to the financial and real estate fraud they have enabled. This is the law for all other bondholders when their investments go south. Why make an exception for participants in the real estate bubble?
The rule caveat emptor should apply to bankers and investors here. They have bought a product - a flow of income that they either believed or pretended could be paid. Any student taught the mathematics of compound interest knows that in the end no economy's debts can be paid. So this should be a special financial caveat.
To keep their activities current, let Fannie and Freddie issue a new series of bonds - the "we won't fake it anymore" series. They would be based on a new honesty based on more realistic appraisals of the affordability of housing, which they were supposed to be promoting all along. These steps would not cause a collapse.
But before stepping up to save Fannie Mae and Freddie Mac, we might ask whether it would be a tragedy for their debt guarantees to cease. Wall Street has given politicians a cover story that to support Fannie and Freddie on the pretense that its packaging and reselling mortgages in big "tranches" provides liquidity. Its defenders claimed to be "modernizing" the real estate mortgage market by creating uniform standards and homogeneous packages. But these packages were increasingly tainted with junk, putting floor sweepings of ARMs with no-down-payment and NINJA (no income, no job) loans into financial sausages.
What Fannie and Freddie did was to provide a vast new source of demand for mortgages. Their role has been to extend the market for mortgage debt, creating opportunities to make money financially in an environment of asset-price inflation - the Bubble Economy. The effect was to push up housing prices. This has been the great American game for a century. And it has turned increasingly to outside investors (including gullible German banks which were the first to go bust by trusting the US junk mortgage market), swelling the supply of loanable funds that bid up property prices.
Prior to Fannie Mae and Freddie Mac, banks that issued mortgages held onto them, because there were no outside blind buyers. This was the pre-fraud era. It is now looking like a Golden Age. Housing prices were lower, and buyers did not have to go so deeply into debt to purchase homes. But the Senate and Congress - at least the Democrats - are urging the FHA and other government agencies to prop up the mortgage market by issuing zero-down-payment loans and other subsidies. The immediate aim is not to help homeowners - who indeed will have to pay more if the housing market re-inflates. Each new economic crisis adds a few new words to the English language. This time we get "reflate". Others include NYU Professor Roubini's "stagdeflation" for a combination of debt deflation of incomes and price inflation for commodities as the dollar sinks in response to the balance-of-payments deficit resulting largely from the war in Iraq. But that is another story. Today's story is about how Congress is aiming to bail out the banks that have bought or packaged these junk mortgages, about how needless this bailout is, and about how much simpler and more fair to just write off the bad debts.
Conclusion
America's $13 trillion in domestic real estate debt is no more payable than is the government's $3.5 billion dollar debt to foreign central banks, or the public debt itself for that matter. Adam Smith remarked over two centuries ago that no government ever had repaid its debts. At that time the aristocracy - the heirs of the Viking warlords who conquered Britain and other European countries and turned their common lands into private property - held most of the land free and clear. Today, real estate has been "democratized", but this has been done on credit. Mortgages are the major debts of most American families. In this role, real estate debt has become the basis for the commercial banking system, and hence the basis for the wealthiest ten percent of the population who hold the bottom ninety percent in debt. That is what Fannie Mae, Freddie Mac and "the market" are all about.
Neither party in Congress supports a new bankruptcy bill. The lobbying money simply isn't there. So the preferred alternative seems to be a new real estate bubble, which means more debt peonage for new homebuyers rather than housing prices falling back to more affordable proportions.
Of course, there is an alternative (TIAA). It is to make rent the basis of the tax system instead of being the basis for expanding debt to the banks. Real estate could free labor and industry from having to pay taxes. Instead, un-taxing property has forced labor to bear the tax burden, and to pay an equivalent sum in interest to the banks as well.
But that is a topic for a future article.
Notes:
{1} "The Price of Fannie Mae", Wall Street Journal (July 10 2008; page A14)
http://online.wsj.com/public/article_print/SB121565255349741343.html
{2} Better Debt Than Stock? by David Reilly, Wall Street Journal (July 12 2008)
http://online.wsj.com/public/article/SB121582541586147925.html?mod=2_1569_topbox
Reprinted in: "Capital Measures of Fannie and Freddie" (July 12 2008)
http://remington-work.blogspot.com/
{3} "The Silence of the Lenders" by Gretchen Morgenson, The New York Times (July 13 2008)
http://www.nytimes.com/2008/07/13/business/13mail.html
_____
Michael Hudson is a former Wall Street economist specializing in the balance of payments and real estate at the Chase Manhattan Bank (now JPMorgan Chase & Company), Arthur Anderson, and later at the Hudson Institute (no relation). In 1990 he helped established the world's first sovereign debt fund for Scudder Stevens & Clark. Dr Hudson was Dennis Kucinich's Chief Economic Advisor in the recent Democratic primary presidential campaign, and has advised the US, Canadian, Mexican and Latvian governments, as well as the United Nations Institute for Training and Research (UNITAR). A Distinguished Research Professor at University of Missouri, Kansas City (UMKC), he is the author of many books, including Super Imperialism: The Economic Strategy of American Empire (new edition, Pluto Press, 2002) He can be reached via his website, mh@michael-hudson.com
http://www.counterpunch.org/hudson07152008.html
Bill Totten http://www.ashisuto.co.jp/english/index.html
Rewarding the Bubble's Enablers
Counterpunch Special Report (July 15 2008)
I am writing this article about Fannie Mae and Freddie Mac while sitting in the Queens Botanical Garden. This was not my plan today. The central air conditioning in my apartment broke down six weeks ago and still has not been fixed. (It's a nice condominium building, but accidents happen.) It is over ninety degrees outside, and nearly 100 as a result of the greenhouse effect in my apartment. Yesterday I took refuge in the Forest Hills Public Library, but it is closed on Sunday. One of the few libraries near public transport that normally is open on Sunday is in Flushing. So I went there to write the final draft describing the past week's financial turmoil.
Unfortunately, when I got to the Flushing library, a lady explained that because of the city's budget cuts, the library no longer would be open on Sundays. Already before noon, when it was supposed to open, a large number of Chinese were waiting to get in, expecting to use the books and computer terminals. There was no sign explaining the situation in Chinese, and they continued to wait as I went down Main Street to the Botanical Garden.
At first glance this might not seem to have much to do with the turmoil of the last few days over the fate of Fannie Mae and Freddie Mac or the real estate markets they have helped inflate over the past decade. But my experience today has everything to do with this topic. These two semi-public mortgage-packaging companies dominate the nation's mortgage market and have supported real estate prices by steering over $5 trillion to enable homebuyers to bid higher and higher prices for homes, earning billions of dollars of bonuses, profits and interest for the bankers, mortgage brokers and Wall Street debt packagers who are the financial beneficiaries of the real estate bubble.
And that is what really is at stake. If cities such as New York do not cut back public services, they would have to do what they and nearly all American cities and municipalities traditionally have done: finance most of their public budgets by taxing property. But to do that in today's market would leave homeowners - and commercial building owners as well - with less revenue to pay their mortgages. Already this year over a million debtors have defaulted on their home mortgages, and enough have now fallen behind to suggest that Treasury Secretary Paulson's warning that two million mortgage defaults for 2008 may be a million too low.
So that is the tradeoff: If cities are to maintain their customary level of public services, they will have to tax property at the traditional rate. But this would mean that housing prices would be less. The revenue paid in taxes would not be available to pay bankers to capitalize into interest payments on higher mortgage loans to buy homes at higher and higher prices. Given a choice between more affordable housing and better public service on the one hand, or "wealth creation" in the form of higher-priced housing (along with its higher carrying charges), Americans have voted overwhelmingly for the latter - that is, for housing so priced it forces buyers deeply into debt, paying bankers.
To me, this seems crazy, but then I'm an economist and we're notoriously unable to explain why people vote against what seems to be their self-interest. In any case, this seeming craziness is what the plunging prices for stock in Fannie Mae and Freddie Mac last week was all about. One politician after another was televised pontificating about the need to keep real estate at unaffordably high prices rather than falling back to more affordable levels. Nobody mentioned the option of cities and states avoiding public service cuts by taxing the real estate - mainly the land's site value - that has soared since 2000. Nobody discussed how an economy would look with lower housing prices and less mortgage debt. All they could say was the need to preserve the value of bonds and packaged bank mortgages held by financial institutions. These are the securities held by the economy's wealthiest ten percent of the population. They take the form mainly of loans to indebt the bottom ninety percent. The economy as a whole may have no net saving, but the top ten percent save - in the form of loans to the bottom ninety percent. And they don't want the value of these loans to be cut back.
Debt write-downs and lower property prices would be good for most of the economy, but are anathema to Wall Street. Bear Stearns already has gone under as a result of its business model based on packaging junk mortgages, and last week it looked like Lehman Brothers was going down the same road. It amazes me that the election is not being fought over this economic issue, but I guess that's why I'm still in Dennis Kucinich's camp rather than elsewhere.
The policy question
For millions of homeowners watching the price of their homes fall below the mortgages they owe, the question is whether to pay or default. Many have no choice. They have Adjustable Rate Mortgages (ARMs) that are resetting at sharply higher interest rates and require amortization payments far beyond what the debtor is able to pay.
The looming defaults threaten financial institutions holding mortgages on such properties, moving up the economic pyramid to reach investors and creditors at the top. Somebody must take a loss. But who? Big fish or little fish?
For lawmakers there are two possible policy responses. The first and seemingly most logical response would be to re-set bad debts at levels that can be paid. This write-down would be in keeping with the direction of legislation since the 13th century to favor debtors more than creditors. After all, bankruptcy laws have replaced debtors' prisons, enabling debtors to make a full start. Truth-in-lending laws, anti-usury laws and similar legislation have sought to balance what people earn and what they can afford to pay for housing and other debts. This is the balance that would be restored by writing down bad debts - or to put it another way, writing off bad loans.
This is not the path that Congress is taking. Instead of bringing debts within the ability to pay, its banking and real estate committees are trying to find a way to re-inflate housing prices. The hope is to enable existing mortgage debtors who have defaulted, or are on the brink of doing so, to get into a position to sell out or to borrow the money due on even easier terms from the Federal Housing Administration (FHA). This would leave government agencies rather than Wall Street holding junk mortgages. It would give security not to home owners and mortgage debtors but to the lenders and speculators holding the $5 trillion in mortgages guaranteed by the Federal National Mortgage Association (FNMA, "Fannie Mae") and the Federal Home Loan Mortgage Corp. ("Freddie Mac"), as well as the default-insurance companies on the hook and whose IOUs have now sunk to junk status themselves.
What is the point of buying insurance against mortgage defaults, after all, if the insurance reserves are miniscule in comparison to the likely default volume? The monoline insurance companies (firms whose only business is to write default insurance) have made their money writing policies, not paying out. Their executives have already taken the money and run. Yet it is for their wealthy financial clients that Congressional hearts are bleeding, not for the victims of subprime mortgage fraud and the associated Wall Street fraud in packaging junk mortgages and selling them to institutional investors at home and abroad.
The question is, how can an economy survive with millions of homeowners defaulting and wealth ownership polarizing between creditors and debtors. This is what plunged the world into depression in the 1930s, and long before that, reduced the Roman Empire to debt bondage and serfdom.
Is it all happening again today? Or can things simply return to normal with today's debts be paid off by borrowing yet more money and running yet further into debt, in what is known as the "magic of compound interest"?
The Democratic congress pushes for American families to pay higher home prices
Congressional banking committee heads are simply behaving as politicians traditionally do by giving priority to their major campaign contributors in the financial and real estate sectors. Led by Democratic senators Charles Schumer from Wall Street and Christopher Dodd from Connecticut's insurance industry, and supported by Congressman Barney Frank from the real estate sector, Congress is seeking to bail out the bubble's sponsors, not its victims. The plan is to re-inflate the housing bubble at least long enough for the largest banks and other financial speculators to dump their riskiest holdings. Book values on these mortgages - and the real estate that backs them - are purely fictitious, despite the AAA whitewash from bond-rating agencies which themselves are now under investigation for the fatal Arthur Anderson-style conflict of interest between their research and sales arms.
Dealing as they do with real estate, and hence with local urban politics where most of the property values and maneuvering occur, Fannie Mae and Freddie Mac are largely Democratic creations. James A Johnson ran Fannie for most of the 1990s and was its main lobbyist. Until June he headed Barack Obama's vice-presidential search team, but resigned when it was revealed that he got mortgages on unrealistically favorable terms from Angelo Mozilo's notorious Countrywide Financial. Fannie Mae's former head, Franklin D Raines, was President Clinton's budget chief. He was forced to step down when serious accounting problems were discovered. Other Fannie apparatchiks include Jamie Gorelick, former Clinton deputy attorney general, and Thomas E Donilon, Clinton chief of staff to the secretary of state.
To be sure, political opportunism leads Fannie and Freddie to cover all the bases, becoming known for hiring relatives of powerful politicians wherever they may be in a position to help. But at least this time the problem is not George Bush's fault. The Wall Street Journal seems closer to reason than the Democratic Congress. Over the weekend its editorial clarified what socialists since Marx have been saying: "What taxpayers need to understand is that Fannie and Freddie already practice socialism, albeit of the dishonest kind. Their profit is privatized but their risk is socialized."{1} Calling Fannie and Freddie "high-risk monsters", the newspaper noted that "Wall Street and the homebuilders also cashed in on the subsidized business, and also paid back Congress in cash and carry". It concluded by questioning whether these government-sponsored enterprises (GSEs) were justified at all. "Apart from outright failure, the worst scenario would be a capital injection that left the companies free to commit the same mayhem all over again two or ten years from now".
In a separate article the Journal noted that, "On a fair-value basis, the company [Freddie Mac] had negative net worth of nearly $17 billion" {2}. The problem is that there is no "market" - that is, no supply of equally gullible buyers - to take on these bad loans, except at distress prices. Through short-term greed and incompetence, the home-debt industry has pawned off highly debt-leveraged mortgage loans drawn up from fraudsters. They can't be called crooks exactly, because instead of being indicted, they have been rewarded with tens of millions of dollars in bonuses for making so much money as debt innovators for the finance, insurance and real estate sectors.
Their place is to be taken by the government as bad-debt buyer of last resort. I suppose this might be called Finance Socialism - the stage at which it becomes necessary to rescue Finance Capitalism, at least its largest institutions ("too large to fail") at the top of the economic pyramid. Or it might be called "real estate finance capitalism". But in Washington-talk it is euphemized in the Democratic Party's usual populist garb as "democratizing property" and "increasing homeownership", by which is meant indebting a rising share of the population to the point where carrying their mortgage absorbs most of their disposable personal income.
Can a new real estate bubble be inflated?
The fact remains that like every financial bubble in history starting with England's South Sea Bubble and France's Mississippi Bubble in the 1710s nearly three centuries ago, today's bubble has been sponsored by the government. Forget the "madness of crowds" free-market propaganda. Insiders and enabling politicians always try to blame the victim. The reality is that Fannie, Freddie and the FHA gave a patina of confidence to irresponsible lending and outright fraud. This confidence game led them to guarantee some $5.3 trillion of mortgages, and to keep $1.6 trillion more on their own books to back the bonds they issued to institutional investors. Their strategy has been to issue bonds paying fairly low interest rates, and use the proceeds to buy mortgages yielding somewhat higher rates. This kind of interest-rate arbitrage is what the S&Ls did in the 1980s - a relevant parallel, as I will discuss below.
The myth is that Fannie's and Freddie's role is simply to spread homeownership by making it affordable for more of the population. Fannie Mae was established in the Depression, in 1938 as part of Roosevelt's New Deal, and privatized in 1968. Freddie Mac was established two years later, in 1970, to buy up S&L mortgages and give "liquidity" to their mortgages, by developing markets beyond the banks and S&Ls that originated these loans. But this turned out to be the "original sin", so to speak. Non-bank investors were obliged to place their trust in the mortgage originators - banks, S&Ls and mortgage brokers, whose ranks are filled with fraudsters and crooks.
Whatever we may call it, their dream is to bring back the seeming golden age sponsored by Alan Greenspan at the Federal Reserve. It was a decade of quick mortgage billionaires writing fictitiously high mortgages and selling them off to pension funds and to German and English bankers eager to seek a few extra fractions of a percentage point in current income so as to justify a big bonus by claiming to outperform more reality-based money managers.
All this is as American as apple pie. Altruistic political talk aside, the reason why the finance, insurance and real estate (FIRE) sectors have lobbied so hard for Fannie and Freddie is that their financial function has been to make housing increasingly unaffordable. They have inflated asset prices with credit that has indebted homeowners to a degree unprecedented in history. This is why the real estate bubble has burst, after all. Yet Congress now acts as if the only way to resolve the debt problem is to create yet more debt, to inflate real estate prices all the more by arranging yet more credit to bid up the prices that homebuyers must pay. The plan is thus to pretend that the Bubble Economy's financial unreality may be made real by Finance Socialism.
Can the plan work? The reason why Fannie and Freddie have been able to borrow at lower rates than their rivals is because their public sponsorship led investors to believe that there was an implicit public guarantee not to let them fail. And in view of the fact that these two agencies account for some $5 trillion in mortgages - nearly half the nearly $12 trillion US home mortgage market - they do indeed seem to be "too big to fail". The face value of mortgages they have guaranteed is nearly as large as the entire US federal debt held by the public. This means that the nominal federal debt would double if they went under. But at least the government can always print money, while the real estate backing the mortgages guaranteed by Fannie and Freddie (or held in their own accounts) is plunging in price into the dreaded Negative Equity territory.
But on their shoulders ride the hope of re-inflating housing prices to bail out the financial managers who sought to make money by debt creation rather than tangible capital formation. So the question is whether housing prices can be raised to a level that oblige families to run into even more debt than they now are carrying - with even lower down payments, subsidized at public expense.
In this case the subsidy would not really be for homeowners at all, but for the financial system's mortgage holders. The aim would not be to make housing more affordable, but less so, because the debts would be larger!
Most investors view the situation as being more political than strictly economic. One hears again and again these days about the "implicit" government guarantee to make good on the bonds Fannie and Fred issued to fund these junk mortgages. Its constant repetition reflects the anxiety that bondholders feel about how sound their bond holdings really are. (The stocks of Fannie and Freddie have now plunged to less than ten percent of their former highs. Investors obviously expect their equity to be wiped out, a la Bear Stearns.)
The word "implicit" means "not explicit". There is a tantalizing hint of what might be, but does not yet exist in a legal sense. Financial free lunchers on Real Estate Finance Capitalism claim to be innocent victims of an "unexpected" bad turn in the market. (Bad news always is "unexpected" as far as financial spokesmen and media reporters are concerned, just as Claude Rains was "shocked, shocked" to find that there was gambling going on at Rick's Cafe.)
The distinction between implicit and explicit may be too philosophical for most money managers who work in the financial institutions that have bought Fannie Mae and Freddie Mac bonds and packages of junk mortgages. Most of these apparatchiks don't need much of an education. All they need is greed, and that can't be taught. It is an addiction - and on Wall Street it lives in the short run, from one annual bonus to the next.
Wall Street bonuses are based on how well one "performs" relative to the norm - a Treasury bond's rate of return, or the average mutual fund or money market fund. Anyone can out-perform these averages simply by buying the most risky and hence highest-yielding bonds around.
Predator vs victim - who will Congress support?
On the subway to my hoped-for cool spot in Queens, I opened today's Sunday New York Times to find an article by the always informative Gretchen Morgenson about a Countrywide Financial customer saddled with an adjustable-rate mortgage re-setting at a rate beyond his means to pay. The mortgagee got so frustrated with non-responses to his earlier attempts at communication that he sent an e-mail message to a block of Countrywide addresses asking to renegotiate his mortgage on more affordable terms so as to avoid default. This is what Henry Paulson has been urging "responsible" lenders to do - and Countrywide is responsible for some $1.5 trillion in mortgage loans, most of them subprime.
The e-mail actually got to Countrywide co-founder and CEO Angelo Mozilo, cited above for having given GNMA head and erstwhile Obama advisor a mortgage on remarkably affordable terms. Mr Mozilo is the Darth Vader of the global mortgage market, and the person probably more responsible than any other for wrecking more lives financially than any other man on the planet, including Ken Lay and Michael Milken. Until the movie biography arrives, we will have to do with Ms Morgenson's article. {3}
Mr Mozilo actually responded. He found the request to lower his company's mortgage demands "Disgusting". The very thought of debtors not living up to written contracts they had signed - contracts which turned out to be bait-and-switch deals signed under duress - seemed to threaten the institution of private property itself. After all, had not the mortgage agreed to "adjust" his teaser interest rate upward to a more real-world rate of extracting his income?
A Countrywide "workout advisor" on the company's "home retention team" tried to be more helpful. She suggested that "Maybe you can eat less", when the mortgagee told her that all he could afford was $10 a day after paying his mortgage.
Perhaps my mind was wandering too far, but I was reminded of Sumerian and Babylonian language for creditors. Contracts said that they would get to "eat" the interest on debts owed by cultivators and debtors. Bronze Age contracts from Hammurapi's time (about 1750 BC) typically called for rural debtors to pay their debts in grain (which exchanged on a par with silver, one liter of grain per shekel of silver), weighed out at harvest time on the threshing floor. Post-classical economic theory is based on the principle of diminishing marginal utility. According to this theory, the pleasure of consuming more of any given commodity diminishes with each additional unit that is consumed. This seemed to suggest that as people got wealthier, they would become less greedy, leaving the path open for the poorest consumers to "catch up". It was a happy picture of economies leading naturally and almost automatically to a more equal distribution of wealth.
Of course, it was utter fiction. But it was a "successful error" that won for the marginal utility school such enormous financial subsidies for economics departments teaching this distraction that it drove classical economics off the board with its discussion of unearned increments, free lunches and the polarization of wealth by rentiers (a word that today is almost as anachronistic as "usurer").
Obviously, these marginal utility theorists never heard of the wealth addiction that Aristotle and other ancient observers described. How much can a creditor "eat" in practice? The answer is, "everything"! That is what wealth addiction is all about.
It is implicit in the mathematics of the "magic of compound interest". This is the magic that has causing the real estate crisis plunging Fannie Mae, Freddie Mac and Lehman Brothers. to the brink of insolvency.
A replay of the federal S&L insurance crisis: Bailing out the risk-takers, not their victims
Junk bonds issued by corporate raiders were the highest-yielding bonds in the 1980s - before they brought down the S&Ls. Since the Federal Reserve flooded the economy with credit after the dot.com bubble burst in 2000, junk mortgages have been the highest-yielding securities. Meanwhile at the Federal Reserve, Chairman Alan Greenspan deregulated the banking system to let the usual array of financial crooks express the "animal spirits" that he believed were the driving force in his Ayn Rand fantasy world.
The result is a replay of the S&L collapse two decades ago - a financial "golden oldie", so to speak. The S&L bailout is relevant today because proposals to bail out Fannie Mae and Freddie Mac bondholders are distressingly like the bailout of S&L depositors in crooked S&Ls back in the 1980s. Only a handful of S&Ls went under - and they were the notorious risk-takers. Their depositors were not neighborhood moms and pops. They were large institutional savers, who didn't care about risk or crooked behavior, because there was a government guarantee by FSLIC: the Federal Savings and Loan Insurance Corporation. And that bailed out the large depositors.
Fast forward to today. Fannie Mae was shown many months ago to have been cooking the books. But large speculators didn't care. Although there was no official government guarantee, there was an "implicit" protection for risk-takers. Financial insurance firms sharply raised the default-insurance premiums for these two government-sponsored mortgage agencies. But investors still were able to make a few basis points more than normal by buying their bonds.
Should they be bailed out? And if the government does not do so, would this mean that Fannie Mae goes under and the US mortgage market plunges?
Do we really want a new bubble? Or re-industrialization?
Let's take a step back and look at the function that Fannie and Freddie have played in today's Bubble Economy.
Who would one expect the Fed as "board of directors" for the commercial banking system, the Federal Housing Agency (FHA), Fannie Mae and Freddie Mac as creatures of the real estate sector, to support? Ostensibly created to serve "the people", ninety percent of whom are debtors, these institutions actually back the ten percent of the population who are creditors.
This year already has seen a million foreclosures and the junk mortgage collapse is worsening. Home prices are plunging as interest rates on the euphemistically named adjustable rate mortgages (ARMs) "adjust" in the only direction they ever were intended: jumping up from teaser rates to distress levels. It is more difficult to borrow in today's market. The economy has reached its debt limit and is entering its insolvency phase.
We are not in a cycle but the end of an era. The old world of debt pyramiding to a fraudulent degree cannot be restored, despite the repeal [of the] Glass-Steagall Act in 1999 that unleashed financial conflicts of interest when the Clinton Administration backed Treasury Secretary Robert Rubin and financial lobbyist Greenspan in claiming that financial markets would be self-regulating and law-abiding. The real estate bubble was made possible by the unique degree to which America's population emerged from World War II relatively debt free. Each recovery has taken off from a higher debt level. This is something like trying to drive a car with the brakes pressed tighter and tighter to the floor each time there is a stoplight (recession). We have now reached the debt limit, and the economy is stuck. The class war is back in business, with a vengeance. Instead of it being the familiar old class war between industrial employers and their work force, this one reverts to the old pre-industrial class war of creditors versus debtors. Its guiding principle is "Big Fish Eat Little Fish", mainly by the debt dynamic that crowds out the promised economy of free choice.
This is being portrayed as a post-industrial economy, but it is a much older story. No economy in history ever has been able to pay off its debts. That is the essence of the "magic of compound interest". Debts grow inexorably, making creditors rich but impoverishing the economy in the process, thereby destroying its ability to pay. Recognizing this financial dynamic most societies have chosen the logical response. From Sumer in the third millennium BC and Babylonia the second millennium through Greece and Rome in the first millennium BC, and then from feudal Europe to the Inter-Ally war debts and reparations tangle that wrecked international finance after World War I, the response has been to bring debts back within the ability to pay.
This can be done only by wiping out debts that cannot be paid. The alternative is debt peonage. Throughout most of history, countries have found again and again that bankruptcy - wiping out the debts - is the way to free economies. The idea is to free them from a situation where the economic surplus is diverted away from new tangible investment to pay bankers. The classical idea of free markets is to avoid privatizing monopolies, such as the unique privilege of commercial bankers to create bank-credit and charge interest on it.
Current proposals would replace bad debts that are not publicly insured (except by an "implicit" guarantee that relevant legislators have bought into) with new debts, and new suckers are to be left holding the bag. Bahrainis and Saudis in particular are being courted.
But most of all, there is a public campaign being waged by the FIRE sector (Finance, Insurance and Real Estate) to convince the American public that, in the infamous words of Margaret Thatcher, TINA, "there is no alternative". (See for instance the Wall Street Journal's excellent coverage of the Fannie Mae/mortgage crisis on July 11 2002, page A12.) When one hears this, it means that political censorship is being mobilized to flood the popular media with the intellectual equivalent of sterile fruit flies being released to stop the spread of a threat. All one hears is a barrage of claims that the government must preserve the financial fictions of Fannie Mae and Freddie Mac in order to "save the market".
But what is "the market" that is to be "saved"? To Wall Street and its Congressional advocates, it is the mass of bad debts growing at compound "magic" rates of interest, beyond the ability of debtors to pay. If the debtors cannot pay, then the Government - "taxpayers" are to pick up the check to Wall Street. Meanwhile, more tax breaks are to be given to leave the finance, insurance and real estate sectors with enough money to "earn back" their losses, by extracting yet more rent and interest from the industrial economy's consumers and wage-earners.
The usual hypocrisy is being brought to bear claiming that all this is necessary to "save the middle class", even as what is being saved are its debts, not its assets. Something must give - and the upper ten percent of the population wants to make sure that it is not its own economic position, but that of the bottom ninety percent. The "way of life" that is being saved is not that of home ownership, but debt peonage to support the concentration of wealth at the top of the economic pyramid.
My modest proposal
Shareholders of Fannie Mae and Freddie Mac probably will be wiped out, as were S&L shareholders in the bailout of S&L depositors in the 1980s. There's a simple way to save Fannie Mae's and Freddie Mac's public functions, if they indeed are deemed necessary to keep supporting the debt market. This can be done without bailing out the speculators who bought the mortgages it packaged.
First of all, not all the mortgages that these two agencies have bought or guaranteed are junk. Most are genuine and are being paid. The poor are honest, after all, and think that they should pay as a matter of honor even if it is not in their economic interest to do so when their homes fall into negative equity. Let these mortgages continue to back the existing Fannie Mae and Freddie Mac bonds to the degree that they actually receive mortgage debt service. If there is a shortfall, let bondholders take the usual haircut that is supposed to go hand in hand with risk. That is why these mortgages had such high rates of interest, after all. The loss would be proportional to the financial and real estate fraud they have enabled. This is the law for all other bondholders when their investments go south. Why make an exception for participants in the real estate bubble?
The rule caveat emptor should apply to bankers and investors here. They have bought a product - a flow of income that they either believed or pretended could be paid. Any student taught the mathematics of compound interest knows that in the end no economy's debts can be paid. So this should be a special financial caveat.
To keep their activities current, let Fannie and Freddie issue a new series of bonds - the "we won't fake it anymore" series. They would be based on a new honesty based on more realistic appraisals of the affordability of housing, which they were supposed to be promoting all along. These steps would not cause a collapse.
But before stepping up to save Fannie Mae and Freddie Mac, we might ask whether it would be a tragedy for their debt guarantees to cease. Wall Street has given politicians a cover story that to support Fannie and Freddie on the pretense that its packaging and reselling mortgages in big "tranches" provides liquidity. Its defenders claimed to be "modernizing" the real estate mortgage market by creating uniform standards and homogeneous packages. But these packages were increasingly tainted with junk, putting floor sweepings of ARMs with no-down-payment and NINJA (no income, no job) loans into financial sausages.
What Fannie and Freddie did was to provide a vast new source of demand for mortgages. Their role has been to extend the market for mortgage debt, creating opportunities to make money financially in an environment of asset-price inflation - the Bubble Economy. The effect was to push up housing prices. This has been the great American game for a century. And it has turned increasingly to outside investors (including gullible German banks which were the first to go bust by trusting the US junk mortgage market), swelling the supply of loanable funds that bid up property prices.
Prior to Fannie Mae and Freddie Mac, banks that issued mortgages held onto them, because there were no outside blind buyers. This was the pre-fraud era. It is now looking like a Golden Age. Housing prices were lower, and buyers did not have to go so deeply into debt to purchase homes. But the Senate and Congress - at least the Democrats - are urging the FHA and other government agencies to prop up the mortgage market by issuing zero-down-payment loans and other subsidies. The immediate aim is not to help homeowners - who indeed will have to pay more if the housing market re-inflates. Each new economic crisis adds a few new words to the English language. This time we get "reflate". Others include NYU Professor Roubini's "stagdeflation" for a combination of debt deflation of incomes and price inflation for commodities as the dollar sinks in response to the balance-of-payments deficit resulting largely from the war in Iraq. But that is another story. Today's story is about how Congress is aiming to bail out the banks that have bought or packaged these junk mortgages, about how needless this bailout is, and about how much simpler and more fair to just write off the bad debts.
Conclusion
America's $13 trillion in domestic real estate debt is no more payable than is the government's $3.5 billion dollar debt to foreign central banks, or the public debt itself for that matter. Adam Smith remarked over two centuries ago that no government ever had repaid its debts. At that time the aristocracy - the heirs of the Viking warlords who conquered Britain and other European countries and turned their common lands into private property - held most of the land free and clear. Today, real estate has been "democratized", but this has been done on credit. Mortgages are the major debts of most American families. In this role, real estate debt has become the basis for the commercial banking system, and hence the basis for the wealthiest ten percent of the population who hold the bottom ninety percent in debt. That is what Fannie Mae, Freddie Mac and "the market" are all about.
Neither party in Congress supports a new bankruptcy bill. The lobbying money simply isn't there. So the preferred alternative seems to be a new real estate bubble, which means more debt peonage for new homebuyers rather than housing prices falling back to more affordable proportions.
Of course, there is an alternative (TIAA). It is to make rent the basis of the tax system instead of being the basis for expanding debt to the banks. Real estate could free labor and industry from having to pay taxes. Instead, un-taxing property has forced labor to bear the tax burden, and to pay an equivalent sum in interest to the banks as well.
But that is a topic for a future article.
Notes:
{1} "The Price of Fannie Mae", Wall Street Journal (July 10 2008; page A14)
http://online.wsj.com/public/article_print/SB121565255349741343.html
{2} Better Debt Than Stock? by David Reilly, Wall Street Journal (July 12 2008)
http://online.wsj.com/public/article/SB121582541586147925.html?mod=2_1569_topbox
Reprinted in: "Capital Measures of Fannie and Freddie" (July 12 2008)
http://remington-work.blogspot.com/
{3} "The Silence of the Lenders" by Gretchen Morgenson, The New York Times (July 13 2008)
http://www.nytimes.com/2008/07/13/business/13mail.html
_____
Michael Hudson is a former Wall Street economist specializing in the balance of payments and real estate at the Chase Manhattan Bank (now JPMorgan Chase & Company), Arthur Anderson, and later at the Hudson Institute (no relation). In 1990 he helped established the world's first sovereign debt fund for Scudder Stevens & Clark. Dr Hudson was Dennis Kucinich's Chief Economic Advisor in the recent Democratic primary presidential campaign, and has advised the US, Canadian, Mexican and Latvian governments, as well as the United Nations Institute for Training and Research (UNITAR). A Distinguished Research Professor at University of Missouri, Kansas City (UMKC), he is the author of many books, including Super Imperialism: The Economic Strategy of American Empire (new edition, Pluto Press, 2002) He can be reached via his website, mh@michael-hudson.com
http://www.counterpunch.org/hudson07152008.html
Bill Totten http://www.ashisuto.co.jp/english/index.html
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