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Too Big to Fail 2

16 July 2008

Weeks ago, it was Bear Stearns.  Today, it’s Fannie Mae and Freddie Mac, and thirteen trillion dollars of mortgage debt hang in the balance.  Are they too big to fail?

James B. Stewart in the Wall Street Journal’s “Smart Money” section says, moderately, that “noone wants to see [the two corporations] nationalized, but…”

Well, not quite.  In the same issue, Holman Jenkins says:  finish them off.

The third element of the Treasury’s weekend heroics, the suggestion that it might use taxpayer money to inject new equity into Fannie and Freddie, was not redundant. It was a terrible idea. Putting taxpayers in bed with Fannie and Freddie’s shareholders would only ratchet up the stakes. Congress would insist on showing a “profit” from this adventure. The game with the federal credit card would start anew.

The obvious solution is to nationalize Fannie and Freddie and break them up. Sell off their regional underwriting offices to private investors. Don’t heed any guff about how Fannie and Freddie are “vital to the functioning of the U.S. housing market.” Houses would still need to be financed, and the private sector would jump at a chance to get the solid, triple-A business that Fannie and Freddie now monopolize.

Allan Meltzer takes his turn at the Journal’s podium with this:

Only in the weird world of Washington are mistakes rewarded with major new responsibilities. After mismanaging both housing loans and the dot-com mess, the Federal Reserve may now become responsible for supervising investment banks…So what can taxpayers expect from an increase in the Fed’s discretionary authority over investment banks? The likely answer is rescues, delays and lax supervision – followed by taxpayer-financed bailouts. Throughout its postwar history, the Fed has responded to the interests of large banks and Congress, not the public.  

Investment banks don’t need the Fed to regulate them. Some clear rules on capitalization would suffice.

The Journal’s editorial board weighed in:

Mr. Paulson’s Sunday statement at least began to show more leadership. The Treasury Secretary wants Congress to give the government more power to rein in the companies, including with a preferred stock capital injection if required. This is progress, but it’s not aggressive enough given the risks. He could make more progress more rapidly toward a safer financial system by putting the companies into federal receivership. If current law doesn’t give Treasury that power – and we hear conflicting legal claims – Mr. Paulson should seek it from Congress.

It’s time to answer the question definitively.  Do the two semi-socialist behemoths – public risk, private profit – serve a vital function that cannot be served by a more purely capitalist structure?  And, more to the point, is the taxpayer better served in the long term by preserving the two corporations or by liquidating them and returning their assets and liabilities to the private sector?

“Too big to fail” implies something that ought to terrify us:  bad management’s only remedy is to put taxpayers on the hook for the outcomes.  

In this case, though, there is a more systemic problem:  we cannot bring ourselves to make the hard decisions when the justification is overwhelming.



One Comment leave one →
  1. 17 July 2008 9:34 am

    Don’t think it is an “either/or” matter. The “private sector” has never been private–unless it is the black market. Human choice is nowhere near ideally “enlightened self-interest.” Need is OK, but greed is not good. Markets can be swayed and whipsawed by speculators and fraudulent behavior. All this is to say that government, it seems to me, has more than a marginal role as free marketeers would have it. Public health, fraudulent representations, and marketplace anarchy (like the floors of stock and commodity exchanges) need containing. When self-policing isn’t done, government needs to step in as a corrective. And while that is not always successful, it sometimes is.

    The church itself ought to communicate a sense of modesty, restraint, and stewardship. But too often it doesn’t. Too often, it simply repeats the business mantra: “Well, that’s just business.” And doesn’t speak or act prophetically.



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