Brad DeLong posted an excerpt of an article by the Economist on Freddie Mac and Fannie Mae, the quasi-governmental corporations that buy up mortgages from banks and bundle them together into asset-backed securities. DeLong didn't comment, but the excerpt prompted some of his readers to offer such insightful comments as:
Who cares what Alan Greenspan thinks? He's a partisan hack like any other, according to Krugman.
Well, Krugman would know a partisan hack when he sees one. (As he does in the mirror every morning.)
The near government agency status of the corporations has allowed for lower middle class mortgage for decades, and Fannie Mae has been moving to mortgage for lower income households that will shield the households from excessively priced debt. The hedging techniques used by Fannie and Freddie are fairly transparent and conservative. What then is the problem? The problem seems to be persistent lobbying by other finance corporations for more of the mortgage market. So, there is another conservative target.
Here are the problems:
- It is simply not true that Freddie and Fannie's hedging techniques are "fairly transparent and conservative." To the contrary, as Berkeley business school professor Dwight Jaffee has demonstrated their hedging practices create "imperfect hedges and thus could impose significant costs on U.S. taxpayers in a potential future F&F bailout."
- Investors believe that because of the quasi-governmental status of Freddie Mac and Fannie Mae, the government will never let them fail. As Clinton Administration Assistant Treasury Secretary Richard Carnell observes: "[They] tell Congress and the news media, ‘Don’t worry, the government is not on the hook’ – and then turn around and tell Wall Street, ‘Don’t worry, the government really is on the hook.’" This enables Freddie and Fannie to achieve a lower cost of capital than competitors by selling equity at higher prices or to borrow at an interest rate below that available to potential competitors. At the same time, the implicit government guarantee apparently encourages management to take risks that firms subject to market competition and lacking a government safety net would never take. In particular, as the Economist pointed out, Freddie and Fannie increasingly hold on to mortgages rather than reselling them as asset backed securities, which exposes them to much higher repayment and other risks.
- Freddie and Fannie have serious and well-documented corporate governance problems. Harvard law professor Lucian Bebchuk and Boalt law professor Jesse Fried, for example, have identified four problems with Fannie Mae's executive compensation arrangements: "First, by richly rewarding executives for reporting higher earnings, without requiring return of the compensation if earnings turned out to be misstated, Fannie Mae's arrangements provided perverse incentives to inflate earnings. Second, Fannie Mae's arrangements provided soft landings to executives who were pushed out by the board for failure; expectation of such outcome adversely affected ex ante incentives. Third, even if the executives had retired after years of unblemished service, the value of their retirement packages would have been largely unrelated to their own performance while in office, weakening the link between pay and performance. Fourth, both when promising retirement payments to executives and when making these payments, Fannie Mae's disclosures obscured rather than made transparent the total values of the executives' retirement packages."
- In an excellent overview of the issues, Fussing and Fuming over Fannie and Freddie: How Much Smoke, How Much Fire?, Fed economist W. Scott Frame and NYU economics professor Lawrence J. White argue, inter alia, that Freddie and Fannie in fact do not focus on "lower middle class mortgage[s]," as DeLong's reader opined. Instead, they argue, much of Freddie and Fannie's lending activities benefit home buyers in higher economic groups.
- No responsible conservative (or liberal) is talking about getting rid of Freddie and Fannie. But there is an emerging consensus, that includes folks on both sides of the aisle that Freddie and Fannie need reforms in their corporate governance and investment practices.
