Against the Fannie/Freddie bailout

The shareholders and bondholders, not the taxpayers, ought to take the hit.

I don’t claim to be an expert on housing finance, but I really can’t make sense of the proposed Fannie/Freddie bailout. If the taxpayers are going to take the downside, why shouldn’t they get the upside to go with it? And what’s the case for “honoring” a guarantee that was never given to the bondholders?

True, if we make the bondholders take a “haircut” after they purchased securities that were backed by a wink-and-a-nod pseudo-guarantee from the government, future investors won’t trust any government guarantee that isn’t written into law. Good. This country is supposed to be run on laws, not on winks and nods.

I don’t have any problem with the Fed opening the discount window to the GSEs for a while, if that means lending to them on good security. But why should be the taxpayers and not the bondholders and shareholders who take their lumps when the overpaid managers of two for-profit enterprises allow them to get overextended in the course of profiting from, and fuelling, a catastrophic financial bubble?

Fannie Mae started out as a government agency. As a government agency, it operated prudently and made a profit. (Not hard, admittedly, when you’re borrowing at Treasury rates and lending at mortgage rates.) Then it was spun off as a private business. As a private business, it has operated imprudently and is now, on a mark-to-market basis, insolvent. That ought to suggest that the job of guaranteeing mortgages and bundling them into securities is better performed by civil servants than by overpaid executives.

To add to all that, high housing prices are social poison. Putting the taxpayers on the hook for mortgage defaults creates a perverse incentive for the government to keep those prices high. Me, I’m agin’ it.

Keep the mortgage market functioning, sure. But that can be done as well by a conservatorship (like the takeover of an insolvent bank) as by a bailout. We have better uses for $300 billion than protecting investors from the consequences of their own folly.

Author: Mark Kleiman

Professor of Public Policy at the NYU Marron Institute for Urban Management and editor of the Journal of Drug Policy Analysis. Teaches about the methods of policy analysis about drug abuse control and crime control policy, working out the implications of two principles: that swift and certain sanctions don't have to be severe to be effective, and that well-designed threats usually don't have to be carried out. Books: Drugs and Drug Policy: What Everyone Needs to Know (with Jonathan Caulkins and Angela Hawken) When Brute Force Fails: How to Have Less Crime and Less Punishment (Princeton, 2009; named one of the "books of the year" by The Economist Against Excess: Drug Policy for Results (Basic, 1993) Marijuana: Costs of Abuse, Costs of Control (Greenwood, 1989) UCLA Homepage Curriculum Vitae Contact: