Monday, September 8, 2008

'Too Big to Fail': Fannie Mae and Freddie Mac, Part II


Paul Krugman urges us not to refer to the Fannie/Freddie takeover as 'nationalization.'

I wish people wouldn’t say that Fannie and Freddie have been “nationalized.” I mean, it’s basically accurate, but it conveys the wrong impression.

The fact is that Fannie Mae was originally a government agency; it was privatized in 1968, not for any good economic reason, but to move its debt off the federal balance sheet (and Freddie was created 2 years later as a competitor.) Private ownership of Fannie and Freddie never made any real sense, and was always a crisis waiting to happen.

So what we’re really seeing now is deprivatization. It’s not something like the UK government seizing the steel mills; it’s more like firing Blackwater and giving responsibility for diplomatic security back to the Marines.

But others are sensing a sea change rather than a return to normalcy. On CNBC minutes ago, while discussing the government take-over, anchor Dylan Ratigan asked, "Is capitalism the new socialism?" An answer was then given by analyst Steve Leisman, who says people who still think in terms of "laissez-faire capitalism" should "get their heads out of the clouds."

At stake, of course, is not just labels and ideology, but practical consequences. Jim Lockhart, Director of the FHFA, says:

[L]et me make clear what today's actions mean for Americans and their families. Fannie Mae and Freddie Mac are so large and so interwoven in our financial system that a failure of either of them would cause great turmoil in our financial markets here at home and around the globe. This turmoil would directly and negatively impact household wealth: from family budgets, to home values, to savings for college and retirement. A failure would affect the ability of Americans to get home loans, auto loans and other consumer credit and business finance. And a failure would be harmful to economic growth and job creation. That is why we have taken these actions today. [I have added the emphasis]

The question that the CNBC journalists are getting at is: Is an economic system 'capitalist' -- in the sense of being a free market -- if certain parts are deemed so important to the system that they are not allowed to fail? Conversely, Mr. Lockhart is less concerned with what the system is called and more concerned with the conditions that the system produces for its members.

Still, in this case ideology and consequences are not entirely separate. One tenet of free-market ideology is that the system, if left alone, will manage to create the consequences the members want. Through the mechanism of supply and demand, the ideology goes, the market will cut out the bad parts and replace it with better parts. Instead, the US government in this case has intervened to force the market to keep certain parts and to create particular consequences -- specifically, to stabilize the housing market.

I propose momentarily setting aside any discussion of whether the move will work or not. After all, right now we don't know if time will prove that nationalizing (or "deprivatizing") Fannie and Freddie was a good or a bad decision -- that is, we don't know if it will succeed in meeting its goal. And in light of the depth of the crisis, it seems clear that somebody had to do something -- and sometimes that somebody is the government and sometimes that something is intervention.

Rather, one question above all should be front and center: Where is the American economy going? Will the system continue growing more centralized? In light of Bear Stearns, and now Fannie Mae and Freddie Mac, the system certainly appears to be going in that direction. But not necessarily. On one hand, perhaps the GSE bail-out is responsible government planning that will allow the free market to collect itself. Or on the other hand, perhaps the bail-out is the most recent sign that centralized planning has eclipsed free-market action.

The fundamental question becomes: Is the bail-out a one-time thing? Or a signal of evolutionary systemic change?

In any event, it seems clear that the current housing downturn has the potential to radically change the American economy as we know it -- its ideology, and its consequences.

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