Esoteric Dissertations from a One-Track Mind

July 15, 2008

Credit Crisis: Fannie Mae, Freddie Mac

Filed under: capitalism, economy, politics — Tags: , , , — codesmithy @ 9:11 am

Paul Krugman examines the coming bailout of Fannie Mae and Freddie Mac in his op-ed column “Fannie, Freddie and You.”  Basically, a bailout of Fannie Mae and Freddie Mac is coming.  Both are quasi-government institutions to encourage home ownership.  While, profits are privatived and losses are socialized, Fannie Mae and Freddie Mac are examples of regulation that worked, well, for the most part.

Krugman points out that both institutions were tightly regulated in terms of lending.  However, they weren’t required to put up enough capital, which left them vulernable to this type of problem when the assets declined.  The capital requirement is just insurance, and without a doubt both institutions should have had more.   Nevertheless, given the scope of the current crisis, taxpayers would be left holding the bag one way or another.  This is the very essence of a social safety net.

The question of whether they should have ever been privatized to begin with is another question entirely, and tellingly, one that Krugman doesn’t ask.  Privatizing these institutions gave rise to the perversity of incentives which led to the lack of capital backing.  However, it is unlikely that a corporation would do much better.  The same type of perversity exists, only it is the shareholders left footing the bill instead of taxpayers.  Sometimes, the financial leaders can spur an after the fact taxpayer bailout by pointing out that it is not them who will suffer, but rather shareholders who depend on some form of financial instruments for their retirement.

There are lots things to get very upset about surrounding this entire crisis.  The Fannie Mae and Freddie Mac bailout is small in the big scheme of things.  If the government starts buying up bad debt from private instutions that avoided regulation, that is the time to get really upset.

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