Jan 13, 2005

More on Fannie Mae

The Mises Economic Blog has a pretty dark summary of the situation unfolding at Fannie Mae. It ends with the following conclusions.

By funneling domestic and foreign credit into residential real estate, they have created a variant of the mal-investment that Mises first identified in his business cycle theory. Mises noted that the extension of bank credit to producers would result in a form of mal-investment from the creationg of more higher order capital goods than could be afforded given the amout of available savings. The GSEs enable credit expansion to fund the construction of residential real estate, while the socialization of risk defeats the markets’ mechanism for containing credit which would occur naturally if private parties were required to bear the risk. The result is an over-consumption of housing, a mal-investment in home building and mortage-brokering, and the creation of the liability associated with the interest-rate and default risk of the mortgage credit.

Is OFHEO really a regulatory agency? Regulatory agencies create and enforce rules that the private sector must follow. The Fannie flap, then, is really a brawl between multiple government agencies: Fannie, OFHEO, and the SEC. Can the government really regulate itself? Raines has been chosen to fall on his sword, taking semi-retirement with a multi-tens-of million dollar pension as his show of contrition and acceptance of responsibility.

In the end, will anything change as a result of the accounting scandal? Undoubtedly, a new CEO with impeccable bean-counting credentials will be put in place to clean up the political mess. Likely, they will not have Raines personal charisma, his Washington connections, or his ability to lobby congress.

I am confident that Greenspan understands the importance of extending the housing bubble to avert the liquidation of the mal-investments that remain from the stock market bubble that he created. Putting Fannie Mae on a tighter leash would inhibit its ability to further inflate US residential real estate. But competition between government agencies is not entirely planned. Perhaps Fannie now is under enough scrutiny and the political capital generated by going after another fat-cat CEO will have unintended consequences of its own.

There has been increased talk of "privatization" of these entities, but like the “privatization” schemes proposed for Social Security, the biggest hurdle would be unwinding the current liabilities. What private entities would take on Fannie’s balance sheet without the Fed guarantee? Risk has been significantly under-priced throughout the financial sector, but no where more so than in the GSEs. An accurate pricing of risk would surely show these firms to have a negative net worth. Who will pick up the difference?

Read the full post here.

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