How we got here

John Steele Gordon has an interesting historical perspective on the current financial mess, going back to the Jackson administration. As you might expect, the heart of the tale centers on Fannie and Freddie:

The aggressive pursuit of an end to redlining also required the active participation of Fannie Mae, and thereby hangs a tale. Back in 1968, the Johnson administration had decided to “adjust” the federal books by taking Fannie Mae off the budget and establishing it as a “Government Sponsored Enterprise” (GSE). But while it was theoretically now an independent corporation, Fannie Mae did not have to adhere to the same rules regarding capitalization and oversight that bound most financial institutions. And in 1970 still another GSE was created, the Federal Home Loan Mortgage Corporation, or Freddie Mac, to expand further the secondary market in mortgage-backed securities.

This represented a huge moral hazard. The two institutions were supposedly independent of the government and owned by their stockholders. But it was widely assumed that there was an implicit government guarantee of both Fannie and Freddie’s solvency and of the vast amounts of mortgage-based securities they issued. This assumption was by no means unreasonable. Fannie and Freddie were known to enjoy lower capitalization requirements than other financial institutions and to be held to a much less demanding regulatory regime. If the United States government had no worries about potential failure, why should the market?

Forward again to the Clinton changes in 1995. As part of them, Fannie and Freddie were now permitted to invest up to 40 times their capital in mortgages; banks, by contrast, were limited to only ten times their capital. Put briefly, in order to increase the number of mortgages Fannie and Freddie could underwrite, the federal government allowed them to become grossly undercapitalized. . .

That was bad enough; then came politics to make it much worse. Fannie and Freddie quickly evolved into two of the largest financial institutions on the planet. . . But unlike other large, profit-seeking financial institutions, they were headquartered in Washington, D.C., and were political to their fingertips. Their management and boards tended to come from the political world, not the business world.

(Via Instapundit.) (Previous post.)

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