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The Cure is the Problem

Over at OTB [1], Steve Verdon restates what I’ve been saying here for weeks:


An older article [2], but relevant.

It is important to understand that, as GSEs, Fannie and Freddie were viewed in the capital markets as government-backed buyers (a belief that has now been reduced to fact). Thus they were able to borrow as much as they wanted for the purpose of buying mortgages and mortgage-backed securities. Their buying patterns and interests were followed closely in the markets. If Fannie and Freddie wanted subprime or Alt-A loans, the mortgage markets would produce them. By late 2004, Fannie and Freddie very much wanted subprime and Alt-A loans. Their accounting had just been revealed as fraudulent, and they were under pressure from Congress to demonstrate that they deserved their considerable privileges. Among other problems, economists at the Federal Reserve and Congressional Budget Office had begun to study them in detail, and found that — despite their subsidized borrowing rates — they did not significantly reduce mortgage interest rates. In the wake of Freddie’s 2003 accounting scandal, Fed Chairman Alan Greenspan became a powerful opponent, and began to call for stricter regulation of the GSEs and limitations on the growth of their highly profitable, but risky, retained portfolios.

The continuing notion that the credit crisis is a result of free markets is just laughable when you have the CRA, Fannie Mae, and Freddie Mac involved in the markets. The governments grubby paw prints are all over this mess. It isn’t the only contributing factor but to say, “Oh it is free markets,” is the liars position.

Which means, of course that McCain’s position that it’s all on ‘Wall Street Greed” is equally suspect to Obama’s calling for increased regulation.

Where Verdon starts straying, in my view, is where he considers that it’s even possible to get government involved in the market without eventual dire consequences:

So my beef isn’t that there is too much regulation or not enough regulation but that this idea that we can find just the right amount of regulation is not going to be possible in a discreationary policy regime. Such a regime is going to be subject to the problems of time inconsistency, rent seeking, and interest group pressures.

The problem, of course is that it’s always that way where the power of government is involved. Things get screwed up to the direct degree that government is involved in the market. Sometimes, involvement is indeed requred. But to the degree it pulls down the market? I don’t think so, Tim.