"Should Government Be A Lending Institution?"

Treasury Secretary Henry Paulson Jr. said Tuesday that two troubled mortgage giants should remain in the hands of shareholders.

Speaking to members of the U.S. Senate Committee on Banking, Housing and Urban Affairs in Washington Paulson, outlined the Treasury's three-step plan to restore confidence in the Federal Home Loan Mortgage Corp. (NYSE:FRE) and the Federal National Mortgage Association. (NYSE:FNM)

The plan includes extending lines of credit for the companies to $300 billion, allowing the Treasury to purchase equity in the companies on a temporary basis and giving the Federal Reserve a regulatory role in the two government sponsored enterprises, known as GSEs.

"We have long maintained that the GSEs have the potential to pose a systemic risk," Paulson said.

That risk can be measured by Freddie Mac (NYSE:FRE-W) and Fannie Mae (NYSE:FNM-Q)'s involvement in "70 percent of new mortgages," and their role as "the only functioning secondary mortgage market," Paulson said.

Although leaning on taxpayer dollars, Paulson repeated his position that the two companies should remain in private hands. "As I have said, we support the current shareholder-owned structure of these enterprises," he said.

The desperate worry over the health of huge financial institutions with country cousin names — Fannie Mae and Freddie Mac — reflects a reality that has reshaped major spheres of American life: the government has in recent months taken on an increasingly dominant role in assuring that Americans can buy a home or attend college.

Much of the private money that once surged into the mortgage industry has fled in a panicked horde, leaving most of the responsibility for financing American homes to the government-sponsored Fannie and Freddie.

A similar trend is playing out in the realm of student loans. As commercial banks concluded that the business of lending to college students was no longer quite so profitable, the Bush administration promised in May to buy their federally guaranteed student loans, giving the banks capital to continue lending.

In short, in a nation that holds itself up as a citadel of free enterprise, the government has transformed from a reliable guarantor into effectively the only lender for millions of Americans engaged in the largest transactions of their lives.

The new reality is scorned by libertarians and conservatives, who fear state intrusions on the market, and by populists and progressives, who dislike the idea of education and housing increasingly resting upon the government’s willingness to finance it.

Ron Paul in the House Financial Services Committee, September 10, 2003

I hope this committee spends some time examining the special privileges provided to GSEs by the federal government. According to the Congressional Budget Office, the housing-related GSEs received $13.6 billion worth of indirect federal subsidies in fiscal year 2000 alone. Today, I will introduce the Free Housing Market Enhancement Act, which removes government subsidies from the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac), and the National Home Loan Bank Board.

One of the major government privileges granted to GSEs is a line of credit with the United States Treasury. According to some estimates, the line of credit may be worth over $2 billion. This explicit promise by the Treasury to bail out GSEs in times of economic difficulty helps the GSEs attract investors who are willing to settle for lower yields than they would demand in the absence of the subsidy. Thus, the line of credit distorts the allocation of capital. More importantly, the line of credit is a promise on behalf of the government to engage in a huge unconstitutional and immoral income transfer from working Americans to holders of GSE debt.

The Free Housing Market Enhancement Act also repeals the explicit grant of legal authority given to the Federal Reserve to purchase GSE debt. GSEs are the only institutions besides the United States Treasury granted explicit statutory authority to monetize their debt through the Federal Reserve. This provision gives the GSEs a source of liquidity unavailable to their competitors.

The connection between the GSEs and the government helps isolate the GSE management from market discipline. This isolation from market discipline is the root cause of the recent reports of mismanagement occurring at Fannie and Freddie. After all, if Fannie and Freddie were not underwritten by the federal government, investors would demand Fannie and Freddie provide assurance that they follow accepted management and accounting practices.

Ironically, by transferring the risk of a widespread mortgage default, the government increases the likelihood of a painful crash in the housing market. This is because the special privileges granted to Fannie and Freddie have distorted the housing market by allowing them to attract capital they could not attract under pure market conditions. As a result, capital is diverted from its most productive use into housing. This reduces the efficacy of the entire market and thus reduces the standard of living of all Americans.

Despite the long-term damage to the economy inflicted by the government's interference in the housing market, the government's policy of diverting capital to other uses creates a short-term boom in housing. Like all artificially-created bubbles, the boom in housing prices cannot last forever. When housing prices fall, homeowners will experience difficulty as their equity is wiped out. Furthermore, the holders of the mortgage debt will also have a loss. These losses will be greater than they would have otherwise been had government policy not actively encouraged over-investment in housing.

Perhaps the Federal Reserve can stave off the day of reckoning by purchasing GSE debt and pumping liquidity into the housing market, but this cannot hold off the inevitable drop in the housing market forever. In fact, postponing the necessary, but painful market corrections will only deepen the inevitable fall. The more people invested in the market, the greater the effects across the economy when the bubble bursts.

     Nearly five years ago, libertarian leaning Republican Congressman and now suspended Presidential candidate, Dr. Ron Paul, foresaw the present mortgage and foreclosure crisis and submitted legislation to forestall that  crisis from occurring, such legislation being the prohibition of further federal government subsidies and guarantees to the giant private mortgage companies, Fannie Mae and Freddie Mac. At present, the Bush Administration continues to pour taxpayers dollars to support these practically failed mortgage companies, which as Ron Paul said five years ago would merely be "postponing the necessary, but painful market corrections (that) will  only deepen the inevitable fall."

    In my opinion, continued "Big government" spending won't solve any of America's economic woes but only exacerbate them. Subsidies for war, covert foreign operations, Wall Street investment banks, mortgage and loan companies, as well as failed alternative energy industries such as corn ethanol, will have to cease. A "limited government" regulated free market will restore the American economy in a way that the "Big government" policies and spending of the present Bush Administration and the potential administrations of Barack Obama or John McCain never will. Banks are lending institutions, the constitutional Federal government is not.

tags: fannie mae  freddie mac  capitalism  the economy  free enterprise  the   free maket  limited government  ron paul  business  takebackamerica  us  

links: digg this    del.icio.us    technorati    reddit