Daily Archives: July 12, 2008

Fannie Mae, Freddie Mac and Your Constitution

The American people are getting a crash course this month in government economics and the wisdom of the Founding Fathers. As they watch their energy and food costs skyrocket and their home value plummet, many are in a daze wondering, Wha‘ Hap’n? Unfortunately, this is likely only the beginning. When the economy of scale meets the law of diminishing returns with the genetic incompetence of government thrown in, you have a formula for disaster.

The Founding Fathers knew from the experiences of governments that had gone before that government is limited in the things it can do well. They also knew that government, while necessary for matters of security, is paid for with the liberties of its people. Therefore they gave us a carefully crafted government, enshrined in the Constitution, that promised maximum security for the people with a minimum sacrifice of liberty.

The national government was given the responsibility for those things which the state governments could not do for themselves, such as national defense, foreign relations and the promotion of international and interstate trade. Everything else was left pretty much up to the state governments. The intention of the founders was for the state governments to be the primary governments affecting the lives of individual citizens.

Their greatest fear was that they would create a government that would expand over time and eventually abolish state sovereignty, in the process, taking away the liberties of the people. This concern is the predominant theme of the writers of both the Federalist Papers and the Anti-Federalist Papers. To prevent this from happening they clearly spelled out the powers delegated to the Federal Government in Article 1, Section 8 of the Constitution.

The economic woes we are experiencing today are the direct result of the Federal Government attempting to do that which it was not designed to do. Both the energy crisis and the mortgage crisis are government created and exacerbated. Both are the results of attempting to blend socialism with free market capitalism, and overreaching in both. Furthermore, they both are the consequence of Congress’ ignoring the restrictions of the Constitution on their powers.

During the housing boom of the late forties and early fifties, brought about by the returning veterans of World War II and their growing families, the number one focus of the American Dream shifted from liberty and freedom to home ownership. By the seventies, the utopian aspirations of the “Great Society” had transformed home ownership from an earned reward for individual thrift and labor, to a “right“ fostered by government.

Congress, in order to “make it happen” decided to go into the mortgage business. They chartered two shareholder owned businesses known as “Fannie Mae” and “Freddie Mac”. Their purpose was to provide money to the mortgage industry by purchasing mortgages and repackaging them into securities which they would than resell to investors. The cost to the government was intended to be minimal since the actual funds would be provided by investors.

These two government sponsored enterprises (GSEs) enjoyed several advantages over their privately managed competitors in the mortgage banking industry. One was their unique relationship to wielders of power in the government. As privately financed enterprises the government is not technically responsible for their success or failure. However, the perception was permitted to develop that mortgages financed by these GSEs were underwritten and therefore guaranteed by the Federal Government.

Furthermore, due to their close relationship with Congress they were not subjected to the same regulatory oversight private banking firms were. Private financial institutions are required to keep a certain level of cash reserves on hand in case of a business downturn. Fannie and Freddie were exempted from this requirement, at least to the same extent private investment firms are, and they were not held to the same stringent accounting practices private firms are held to.

So then, what we have, are two government sponsored financial enterprises, undercapitalized and under regulated competing in the market place for mortgage backed securities. Their investors are led to believe that investments are guaranteed by the “full faith and credit” of the U.S. Government. Furthermore they have access to cheaper money at more lenient rates than their competitors. As a result, Fannie Mae and Freddie Mac soon became the nation’s largest holders of mortgages in the secondary mortgage market.

Together they hold over five trillion of the twelve trillion dollars in mortgage debt currently outstanding in the U.S. Their position as the “lender of last resort” for many mortgage brokers results in a larger than normal inventory of mortgages to homeowners who are bad credit risks. Since their investments are almost exclusively in the home mortgage market, the rising rate of mortgage defaults and falling home prices places them in serious jeopardy.

On Friday, the Federal Deposit Insurance Corporation took over IndyMac, a California based mortgage bank, in the second largest banking failure in U.S. history. IndyMac is the largest casualty thus far in the subprime mortgage crisis, more or less created by the federal government in its rules concerning “equal opportunity lending practices“.

To further complicate the situation Senator Chuck Schumer (D-NY) made public—presumably for political publicity—a letter he had written to the Office of Thrift Management June 26, questioning the soundness of IndyMac. The result was a run on the bank. Over the next two weeks investors withdrew over $1.3 billion from their accounts necessitating the take over by the FDIC.

At the same time shareholders in Fannie Mae and Freddie Mac began dumping their shares in those two GSEs. Many in the Treasury Department are privately worried that Fannie Mae and Freddie Mac may follow IndyMac into insolvency necessitating a bail-out by the government. If that happens the taxpayer is on the hook for $5 trillion dollars in outstanding mortgages.

Look for the socialist/democrats in Congress to begin floating the idea of nationalizing the home mortgage industry should Fannie Mae and Freddie Mac continue their downward slide.

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Reference Sources:
The IndyMac Takeover Wall Street Journal
Fed Can Lend to Just About Anyone WSJ
Critics of the Firm Sadly Say “Told You” WSJ
The Doc Is In
The American Energy Crisis