Regulating Fannie and Freddie

[Adrian II]

For years now I have advocated what I regard as modern Socialism: harnessing competition in the public interest.

The state should set parameters for markets to ensure truly free and effective competition, i.e. competition based on quality and price, not on (semi)monopolistic price-setting, child labour etcetera. The more essential certain services are to the economy or to non-calculable values of the nation, the more the state should guarantee that they are fairly accessible to everyone. Examples of such services that couldn't or shouldn't function on a cost-benefit basis are policing, telephony or education.

Members who do not share this view will at least share with me the need for regulation. No market could ever function without regulation. It is no surprise that the champion of free markets, the United States, has introduced some of the toughest anticartel laws in the world. But do they work? And if they don't work, then why is that?

In short: what is fair and efficient market regulation, and how do we implement it?

Let's take Fannie and Freddie as example. I would take an example from my own country if everyone on the Org read Dutch, but that isn't the case and there is a lot of English-language info on F & F available which makes discussion much easier. Besides, I am fascinated by the Fannie and Freddie case.

This article breaks down the essential issues nicely.

Whenever the mortgage finance giants, Fannie Mae and Freddie Mac, find themselves in a tough spot — and boy, are they in a tough spot now! — they always seem to find a way to blame their problems on “the mission.”

“We exist to expand affordable housing,” says Fannie Mae on its Web site, and although it also lists its other mission — providing liquidity for the American housing market — it is the former that has long been the companies’ trump card.

That mission of creating affordable housing is the reason that Alan Greenspan, the former Federal Reserve chairman, could testify, year after year, that Fannie and Freddie had become so large, and took so much risk, that they could one day damage the nation’s financial system — only to be utterly ignored by the same members of Congress who otherwise hung on his every word.

The mission is why the two companies were able to run roughshod over their regulator for years, and why the Bush administration was unable to rein them in, even after an accounting scandal.

The mission is why their two chief executives, Daniel Mudd at Fannie and Richard Syron at Freddie, could take home a combined $30 million last year, while presiding over one of the great financial disasters of all time, posting billions of dollars in losses with no end in sight.

The U.S. government has entrusted these two companies with the 'mission' of making affordable housing available to all Americans. This is essentially State Socialism: a (semi)monopolistic company is required by the government to meet policy goals and in return for that it gets all sorts of tax and regulatory breaks from same. The result has been as desastrous as those of State Socialism everywhere in the world. Corruption sets in and the reslt is the opposite of what was envisaged by the policy:

That would be hard enough to swallow if the cause had, in fact, been the companies’ willingness to finance low-interest loans to working-class home buyers. But the real reason was greed. [..] The problem is that while the two companies are still called government-sponsored entities, they are also publicly traded corporations. And for much of the last two decades, they have been hell-bent on growth, the clear goal being to push up their stock prices.

The net result is that the U.S. governmnt is now dependent on these self-created monsters:

[..] given the paralysis in every other sector of the market, the country badly needs Fannie and Freddie to do what they are chartered to do: “wrap” loans so that banks will keep writing mortgages. That’s why Congress recently passed a law that allows Fannie and Freddie to insure mortgages up to nearly $625,500, from the previous limit of $417,000. That’s also why the Treasury is now taking pains to ensure the marketplace that the companies will not go bust, even if it means a government takeover.

My conclusion is that private companies can and should never be burdened with public responsibilities. It is a recipe for fraud, malpractice, policy failure and financial disaster.

So my question is this: How do you regulate a market in the public interest without burdening the parties with public responsibilities? How do you make markets work in the public interest without any of the market parties working in the public interest? I have some thoughts on the matter, but I would rather hear other peoples' views unobstructed by my assumptions.

The author of the article has as idea:

You want to know the truth about “the mission?” The country doesn’t even need Fannie and Freddie to help with affordable housing. Several laws mandate that banks reinvest in the communities in which they operate — and that mandate has come to be defined largely as making loans available for affordable housing. Several executives involved in community-based banking told me that Fannie and Freddie actually refused to buy those mortgages — they weren’t profitable enough. (A spokeswoman for Freddie Mac denies this.)

Are such mandates the answer to my question?