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Fannie Mae: The credit crunch meets the F-word

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Paul Mason | 10:58 UK time, Saturday, 12 July 2008

The panic on Friday about the two US mortgage giants, Fannie Mae and Freddie Mac, is followed by the collapse of California's IndyMac, a regional mortgage lender. Customers at Indy have been told their money (up to a $100k limit) has been transferred to something called "IndyMac Federal Bank". The crucial letter in the acronyms that Freddie and Fannie are short for is F, as now also with Indy: the two giants are Federal institutions, as is - now - the busted Californian bank. Slowly but surely the state - not just in America but here too - is having to bail out the financial system, and I think this could have a big impact, eventually, on politics too....

Fannie Mae was founded in 1938 as the monopoly provider of mortgage loans. It was privatised in 1968, Freddie set up to expand the operation in 1970: they don't issue mortgages - they underwrite them for other institutions. Together they have underwritten $5 trillion of mortgages - half of all US mortgages.

On privatisation they received a bailout guarantee from the government and a direct line of credit from the US treasury; but they were listed companies - their shares traded on the stock exchange and they made a healthy profit. So healthy in fact that pure private capitalist banks had been baying for them to be unshackled from this part-private, half-life existence.

Thus Fannie and Freddie were sustained by one of those necessary fictions that underpin finance capitalism: that this $5 trillion was not really guaranteed by the US government at all. Now that fiction is collapsing (every step of the financial crisis has destroyed a necessary financial fiction) we are confronted with the emergence of something very strange: a state backed financial capitalism.

Consider this: right now the US legislature is about to pass a separate bill allowing the government to underwrite $300bn of mortgages for those whose homes are about to be repossessed; the US Treasury has already doled out in excess of $100bn cheap loans to banks to keep them afloat and "reinvented" a rule allowing it to underwrite the rescue of Bear Stearns by JP Morgan. Now it is faced with at the very least having to shoulder $40bn of Fannie and Freddie's debts (the two companies have insisted they are solvent and their is nothing wrong, but many analysts disagree, as does the market which has wiped 78% off their share value since January). And one option being discussed is to take the whole of Fannie/Freddie's mortgage book into public ownership, Northern Rock style. It is an option that, as with Northern Rock, they will surely try to avoid - because $5 trillion is the size of the US national debt!

(Put another way, the annual GDP of the United Kingdom is about $2.5 trillion and the entire GDP of the world, nominally, just under $50 trillion!)

(Temporary detour: Brad De Long who appeared on Newsnight last night to discuss all this is not happy at the way our discussion was handled. See here.)

All over the word, slowly but surely, the state is becoming exposed to the debts and liabilities of the finance system. We've seen it here with Northern Rock - and with the Bank of England's special liquidity scheme, and with the expanded deposit guarantee. The words "too big to fail" - once uttered as a joke, about a theoretical situation in the dining rooms of the investment banking world - have now been elevated into a philosophy.

The strange thing is it's being done on the watch of governments committed to removing the state from the economy. It is being done, in other words, in defiance of the official ideology of governments, regulators, banks, business schools, accountancy firms, TV pundits, Nobel prizewinners and nearly every think tank on earth.

On this basis I will make a prediction. Soon the ideology will move into line with the practice. Soon somebody will argue that a state-backed finance system, with much heavier regulation, is better than the one the world's leaders have been trying to patch together at the G8 summit.

Fannie Mae was born during Franklin Delano Roosevelt's second term, when the New Deal moved from a series of ad-hoc responses to the depression to a more holistic vision of a state-revived and regulated American capitalism. Incidentally FDR also created the Federal Deposit Insurance Corporation, which moved in last night to seize the assets of IndyMac. And the Securities and Exchange Commission which will now surely begin an investigation into how things went wrong. In short, the regulatory architecture of modern US finance was born as the result of a spectacular economic disaster which ruined the lives of millions for a generation.

Roosevelt and his allies did not start out with a coherent vision of what to do in the face of the crisis. They improvised - albeit branding the whole programme with the catch phrase "The New Deal". They closed 4,000 banks, they outlawed the concept of the investment bank as we know it; they outlawed financial speculation.

I am not advocating a return to Rooseveltian state captialism - but I do think the evolution of FDR's thought is worth studying.

Because what basically happened was that a coalition of interests determined to stop the finance sector from destroying the world economy found a leader prepared to go beyond muddling through and to envision a new kind of market economy where the state's mission was to defend the little guy against the steamroller of unemployment, hunger and speculation.

I have thought for some time that the global model developed around climate change might eventually seep through the thinking of politicians about the economy. The consensus devloped around Kyoto involves voluntary re-regulation, new taxes, quotas and artificially created prices. It is state intervention on a vast scale to save the world for our children - and it is done without apology.

In the economic sphere we are still at the stage where huge state interventions into the finance system are being sold as "temporary" or "abnormal". With a bit of pro-activity from regulators and government, we may yet head-off a deep recession and we will look back on the nationalised Northern Rock as an episode.

But if more dominoes fall in the financial system the point will come where somebody tries to make the case that a state-backed capitalism is better than what we've had for 20 years.

I tried this argument out on a bunch of investment bankers at a dinner 18 months ago and their faces turned the colour of vichyssoise. "The fact that you can't imagine it, and that you can't think of any mainstream politician who would advocate it" I said, "means you should probably go and risk-model it right away".


  • Comment number 1.

    Hi Paul. Thanks for that meaty exposition - it makes a welcome chew on a Saturday. I still think there is a lack of 'reality' (in the ancient Chinese, philosophical sense) in all this, so make no apology for re-posting as below. (I was tempted to re-title it: 'It's the Reallity stupid.)


    The trouble with money is: whilst it was once gold or silver, now it becomes just numbers. There is a similar problem with cosmology: they turn everything into numbers and then think they can ‘see’ things in space that have NEVER BEEN SEEN.
    Money has no human dimension. If I tried to sell you a car on the assertion that I had lent it to some bloke who was going to bring it back, would you pay me? Yet debt is traded. It is all part of the bonkers world we have made. The only taboos we now have are taboos against being discriminatory (to which one blogger recently referred). In the West, few people now do primary work, and those manipulating money are best rewarded. Meanwhile we are 'doing a number' on 3rd worlders (who can still survive by their own efforts alone) to get educated and 'a proper job' so that next time the crash will include them! That's progress for you.

  • Comment number 2.

    Hi Paul

    Have you seen Brad DeLong's reaction to being paired with Grover Norquist in the interview with Gavin Esler? He's not a happy man.

    I was only half-watching Newsnight, to the extent that when I caught one look at Grover Norquist's face, went "Agggh! Grover Norquist!", swore and changed the channel.

    This meant that I missed what Brad DeLong had to say, which I only saw due to the BBC iPlayer version of Newsnight.

    Which prompts the question; couldn't the production staff at Newsnight have found someone saner than Norquist?


  • Comment number 3.

    This comment was removed because the moderators found it broke the house rules. Explain.

  • Comment number 4.

    Dear Mr. Mason:

    Your lead in was--as it usually is--very good. The next step in the discussion would be to ask why Ben Bernanke and Hank Paulson--smart, public-spirited, reality-based people, for all that they are Republicans and Bush nominees--think that the right thing to do is for the government to embrace rather than tell the GSEs that you were privatized 40 years ago and are no longer our business.

    But you cannot ask and answer that question if you put Grover Norquist on the air, whose M.O. is to ask himself: What plausible lies can I tell that will:

    a. increase the chances that taxes on the rich will stay low after 2011, and
    b. increase the chances that the Republicans will win the next election?

    And then to tell them.

    Putting on Norquist changes you from an information show to an entertainment show. And, frankly, Brad Pitt is much prettier than Brad DeLong; and professional sports has a much more compelling narrative thread than financial regulation. You cannot compete with either Hollywood gossip or sports as an entertainment program...



    Brad DeLong

  • Comment number 5.

    Skip "recession" and talk about the criteria for financial DEPRESSION.

  • Comment number 6.


    We are going to end up having a "severe"

  • Comment number 7.

    I am no economist Paul so I am not pretending to your throne or even nearby footstools etc.

    I had wondered whether in relation to climate change it will become a global issue to control population levels for sustainability (potentially infinite population v finite resources).

    I had raised the question before, being no economist, as to whether economic growth depended implicitly on population growth. I assumed that if the risk/benefit ratio was wrong there would be few new ventures and the wheels would gradually come off an unrestrained free market.

    As I think that you are proposing restrained capitalism with state backed finance where it is harnessed to need that's quite consistent with my views anyway so I would not be whinging.

    On a separate note do you have any views on whether the politicians SHOULD have seen this coming. The reason I ask is I am sure that there were concerns about sub-prime almost before they were implemented. Were economists screaming long before the problem became apparent? I never even heard of CDS until the other day so I definitely didn't hear anything about that.

    It seems a worry to me that the BofE and FSA etc did not see this stuff coming OR they warned Brown and he went into ostrich mode. Perhaps the finance is too complicated even for them? In a similar vein I am puzzled that oil discoveries don't seem that great, we are supposed to hit the carbon shortfall within twelve years, and nobody seems worried. That does not compute.

  • Comment number 8.

    Goodie, I'm glad I caught it. Is there any chance of a follow-up on this story?

    It would be particularly interesting to see a bit more about the elements constituting F&F losses: are really all of the USD 11bio (and counting) 'bad debt', or, given that this has been a while coming [1], are part of those losses due to more general financial (mis)management and increased borrowing costs/falling share-prices? What happened to the USD 20bio that F&F are said to have raised as contingency cover? What proportion of total debt do the write-offs represent? Etc.

    [1] Why the surprise?...

    14May2008 Fannie and Freddie capital alert
    28Feb2008 Analysts brace for Fannie Mae, Freddie Mac losses
    25Nov2007 Tough stance on Freddie, Fannie vindicated

  • Comment number 9.

    When conforming mortgages started defaulting homeowners, a loan modification can be a great solution. If you have delinquent payments and meet the requirements you can apply for the Federal Loan Modification program. Requirements are defined – you must be able to prove hardship. You also have to have gotten the mortgage before Jan 1st, 2009. If your mortgage is through Fannie Mae or Freddie Mac, your window of opportunity closes in 2010, if not then you have until 2012 to file an application. If your mortgage or personal loans are in trouble, then you would do well to get assistance with loan modification.


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