How Mae and Mac jacked up the US debt by 50% overnight [updated]
Once upon a time, the US government set up three agencies to provide home loans to people.
The Federal National Mortgage Association (FNMA) was founded by FDR to improve the liquidity of the mortgage market. It sits in between the mortgage borrower and the lender. Its job is to assume the risk of mortgage default, in return for a fee. In the 1960s, part of it was removed from the federal balance sheet by spinning it off into a private corporation. It was replaced by…
The Government National Mortgage Association (GNMA), part of the Department of Housing and Urban Development (HUD). GNMA bundles mortgages into securities which it guarantees even if the mortgages default, and then sells them on to big investors. It handles mortgages for veterans and native Americans.
The Federal Home Loan Mortgage Corporation (FHLMC) was set up in 1970. It basically does the same job as the FNMA, and was set up to provide competition for that organization.
In addition, the The Federal Agricultural Mortgage Corporation (FAMC) provides loans for agricultural real estate and rural housing.
Finally, the Student Loan Marketing Association (SLM) was set up to provide federal student loans.
Before long, people working in the housing industry came up with names that were easier to say and remember than the abbreviations the government used. FNMA became known as Fannie Mae, after the candy company Fannie May. GNMA became known as Ginnie Mae, and someone came up with Freddie Mac for FHLMC, presumably because the H is silent.
By the mid 80s, all the government agencies were called Mae or Mac; the FAMC became known as Farmer Mac and SLM became known as Sallie Mae.
Once the slang names became sufficiently entrenched, several of the organizations decided to officially change their names to the slang versions. Hence, FNMA’s logo officially says FannieMae, and FHLMC’s says Freddie Mac.
Before long, some private corporations worked out that they could suggest that they were big government-backed outfits by naming themselves something ending in "Mae" or "Mac", without technically lying to customers. Hence a bank in Pasadena called itself IndyMac, and one in Brea called itself ResMae.
Fannie Mae and Freddie Mac have ended up guaranteeing almost half of the mortgages in the US, for a total of around $5.3 trillion. Since they were officially run as private corporations, they were able to spend a lot of money ensuring that they remained unregulated and able to invest in subprime mortgages–i.e. mortgages that the borrowers would never be able to pay back, in quantities large enough to ensure that the CEOs and shareholders of the lending companies would get rich.
So as the housing bubble has started to collapse, so has Fannie Mae’s stock price. (Check the 1 year or 5 year graph.) Freddie Mac’s stock price has been just as ugly.
Now, as already mentioned, Fannie Mae is (strictly speaking) a private corporation. However, over the years they have bent the rules and implied that the US government backs their loans. It wasn’t true, but by lending unwisely they’ve become so big that the government now thinks it can’t afford to let them fail. So last weekend, the the Treasury Department and Federal Reserve announced that they would make funds available as necessary to keep Fannie Mae and Freddy Mac solvent.
In other words, last weekend the US government effectively added up to $5.3 trillion to the national debt, which is an increase of 50%.
So ironically, by a year or two ago the situation had become so dire that IndyMac and ResMae found themselves with names that had negative connotations. ResMae collapsed last year, and now IndyMac has collapsed.
Now, in the event of a US bank’s collapse, individual consumers are protected by the Federal Deposit Insurance Corporation or FDIC. Basically, the government guarantees your money won’t disappear if the bank collapses, up to a limit of $100,000 per person.
Unfortunately, the FDIC doesn’t actually have enough money to bail out all the banks that are expected to crash. In fact, before IndyMac crashed they had funds to cover just 1.19% of the total insured deposits. After IndyMac, they dropped below the legal mandatory minimum of 1.15% coverage.
Theoretically, the FDIC gets its money by charging premiums to banks who wish to assure investors that they are FDIC guaranteed. So the problem of bailing out the FDIC will be passed on to the average taxpayer, in the form of higher bank fees. And if that fails, the taxpayer will be forced to bail out FDIC directly.
Some analysts are now comparing the fiasco to ENRON. Except this time, it’s an ENRON where the taxpayer has to bail out the crooks. So, another great victory for reduced government regulation and the free market.
Update:
On 2008-09-08, the US government formally took FNMA and FHLMC into public ownership making the bailout official. While not every loan is going to be defaulted on, the taxpayer is potentially on the hook for the entire amount; it’s on the balance sheet as a liability.
Tagged: economy, Enron, FAMC, Fannie Mae, FDIC, FHLMC, FNMA, Freddy Mac, GNMA, HUD, IndyMac, ResMae, subprime mortgages
3 Responses to “How Mae and Mac jacked up the US debt by 50% overnight [updated]”
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July 22nd, 2008 at 20:45 -0600
I must confess to near-ignorance about economics. It is ALL voodoo to me. I have two questions.
First, is the problem really that these private corporations have gone unregulated, or that the government is willing to bail them out at the expense of taxpayers?
Second (and this reveals my utter incomprehension of economic matters), if $5.3 trillion was lost by the corporations, who is $5.3 trillion richer? Or is the world economic system an open system where wealth can just vanish?
July 23rd, 2008 at 13:50 -0600
Both/neither/either, take your pick.
Essentially you need to ask why would a company not do dumb stuff (and by dumb stuff I mean borderline dishonest/immoral/actual dumb stuff).
If you take a harsh market driven approach then you don’t need regulation because the market will regulate itself. What this essentially means is that if a company does something really dumb then it will be punished either by suppliers (in this case the people who lend them the money) or the customers (in this case the people who borrow the money) who won’t trust them anymore.
Think about it - you know a mortgage company takes excessive risks would you borrow from them? No - you want your mortgage to be safe. If you were a financial institution would you lend to them? No - you wouldn’t trust them to be able to return your money.
So, the market says, regulation is unnecessary because the company will act sensibly because if it does not then it will go bankrupt because it either has no customers or no suppliers.
BUT for this to be true a couple of things must be true. Primarily the companies must be held accountable for their actions - if a company does something dumb then it must face the consequences.
This is where the government bailout causes problems. The market states that if the company does something dumb it must pay the consequences because the consequences are the only thing that stops it doing dumb things. But if the company knows that the government will bail it out what incentive does the company have to not act dumb? None.
So everytime the government bails a company out it sends a message you will not be held accountable for your actions, which gives some companies license to over stretch themselves knowing that the government have their back.
So, not only does bailing them out cost tax dollars (or pounds over here), but it also screws up any chance the market had of regulating itself.
You’ll notice that big business (airlines in particular but business in general) will spend their time saying that they don’t need government interference because the market will regulate itself but when things go wrong they very happily demand the bailouts… You have to wonder what happened to their precious market at that point.
So to regulation - well for market regulation to work (if it does) we come back to one of the other things that must be true for the market to regulate itself - people must have good information. When a company does dumb stuff (or good stuff) people must be able to find out about it. Part of regulation says you’ve got to be honest and you’ve got to tell people stuff.
The other part is that companies have no obligation to do anything except make money for their shareholders. Terrifyingly this is not just an opinion, this is enshrined in law. Ultimately this means that they don’t care about you any more than is required to make money out of you. So regulation also exists to make sure that this interest doesn’t override the interests of individuals too heavily.
So regulation exists to ensure companies are open and honest and that where their interest conflict with people’s interests, the balance isn’t too far in the company’s favour.
So did regulation fail? Absolutely. If people had known what was happening then they’d never have lent/borrowed the money. If the regulation had been tighter the companies wouldn’t have been allowed to lend money to people they knew couldn’t afford to pay it back.
And did the government **** up in bailing them out… Actually a tougher question. In a strict market sense (and they are meant to love the market) yes, they shouldn’t have done it. In a national economic interest sense, they arguably did the right thing as having banks collapse on you has a way of ****ing your economy.
Who is $5.3 trillion richer? No-one (at least not yet) but it is real money. No-one because all the government are doing at the moment is guarentee the debt. It’s the equivalent of you owing me $10, me being a bit worried so mathew steps in and goes, that’s OK, if he doesn’t pay it back I will. By doing this the government (in the example mathew) hope that because people have confidence ultimately the debt (or most of it) will be paid back normally by the people (you) to the lender (me) meaning that they don’t have to do anything and ultimately don’t end up spending any money.
Ultimately I think the claim the government have increased the national debt by $5.3 trillion a little misleading. It’s a worst case scenario that almost certainly will never come to pass. Most people will repay their debts, and even those who don’t won’t default on the whole amount because much of it will be covered by collateral (in the case of individuals their houses).
But if the government does have to cough some or all of the money who is $x trillion richer? Lots of people - mainly the people (largely property developers) who sold the stuff to people who bought it with money they’d never pay back, and the financial organisations who took their cut as the money was passed around. It was/is real money.
Don’t you love the free market?
July 23rd, 2008 at 20:18 -0600
I’m going to have to say both.
If you have unregulated markets, you get the kind of bank collapses and pyramid schemes seen in Eastern Europe in recent years, and corruption of the BCCI kind.
And if you bail out banks when they make bad decisions, the CEOs learn that they won’t be held accountable for bad decisions that enrich them.