Well, Freddie My Fannie!

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A recent piece in the Wall Street Journal, buried by the brouhaha surrounding the election and the Libya cover-up, indicates that the Federal Housing Administration (FHA) is in profound financial trouble. Indeed, it seems to be following its siblings Freddie Mac and Fannie Mae into the swamps.

The FHA has been around for nearly 80 years, and gives taxpayer backing to loans for homebuyers who put as little as 3.5% down. But more recently, the FHA has been used to reinflate the housing market by allowing lots of mortgages to be written. It now guarantees a staggering $1.1 trillion in loans.

The FHA is supposed to use its reserves to cover losses of the loans that go bad. As late as last year, it was estimated that after covering losses, the FHA would have $2.6 billion left in reserves. But, especially because of dicey loans issued between 2007 and 2009, the FHA is projected to lose $46.7 billion this year. That exceeds the $30.4 billion in reserves. The $16.3 billion deficit will almost certainly have to be covered by tax dollars from the budget. This is on top of the $137 billion already ripped off from taxpayers to cover the rescue of those Twin Towers of Corruption, Freddie Mac and Fannie Mae.

In fact, independent housing economist Thomas Lawlar states bluntly that “if [the FHA] were a private company, it would be declared insolvent and probably put under receivership like Fannie and Freddie.”

There is no doubt even more of this to come. The federal housing agencies (FHA, Freddie, Fannie, and lesser ones such as the VA) now back 90% of all new home loans, and the Fed continues to pump out the money ceaselessly. God help us if there is another major “correction” in the housing market.

In a better world, we would amend the Constitution to require that after ten more years (say), the federal government will have ended all housing subsidy programs and be permanently banned from any involvement in the housing market from that point on.

But this is far from a better world.




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Should the Bank's Loss Be the Law's Gain?

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The great thing about laws is that they protect us when we are unwilling and unable to do so on our own. Laws are great because they make sure no harm is done. So when it came to our attention that JP Morgan Chase just lost $2 billion because of risky investments and hedging, it may have seemed that what was needed was more and better laws, not personal responsibility.

Of course this isn't true.

Laws are necessary but not sufficient. Laws will never be able to keep pace with new developments in the financial sector, or anywhere else, which is why laws will never prevent problems but only react to them. And being reactionary instruments, laws cannot prevent the next wave of risky financial instruments or clever schemes to make money off of money.

In addition to not being able to anticipate problems, laws have unintended consequences that are sometimes worse than the problems they were designed to correct. Look at the laws that led to the housing bubble. For a time, the government, through various policies but primarily through Fannie Mae and Freddie Mac, infused more money into the housing sector than the market would have on its own. By making loans easy and affordable for people who would have otherwise not been able to secure home loans the government encouraged a misallocation of resources that drove up home prices.

Making loans available to people who would not have qualified without government interference pumped more money into the housing market than the market demanded. This drove up demand, which in turn drove home prices beyond market levels. Housing prices fell because the market corrected itself. This correction is what we recognize as the bubble bursting. The bubble and the burst were unintended consequences of the government getting involved in the housing industry.

In the banking and finance industry the government also distorts risk assessment, thereby forcing a misallocation of resources. Keeping interest rates low discourages saving and encourages investing. Low interest rates make putting your money in the bank an unattractive option if you want a return on your investment. So if you want your money to make money, you put it in the stock market. The government is essentially affecting the supply and demand of money rather than letting the market set interest rates and therefore determine where capital flows. This forces money into circulation that would otherwise not be there.

The banking laws we have in place encourage risk taking in other ways as well. First, banks the size of JP Morgan Chase know they will get government bailouts when they bet wrong, which means they can take whatever chances they want, and there is no risk involved. Second, the FDIC insures traditional deposit accounts up to $250,000, which means that no matter what kind of investments a bank makes with your money, as long as your account is below the $250,000 threshold, no one loses. Banks can fail in any number of ways without anyone involved failing to make money. The unintended consequence of government interference is an increased willingness of banks and their investment arms to take greater risks, which become no risks at all.

Certainly FDIC insurance has many benefits, as did the Wall Street and automotive bailouts, but there are unintended consequences that may have counteracted the favorable effects, if not encouraged the sort of risky behavior that created the need for the laws in the first place. The only solution is for individuals to take responsibility for their own actions. In view of our attachment to laws, this is an unlikely solution, but it is the only one with any promise.

Laws allow us to relinquish personal responsibility. When we make a bad investment that we did not understand entirely, or get into too much credit card debt because we failed to control our spending habits, it is easier to blame the lack of sufficient laws than to blame ourselves. If we were not motivated to make money we would have no reason to enter the stock market or make risky investments. But if we are motivated to do these things, the least we can do is spend some time understanding what we are getting ourselves into. If we don't understand what others are doing with our money, or understand the risk involved, then we shouldn't get involved. And if we do get involved with something we don't understand, we have only ourselves to blame. Laws can't help this; only we can. More time and energy should be directed toward cultivating character than toward crafting laws.




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