…the end of man is to know

Since my last legitimate post, the US economy received another shock in the form of the government’s presumed bailout of Fannie and Freddie. There seems to be some confusion over what exactly is going on.

In the 1930s, the US government established Fannie Mae as a means of insuring loans. In the 1970s, Freddie Mac was created for similar purposes. Even though these institutions were government-created, they are publicly traded “private” companies. Even though they are “private” companies, they are privy to unique government goodies. And therein lies the rub:

Hopefully you’re recognizing the inherent flaw in this whole plan. The government is insuring the viability of organizations that profit off of risk. If Fannie and Freddie take on more loans, they get more money. If the loans are paid back, that’s great. If the borrowers default, the government still pays off Fannie and Freddie. In short, this creates a moral hazard (a situation in which the negative consequences of a particular action do not follow on the actor). As any economics, poli sci, or philosophy course will teach you, moral hazards are BAD NEWS. Moral hazards artificially encourage people to take too many risks. It is only when those risks don’t pan out that we even become aware of the situation. Such is the case with Fannie and Freddie.

So where are we at now? Well, we’re at a place where two companies are holding $5 trillion of liabilities (money that needs to be paid back to various people and institutions). The media continually forgets that Fannie and Freddie also have trillions of dollars of assets (money that it has to pay off the aforementioned liabilities). So before we get ahead of ourselves, remember that we are NOT instantly $5 trillion in the hole. At the same time, we don’t know exactly how much F & F are in debt. We do know that in the past 2 years, they have combined to lose $100 billion ($300 for every man, woman, and child in the nation).

Even the most hard-line of conservatives acknowledge the need for a government bailout. There is simply no way that the government can watch and wait to see if two of the largest financial institutions in the world collapse. The proposed plan has the United States government forcing Fannie and Freddie to print new stock shares and having the government buy those shares. This way the companies get desperately needed money and the government formalizes its controlling interests.

Yet, this plan will be fully-funded by the American taxpayer. The government will buy stock shares and fund it through tax revenue. Also, the increase of stock shares will decrease F & F stockowner’s value, due to the decreasing value of each additional share. Worse, the increase spending will serve to spur the same inflation that we are trying to prevent. All in all, the buyout plan is the least-worst option.

Hopefully, voters and politicians can learn something from this debacle.

Voters: be prudent with your money and lending patterns. Borrow less and don’t borrow money you can’t repay. Those who have taken out bad loans now pay for it with higher taxes. Worse, good borrowers also have to share some of the burden.

Politicians: stop creating pseudo-private organizations. Public companies suck, but they at least have some element of oversight and social welfare in mind. Private companies usually benefit from desiring profit, but do carry more risk. If you MUST make something government-run, don’t let it be traded on the stock market and NEVER let companies seek profit while guaranteeing their viability.

The great tragedy of this debacle is two-fold. First, the government’s own ineptitude in creating these institutions is to blame. Moreover, the government now must enhance its powers to reign in F & F. How politically unfortunate that the government gets too powerful and then needs to be even more powerful to slay its own monster. Second, the honest citizen-consumers who are diligent in their finances are now responsible for those who can’t repay their debts. How ironic that the low-income individuals who indulged their dreams of home or business ownership and failed, largely don’t pay federal income tax. Therefore, they don’t have to pay a dime to support the government bailout. This isn’t progressive income redistribution. This robbing from the intelligent to cover the incompetent.

And that is the pragmatic reality of Fannie and Freddie.