Too Big to Fail

Paul Krugman discusses the GSE situation and concludes:

And let’s be clear: Fannie and Freddie can’t be allowed to fail. With the collapse of subprime lending, they’re now more central than ever to the housing market, and the economy as a whole.

That seems about right. But it's one thing to say that the enterprises can't be allowed to fail and it's another thing to say that the shareholders' investments in the enterprises can't be allowed to fail. Why can't the whole thing be nationalized? There seem to be sound economic reasons for letting the executives press the big red "Come Save Us" button, but surely there should be consequences.

Comments

Taking on a few trillion dollars' worth of obligations might have some negative consequences.

Posted by Elvis Elvisberg | July 14, 2008 9:57 AM

Why can't the whole thing be nationalized?

Maybe they will be in the end. But I'd guess the main reason is that the government doesn't think it would be a good idea for the taxpayers (and the currency) to be on the hook for the entire, say, $400 billion (my estimate) in worthless loans Fannie and Freddie are responsible for. And as far as I can tell, if We The People buy these two turkeys outright, We The People own all the debt. Better to inject only the amount of capital needed to shore up the system. Yes, the whole damn system needs some major rethinking, but in the meanwhile there's a depression to stave off.

Posted by Jasper | July 14, 2008 10:01 AM

The New Capitalism demands no nationalization. Just deregulation, lower taxes and a bailout in the end.

Posted by carsick | July 14, 2008 10:03 AM

The shareholders here are pretty much everyone with 401k or a pension fund. These two companies are large portions of people's retirement plans. If the shareholders didn't get some compensation it would make Enron look like a walk in the park.

The bailout number from what I've read is on the order of $5 Trillion, effectively doublling the national debt overnight.

There is little doubt that as a country we are in for a VERY rough road ahead.

Posted by Anon | July 14, 2008 10:12 AM

In 2007 Daniel Mudd, Fannie Mae's CEO received $12.2 million in compensation, and that represented a 15% CUT from what he got in 2006.

http://english.pravda.ru/news/business/31-01-2008/103770-fannie_mae-0

I will leave it to others to find out what the Freddie Mac CEO makes, but it ain't chump change. Let's all hope they enjoy their big salaries, because now we're going to help pay them.

Posted by kafka | July 14, 2008 10:13 AM

Nationalized!? You commie!

Posted by Magnolia Fan | July 14, 2008 10:15 AM

Owning all of the stock of a company does not legally obligate you to pay off the company's debt. But that's not really relevant, as the government has already said it will backstop the debt, so why not own the upside as well as the downside?

Posted by richard | July 14, 2008 10:18 AM

The bailout number from what I've read is on the order of $5 Trillion, effectively doublling the national debt overnight.

Fannie/Freddie guarantee or have on their books over $5 trillion in mortgage debt (about half the national total, so I'm told). This does not equate with the bailout number, however, as the non-performing portion of this $5 trillion is reckoned to be on the order of 5-7%. Hence my 10:01 estimate.

Posted by Jasper | July 14, 2008 10:25 AM

From:

http://fundublog.com/hr/769/fannie-mae-ceos-pay-rose-in-07-as-losses-mounted/

"The head of Fannie Mae, a company chartered by Congress to help more Americans own homes, reaped a 7 percent rise in pay last year, to $13.4 million, while the company lost money and the country suffered its worst housing crisis in decades.

Fannie Mae (FNM.N: Quote, Profile, Research) posted a $2.1 billion loss in 2007 and its shares fell 33 percent as the subprime mortgage crisis bled into all parts of the mortgage market while home prices fell nearly 9 percent.

Fannie Mae Chief Executive Daniel Mudd also received $5.4 million from stock awards that vested in 2007, according to a Securities and Exchange Commission filing by the company."

Posted by kafka | July 14, 2008 10:25 AM

Nationalized!? You commie!

I agree with Matt. The government should appropriate the means of production once the private market get this screwed up.

My favorite moment of Bill Clinton's presidency was when he floated the trial balloon of investing Social Security funds in the stock market (hey, it's always going up!). The Wall Street Journal editiorial page almost blew a gasket and Clinton quickly withdrew the idea.

Posted by Peter K. | July 14, 2008 11:02 AM

Fannie and Freddie can be saved, but we have to remember that shareholders are always at the bottom of the totem pole when it comes to getting their money back. First, preferred creditors get their money back. Then secondary creditors. If we're going to make some kind of bailout, the taxpayers are going to come out ahead of the shareholders, because the taxpayers are going to BECOME the primary shareholders.

A government bailout is effectively a modified form of bankruptcy that keeps the institution afloat. Bankruptcy almost invariably involves the shareholders losing their investment, because there's nothing left of the assets to make the shares worth anything.

Yes, losing money in the market isn't pretty, but why should Fannie and Freddie shareholders get their money back, while the stockholders of Enron and Aloha Airlines get nothing? Didn't people know not to put all their eggs in one basket?

Posted by Tyro | July 14, 2008 12:05 PM

I agree with Matt. The government should appropriate the means of production once the private market get this screwed up.

But it hasn't been a private market since the late 1960s (arguably since the late 1930s). That's the problem. People managed to buy homes before Fannie Mae, and they manage to do so now in other countries without Fannie Mae. And sometimes they have home ownership rates just as high as America's.

I think government should get the hell out of the mortgage banking business the second this mess is sorted out. I know it would be terrible if Americans had to rent rather than own, or make slightly higher mortgage payments, or live in slightly smaller houses, and that this might impair their ability to build home theaters or drive Hummers, and Toll Brothers will be less profitable, but we'll all be better of in the long run shifting resources into more productive sectors.

Posted by Jasper | July 14, 2008 12:11 PM

Capitalism is often compared to Darwinian evolution. So what kind of banks are going to evolve when some institutions are too big to fail, but smaller ones aren't? Survival of the biggest.

Mammals couldn't evolve into anything bigger than rats while the dinosaurs were around. And so goes the economy: Chaseasaurus Rex, Citipus Morgannicus and a whole bunch of little rats, scurrying around in the dark.

Posted by Aatos | July 14, 2008 12:18 PM

Time to bring the hardest working member of the Reagan Admin out of retirement.

Rosy Predictions, c'mon down. John McCain is calling!

Posted by Jeffrey Davis | July 14, 2008 12:24 PM

Yes, let's nationalize them. As our recent experience taking over airport security proves, nationalization is the answer. Nationalization is always the answer.

Posted by RW Rogers | July 14, 2008 12:51 PM

The New Capitalism demands no nationalization. Just deregulation, lower taxes and a bailout in the end.

Your forgot the final step: Repeat.

The life cycle of monopolies is 1) Consolidation; 2) Growth to the point of being "too large to fail" all the while extracting as much value from whatever space the corporation occupies as possible; 3) inevitable failure; 4) government bailout because entity is "too big to fail." 5) Repeat.

Posted by ibc | July 14, 2008 12:54 PM

Time to bring the hardest working member of the Reagan Admin out of retirement.

Rosy Predictions, c'mon down. John McCain is calling!

You're just suffering from a mental recession.

Posted by Peter K. | July 14, 2008 2:14 PM

"Yes, let's nationalize them. As our recent experience taking over airport security proves, nationalization is the answer. Nationalization is always the answer."

While the premise of your question is rediculous, I'll entertain it long enough to say that we haven't seen any airports blow up recently, whereas banks don't seem to be doing so well.

Posted by dannity | July 14, 2008 5:01 PM

"we haven't seen any airports blow up recently"

Yeah - but we've got ONE MILLION names on the "terrorist watch list".

If there are that many terrorists possibly flying to the US, it's time to surrender.

Then you can also read the pilot's story about how he tried to take airline approved eating utensils on to the plane - he couldn't.

Quintessential TSA stupidity: taking airline cutlery away from a pilot
Ask the pilot
By Patrick Smith
http://www.salon.com/tech/col/smith/2008/07/11/askthepilot283/

I'm sure this prevented the airport from blowing up.

Posted by Richard Steven Hack | July 14, 2008 10:52 PM

I have to believe there is a middle ground between bailing out the shareholders and outright theft. I would completely agree that a government bailout should be accompanied by government ownership, but shareholders, in that case, should be no worse off than they would be under any other sale.

Posted by Mario | July 16, 2008 6:23 AM