How the mortgage crisis winds up

Tyler Cowen posts on the coming bailout of Fannie Mae and Freddie Mac. Bottom line: after all of the stupidity, greed, and outright fraud, we the taxpayers will all pay up to make sure that the housing market doesn’t fully collapse. If you see a house flipper, mortgage broker, or investment banker who didn’t overextend themselves and lose everything, I think you should be allowed to punch them once in the face with impunity.

Back in April, David Einhorn gave a speech called Private Profits and Socialized Risk. The title alone sums up the current situation.

The bottom line, though, is that the government must bail out these agencies. Here’s why. Freddie Mac and Fannie Mae buy up mortgages and package them as investments that are sold to institutional investors (like foreign governments, among others). They purchase these instruments even though they pay a relatively low interest rate because they assume that the US government will guarantee that the Freddie Mac and Fannie Mae won’t default on those investments. If that assumption does not hold, the securities sold by Freddie Mac and Fannie Mae will have to pay a much higher interest rate to make up for the higher than anticipated risk profile. That, in turn, will drive up the mortgage rates home buyers pay, slowing down the housing market and killing demand for more expensive homes.

Letting these two quasi-governmental companies fail would crater an already failing housing market, destroying an awful lot of wealth. That’s not something any politician is going to let happen if they can stop it (nor should they). The US is sort of like the family where the single income earner takes month’s wages and blows them at the casino. You may hate them for what they did, but you still have to take them back in because they’re the only one with a job in the first place.

Update: Add Fannie Mae and Freddie Mac to the list of things about which I know more than Sarah Palin.

2 thoughts on “How the mortgage crisis winds up

  1. I think you’re missing the fact that because of this bailout, Treasuries are going to go through the roof. The US government is borrowing about $20billion WEEKLY. Now they need to borrow another $200billion to bail these jerks out. How much do you think the market is going to charge for this? And in any case, the slowing of the housing market means that the duration space is going to increase dramatically. How much do you think buyers are going to charge for having to hold onto a CMO for 10 years longer than they were planning to hold them when they bought these things only 2 year ago?

    Sorry, but you were dead right when you said that punching the jerks behind this with impunity would should be legal. Your other conclusions, unfortunately, are wrong.

  2. If you see a house flipper, mortgage broker, or investment banker who didn’t overextend themselves and lose everything, I think you should be allowed to punch them once in the face with impunity.

    I disagree. If you see one of these people who didn’t overextend themselves, you should shake their hand. The ones who deserve a punch are the ones who did overextend themselves, nearly lose overything, and then got bailed out by our tax dollars. We’re subsidizing their personal downside to attempt to lessen the damage their irresponsibility is doing to the economy as a whole.

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