BarrHQ.com

Bob Barr rejects the Bush administration’s taxpayer bailout of the housing industry.   This bill includes provisions to reward Fannie Mae and Freddie Mac for their disastrous, risky strategies.

While Fannie Mae and Freddie Mac have used the vague promises of government support to borrow at lower interest rates and so funnel more money into home mortgages (and generate profits for the stockholders and high salaries for top management,) these funds are just shifted from other parts of the economy.  This results in less economic productivity, which restrains growth in real incomes.    From the point of view of a libertarian economist, the long run answer is clear, and is summed up well in the title of one of Congressman Barr’s media releases– Bob Barr Says Privatize Fannie Mae and Freddie Mac, End Government Subsidies .    However, a bit of controversy has developed, especially among the Libertarian rank-and-file, regarding Barr’s insistence that government must keep these institutions from failing in the short run.  

Fannie Mae and Freddie Mac borrow short term funds to finance home mortgages.   (They also issue and guarantee mortgage-backed securities.)  They often borrow funds for 90 days and use the money to purchase mortgages that are gradually repaid over 30 years.   When the 90 day loans come due, they must borrow new money to pay off these debts.  What will happen if no one will lend new money?  They will be unable to repay what they owe.  They will default.   They will be bankrupt.   They will be liquidated.  Their assets will be sold off.  And the receipts will be used to make partial payment to those who lent to Fannie Mae and Freddie Mac.   (Those holding securities backed by mortgages in default and guaranteed by a bankrupt Fannie Mae or Freddie Mac would also take partial losses.)

Unfortunately, Fannie Mae and Freddie Mac own 50% of U.S. mortgages.   Selling off the mortgages they hold will depress the current market value of mortgages.  About 50% of the assets of federally-insured banks are mortgages, so this will reduce the current market value of the assets of those banks.   Could this lead to bank failures?  To additional liability for FDIC?     

I believe that it is important for libertarians to support deregulation and privatization, but to do so in a responsible fashion that is carefully planned to minimize the risk of sudden financial catastrophe.    I have three reasons.  

The first is narrow political pragmatism.  A proposal for privatization and deregulation that is never implemented does no good.  Libertarians will never be able to implement any proposal for privatization or deregulation if there is any hint that they have a cavalier attitude regarding a repeat of the Great Depression.  

The second is also political.  No matter what the long term benefits, if Libertarian proposals cause financial disaster in the short run, voters will almost certainly replace Libertarian political leaders with politicians who advocate even more extensive regulation.   The long term benefits will never materialize.

Finally, I believe that it is wrong to privatize and deregulate in a way that causes people to suffer unemployment and bankruptcy if there is an alternative path that is less disruptive.   Change always involves economic dislocation, but creating unnecessary suffering is wrong.

Barr’s general statements regarding the need to avoid collapse in the short run provided the correct note of responsible  reform.  His specific proposal for a limited extension of the Federal line of credit to Fannie Mae and Freddie Mac, with a Congressional statement that this limit will not be further extended, would reduce the risk of default and the chance of a catastrophic scenario.   The institutions could borrow from the government to a greater extent to repay the funds they owe and avoid default.  

However, there are two problems with this approach.   If the extension in the line of credit is insufficient to pay off all of the all of those owed money by Fannie Mae and Freddie Mac, there remains the risk of default, liquidation, depressed mortgage prices, and the spread of losses to the banking system.   Perhaps worse, the reduced risk of default will allow the two institutions to continue to operate as before.    While the bailout bill, including the Treasury providing an unlimited line of credit and being given the ability to directly prop up the prices of shares of stock in the institutions was designed to maintain business as usual, any short run support for the institutions will inevitably reduce the pressure for reform.

Is there an alternative?    There is.   If the institutions are threatened by default, the Office of Federal Housing Enterprise Oversight can place the institutions under conservatorship.   This effectively nationalizes the institutions.    The management and stockholders can be made to pay for the consequences of their risky strategies–as much as they would pay if the institutions defaulted.   

Unfortunately, the national debt would be increased by nearly 50% by a government takeover of Fannie Mae and Freddie Mac.    Worse, direct government control is consistent with an expansion of their activities.   There is no alternative to a commitment to true privatization and deregulation.  

And, of course, that is why we need to elect Bob Barr.  And a Libertarian Congress as well.