The content of this memo is now included in the paper on Coalition of Borrowers.

To:       Honorable President Barack Obama
Sub:     Unanimously agreeable rationale of governance and
determination of Fannie and Freddie policy
Date:   March 12, 2014

Dear President Obama,

The prevailing rationale of governance assumes that individuals maximize the utilities of their wealth or consumption.  This rationale has inextricably bonded the vast majority of households, their employers and governments with an estimated $100 trillion of debt worldwide.  The gargantuan debt burden is the crux of the current global economic crisis.  The vast majority of indentured borrowers cannot accept the prevailing rationale of governance that has caused their bondage. 

No one including usurpers (robbers) will like to be usurped (robbed), even surreptitiously.  This universal fact makes governance that precludes usurpation unanimously agreeable.[1]  This memo illustrates how the U.S. can use the unanimously agreeable rationale of governance to set policy for the two home financing entities, Fannie Mae and Freddie Mac.

Foundation of the Prevailing Rationale of Governance:  Robert Lucas won Nobel memorial prize in economics for rationalizing arguments-of Nobel colleagues Milton Friedman and Edmund Phelps and John Muth-that monetary stimulus (printing or borrowing new money and/or cutting interest rate on savings) raises future inflation while boosting employment only in short run, not long run.[1]  Governments and central banks have followed this rationalization to inject frequent monetary stimuli to boost employment in short runs.  This is how the staggering amount of debt has been created worldwide.  The rationale underlying frequent short run monetary stimuli is Ken Arrow’s Nobel memorial prize winning theory that individuals make choices by maximizing the utility of their wealth or consumption. 

The unanimously agreeable rationale of governance stated above is necessary to resolve an apparently abstruse policy on Fannie and Freddie.  Contrast the opposite preferences of creditors and debtors: 

  1. Creditors want to shut down Fannie and Freddie.  If Fannie and Freddie are shut down, private banks will face less competition in home mortgage financing.  Less competition means higher return on creditors’ investments in mortgages made through private banks.  With Fannie and Freddie eliminated, private banks will have larger home mortgage portfolios than that they currently have.  Private hedge funds jointly owned by creditors and private bank executives can then use the larger home mortgage loan portfolios for greater leverage in trading to usurp others’ wealth. Fannie and Freddie charters do not allow such private hedge funds for creditors.
  2. Borrowers and the home building industry want continuance of Fannie and Freddie for as low an interest rate as possible to home mortgage borrowers in completion with private banks. 

Creditors and borrowers arrive at diametrically opposite choices based on maximization of utilities of their wealth or consumption.  The government cannot, therefore, use the prevailing rationale of maximization of utilities of individuals to set a policy for Fannie and Freddie.  The vast majority of borrowers will not accept the prevailing rationale for governance which has inextricably bonded them.    

So, how should the government decide whether to continue or wind down Fannie and Freddie?  Research shows that Fannie and Freddie-as private shareholder-owned entities, regulated like private banks-are necessary to attain equilibrium (stability), efficiency and fundamental fairness in the economy. [3] This equilibrium is surprisingly consistent with the unanimously agreeable rationale of governance for the following reasons: 

  1. As shareholder-owned entities, Fannie and Freddie have the incentive to charge sufficiently higher mortgage interest rates than the cost of their funds and operation including salaries and benefits of their staff.
  2. In equilibrium, private banks are allowed to compete with Fannie and Freddie to earn the same level of profits (or better if they operate more efficiently) on their equity investment in mortgage lending business. This allows creditors to earn at least the same rate of return on their mortgage investment at private banks as they can earn from such investment in Fannie and Freddie. 
  3. The equilibrium allows private banks to earn at least the same level of compensation for their executives as Fannie and Freddie offer to their staff to generate their profits.
  4. In equilibrium, shareholders of Fannie and Freddie are required to hold as much capital as private banks and absorb the first-risk, as residual claimants, before the government steps in to protect guaranteed debt holders. 
  5. Directly or indirectly, private banks lend their allied hedge funds that trade to usurp others’ wealth, surreptitiously.  The unanimously agreeable rationale precludes guarantee of such private bank debt.  Fannie and Freddie charters do not permit lending to private hedge funds.  The unanimously agreeable rationale cannot, therefore, preclude government guarantee of their debts.   

Conclusion: The punditry for winding down Fannie and Freddie is not logically founded in the prevailing rationale of governance.  Such punditry is also inconsistent with the unanimously agreeable rationale of governance, presented here.  The unanimously agreeable rationale of governance is constitutional, stable and efficient.  The prevailing punditry to wind down Fannie and Freddie is unconstitutional, inefficient and unstable.[4]

With best regards,
Founder, Citizens for Development and Pro-Prosperity.Com

[1] http://pro-prosperity.com/Research/Governance-and-Most-Efficient-Competitive-Economy.pdf
[2] The Phillips curve (plot of employment against inflation) is sloping upwards in the short run, but is vertical in the long run.  http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/1995/press.html
[3] http://pro-prosperity.com/Research/Coalition%20of%20Borrowers.pdf
[4] My holding of a few Fannie shares is irrelevant to the epistemic truth of unanimously agreeable rationale of governance presented here. I did not have any stockholding in 1991 when I found that federal guarantee of bank debt was inefficient and unstable for the system of money and finance. A similar conclusion about FMIC is similar.