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First-best Governance of Fannie and Freddie (Home Mortgage Market):
Natioal Goal: Preserving Hard-earned Wealth of People The Necessity of Keeping Fannie and Freddie as Government Sponsored Enterprises April 6, 2013. Updated April 12, 2013 Sankarshan Acharya |
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To: Honorable President Barack Obama Cc: Honorable House Speaker John Boehner Date: April 12, 2013 Sub: National goal: preserving hard-earned wealth of people. The necessity People see national security as paramount because it safeguards their hard-earned wealth. So, preservation of hard-earned wealth should be the ulterior national goal. People work hard to accumulate assets like home, land, financial holdings and cash to enjoy freedom from bondage. If they trust only a government institution like the Pentagon for national security, why should they be presumed to accept private financial institutions for preservation of their hard-earned wealth?[1] If national security is serious, the goal it serves cannot be non-serious. The government should accomplish this serious goal efficiently (at least possible cost) but not for profit. Taxpayers never support an inefficient for-profit government, which profits through high taxes, debt and monetary expansion and causes inflation in the prices of food, fuel and energy on which people depend for survival. For example, despite having worked hard to produce enormous profits, Fannie Mae CEO made a stunning revelation yesterday (by echoing Treasury views) that it is generating enormous profits for the Treasury and that taxpayers would not want to have 90% of the mortgages insured and securitized by government sponsored financial institutions. This is really contrary to the national goal of a not-for-profit efficient government:
Fannie and Freddie thus uniquely help accomplish the national goal. Why would taxpayers then not want Fannie and Freddie remain the largest diversified government institutions for mortgage insurance and securitization? What bedevils the national goal is the lust of mega creditors for usurious interest rates on home and business mortgage lending which is possible after GSEs are decommissioned. The thought of dismantling Fannie and Freddie or of curtailing their role as GSEs is antithetic to the national goal of preserving the wealth of people. Why? Creditors are ultimately protected by debtors. Unless debtors sustain their wealth and income, creditors cannot expect to fully recover their claims. Only an equilibrium interest rate can maintain balance between creditors and debtors. The equilibrium rate of interest payable by creditors is equal to the cost of funding and operation of GSEs. GSEs are vital for accomplishment of the national goal. Even an attempt to eliminate the GSEs caused a financial crisis which is considered by the Federal Reserve as worse than the Great Depression. Elimination of GSEs is not sustainable. Any equilibrium interest rate after the elimination of GSEs is simply moot. The home and business mortgage borrowers (especially the crucial vast majority) should not pay significantly more interest than the cost to taxpayers of funding and operating Fannie and Freddie as government run institutions. If at all, the prime borrowers should receive significant discounts to recoup their massive equity losses wrought by the mega creditors which decimated the real estate market like short-selling of mortgage-backed securities and of stocks of mortgage companies (like Lehman Brothers, Bear Sterns, Washington Mutual, Fannie Mae and Freddie Mac) and dumping fictitious mortgage backed securities (backed by no real loans) on Fannie and Freddie. Policy for Fannie and Freddie: If private investors are not investing now in Fannie and Freddie, it is only because of the agreements they have lobbied to impose through the Treasury on GSEs like 10% dividend payments to Treasury even when the GSEs made losses. The cost of taxpayer funding of GSEs is near 0%. Why should GSEs not be allowed to refund the taxpayer funds (like AIG did) with interest equal to the true cost to taxpayers of nearly 0% on these funds? The Amendment 3 of the senior preferred stock agreement with the Treasury asks the GSEs to return all the profits above a minimum capital reserve amount as dividend. According to this amendment, Fannie Mae paid a dividend in the first quarter of 2013 equal to $4.23B on $116B of taxpayer funds or about 3.65% per quarter, i.e., 14.59% per year. This is usurious extraction of profits from mortgage borrowers funded by Fannie Mae. To revive the role of Fannie and Freddie for achieving the national goal, the following policies are crucial:
Policy should depend only on accomplishment of the national goal by a not-for-profit efficient government. With profound regards, [1]Decimation of trust of people in private financial institution was clear during the banking panics of 1907. People preferred to keep their hard-earned savings in real assets or cash under their pillows. Private financial institutions have foisted subterfuges on people (passed as law) like the federal deposit guarantee up to a limit (through the Glass-Steagall Act of1933) and blanket protection all bank debt and money market funds without limit since 2008.
To: Honorable President Barack Obama Cc: Honorable House Speaker John Boehner Date: April 6, 2013 Sub: First-best government policies for Fannie and Freddie I. Policy choices for Fannie and Freddie Option 1 (first-best ): Allow the government sponsored enterprises (GSEs) to build their equity capitals by retaining their profits, as opposed to transferring their profits to subsidize the Treasury. This is feasible because Fannie and Freddie have reported massive current and future expected profits. This option is vital to restore investor confidence in the GSEs, to minimize the long-term mortgage risk and cost to the economy, and to continue the nascent recovery of the housing sector. The reported earnings reinforce my prior analysis that the financial catastrophe of 2008 was not caused by either GSEs or by reckless household borrowers (vide Section III). Option 2 (second-best): Privatize or dismantle GSEs. The prevailing system of governance allows each political party, union, association or corporate body to extract extra benefits or subsidies. This system is not sustainable because it expands public debt, depletes natural resources and deteriorates the environment. This system has, therefore, crashed publicly in 2008. The crashed system is second-best. The wisdom underlying it remains paralyzed since the crash. Adoption of the paralyzed second-best wisdom is suicidal for the economy. The wisdom of privatizing or dismantling the GSEs is second-best. The essence of the first-best system is no-subsidy mantra which is attained in equilibrium among subsidy-seeking parties. This system is economically efficient, stable and constitutional. No party can thus oppose it. The first-best system means that home mortgage holders should pay only the cost of money to the government plus the price of service rendered by the GSEs. Option 1 guarantees but Option 2 jeopardizes this first-best policy goal. II. Treasury has adopted second-best policy for GSEs The current Treasury policy (imposed in September 2012 through Amendment 3 of the Senior Preferred Stock agreement) transfers of all profits of either GSE above a minimum capital reserve amount to the Treasury. This constitutes a direct subsidy from home mortgage holders via GSEs to the Treasury. This policy is, therefore, second-best. The only purpose of the current second-best Treasury policy is to prevent the GSEs from building their own equity capital based on their profits. This policy will always keep potential investors in GSEs on tenterhooks, worrying about what the government would do again to their investments. The Treasury policy is obviously aimed to dismantle or privatize the GSEs to transfer massive subsidies from the current GSE stakeholders and home mortgage holders to a few beneficiaries of this policy. Such transfers will eventually crash the system again. The primary goal of no-subsidy mantra governance - besides repealing of all rules and policies that legalize subsidies - is to pool the risk and cost to the economy. Pooling risk reduces the aggregated risk, lowers the cost of financing the reduced risk and thus improves efficiency of an economy. The GSEs were created, after private banks balked, to pool the risk of long-term mortgage loans with a view to expanding home ownership and facilitating social stability. Reverting back to the failed second-best wisdom of privatizing or dismantling the GSEs is certainly not a path towards first-best efficient governance that USA badly needs. The only way to build investor confidence and reduce risk and cost to the economy is to let the GSEs build their own equity capital based on their earnings and to make the Treasury not charge more than the cost of its capital on its outstanding lending to the GSEs. III. Warning about imposing second-best GSE policy on economy The crucial vast majority of the nation invents, innovates and produces globally competitive goods, ideas and services. It uses its hard-earned savings to hold long positions on financial and real assets. The nation and its taxes depend on the crucial majority. Yet, the nation has adopted rules to help mega-short sellers use publicly insured funds to bet against the long positions of the crucial majority to usurp the latter’s hard-earned wealth. The mega short-sellers are the members of the Clearing House, who crafted the Federal Reserve Act of 1913, and the hedge funds privately controlled by their executives. The usurped wealth finances academic endowments and political parties that help rationalize and pass rules to facilitate usurpation. The system of betting against those who prop the academy, government and nation thus continues. Erosion of hard-earned wealth keeps the crucial vast majority on tenterhooks and makes it work less efficiently. As a result, the economy falters, which leads to lower tax collections and higher fiscal deficits of the nation. The Federal Reserve and the Treasury have facilitated mega short-selling at the behest of the Clearing House members. The Fed’s current strategy of printing new money boundlessly is unlikely to restore normalcy in the economy. But it may divert the attention of the crucial vast majority from the rules that facilitate transfer of its hard-earned wealth to mega short-sellers. This is why we should never forget that the mega short-selling strategy, which decimated the hard-earned wealth of the crucial vast majority in 2008, is still holding the economy hostage. Here is the sequence of events since 2000 that should remain indelible for any economic policy making:
IV. Conclusion In their latest earnings reports, Fannie and Freddie state that their profits are driven by Fed’s purchase of mortgage-backed securities at virtually no cost to GSEs and due to a recovery of the depressed housing market. These reports indicate that the Fed adopted an unprecedented policy to repair the damage to the housing market caused by the mega short-sellers. I have argued how mega short-sellers used publicly insured funds at their disposal to push commodity prices prior to 2007 and how the Fed used such price inflation to raise interest rates. The borrowers had to pay for the artificially higher commodity prices and higher interest rates and thus subsidized and enriched the mega short-sellers. The lowered interest prevailing after 2007 is perhaps closer to the equilibrium, as indicated by insatiable demand to purchase Treasury securities yielding historically low yields. But the Fed policy of printing massive amounts of new money, unfortunately, amounts to mega short-selling of dollars which can undermine the value of savings held in dollar terms. The Fed is attempting to correct problems caused by one set of subsidies through another scheme of subsidies. The Treasury has remained on its old path of second-best policies that subsidize a few indolent financial institutions and their executives by burdening the crucial vast majority that invents, innovates and produces globally competitive goods, services and ideas. Such monetary and financial market policies cannot repair the serious damage to the real economy (unemployment and wealth destruction) caused by mega short-selling. With profound regards, Sankarshan Acharya Acharya, S. (2013), “Constitutional Capitalism for First-best Governance, Obtained in general equilibrium based on rational microeconomic analysis, devoid of parochial dogmas, politics or prejudice,” available at http://pro-prosperity.com/Constitutional%20Capitalism.html
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