Social subsidies may make good politics, but all too often bad economics. When Fannie Mae was created in 1938, the seeds were planted for the biggest housing bust the world has ever seen; the going was good while the party lasted for the first 80 years, but ended in the financial crisis of 2008 Social subsidies may make good politics, but all too often bad economics. When Fannie Mae was created in 1938, the seeds were planted for the biggest housing bust the world has ever seen; the going was good while the party lasted for the first 80 years, but ended in the financial crisis of 2008 – the hangover for many still remains. In 2008, many feared the dollar might collapse should Fannie Mae and its smaller cousin Freddie Mac (together here Government Sponsored Entities or GSEs) fail; little did those so fearful know that the government would embark on the largest bailout in history; the U.S. dollar rallied as the GSEs were put into conservatorship, making the previous implicit government guarantee just about as explicit as is possible.
Now, it appears the proposed “reform” of these entities only has stakeholders in the status quo; we are concerned this may ultimately open old wounds, and next time, the U.S. dollar may not be bailed out again. While the focus in recent months has been on challenges in the eurozone, investors tend to forget that the origin of the crisis was ultimately the U.S. housing market. While the rest of the world may have bought bad securities and structural deficits may be prevalent elsewhere, it is the U.S. where “Patient Zero” lives. The problem is, there are still millions of them. While financial institutions around the world are recapitalizing and governments are addressing their structural deficits (some better than others), policy makers in the U.S. are fighting the patients’ symptoms without offering a cure. Moreover, the U.S. is not addressing its own structural deficit, increasing the risk that the deficit virus the U.S. dollar is affected with morphs into a full blown disease that includes a tumbling currency and inflation as side effects. Don’t expect to have another 80 years to prepare for this potential crisis.
We have lived with the GSEs for such a long time that we can barely imagine a life without them. How weird for a country that has historically boasted the freest markets in the world: the mere existence of GSEs resembles more of a planned economy approach. Here’s the first problem with subsidizing housing for the masses: depending on the economic environment and perceived future income potential, rational home buyers allocate a certain percentage of their income to service a mortgage. If the government comes in to subsidize homebuyers, all those receiving the subsidy can afford to pay more. Over time, the subsidy will translate into higher home prices, thus eroding the benefit the policy originally intended to achieve. It is not surprising that the GSEs have gradually increased the mortgage amounts they are subsidizing. The GSEs are not all that different from a government run Ponzi scheme; and all existing homeowners have a vested interest in keeping the scheme running. That doesn’t make it right.
It is important to acknowledge that GSEs are fundamentally ill conceived. Without subsidies, home prices may fall – that’s correct. But that will make homes more affordable!!! Policy makers don’t seem to be interested in affordable home prices, but in the short-sighted belief that preserving the value of overpriced homes through government interference will get them re-elected.