Murphy on Freddie & Fannie Takeover
In Sunday’s Philadelphia Inquirer, I argue it was not good. A juicy excerpt:
If Congress defangs the alternative minimum tax, as it did last year to prevent a large increase on the middle class, the latest Congressional Budget Office forecast projects a record deficit of more than $500 billion for the fiscal year starting Oct. 1. Making the federal government ultimately responsible for roughly half of the nation’s mortgages will make it impossible for the next president to take other measures to help a sputtering economy, such as tax relief.
…
Because of the desire to avoid “moral hazard” – encouraging risky investments by large firms because they believe the government will bail them out if things turn sour – the government-engineered rescues of the Bear Stearns Cos. Inc. and now Fannie and Freddie were designed to punish common shareholders. Fed Chairman Ben S. Bernanke and Treasury Secretary Henry M. Paulson Jr. did not want to reward bad bettors on Wall Street with taxpayer money. Yet this insistence on stern terms might have doomed Fannie and Freddie, making the takeover inevitable.
Private investors are now much more reluctant to inject billions into solvent yet illiquid enterprises because they know they might be left holding the bag in the event of another bailout of a firm deemed “too big to fail.” This paradoxically makes it difficult or even impossible for such firms to raise private funds, and then they have no choice but to turn to the government.
In a vicious cycle during the last year, investor behavior has been based less and less on fundamentals and more on government announcements. If Paulson’s secret strategy has been to show that throwing around billions of dollars won’t fix a broken economy, taxpayers can only hope this was the final demonstration of the rule. This is hardly the path to economic recovery.
