It is a subsidy to the institution that is guaranteed, and results in a massive liability when the expanding unfunded risk of the institution is uncovered. Think bank deposits (S&L Failure of the 1980’s), Social Security, Medicare, and of course the guaranteed bonds of Fannie Mae and Freddie Mac supporting the resulting housing bubble and financial crisis.

The government ran an off-budget loan-department (Fannie and Freddie) that borrowed $5.4 trillion ($5,400 billion), as much as the total debt of the US before that. Fannie and Freddie were regulated and directed by the House Financial Affairs committee, chaired by Barney Frank (D. MA) and controlled by the Democratic majority for the last two years. The bad loans were made mostly in the last two years, under their direction and encouragement.

The crisis was powered by the unlimited guarantee of the U.S. Government through Fannie Mae and Freddie Mac, along with Government influenced ratings agencies that put AAA ratings on pools of sub-prime loans (Their Motto: Historical models predict they will be OK)

We Guarantee It is my detailed review of the government intervention that led to our financial crisis.

Bob,

Thank you for your comments, and for expressing your unique and informed perspective on these matters. Fascinating stuff for me, especially since our differences on the subject are more of relative weighting, rather than diametrical.

It’s late, so I must be brief and therefore unable to do justice to your learned comments. But while I suspect our personal ideologies may differ, I find it interesting and reassuring that our combined assessment of the situation is very close.

My apologies however, for the Chicago Economics comment. It was a cheap shot, as you might have assumed. But as the rare Liberal antagonist here, I occasionally have been known for such missives, as many here will attest. Sorry.

A final comment – as a private investor with an interest and a bit of experience in economics and finance, I could see serious economic trouble building on the horizon, long ago. In fact, lex may remember a (tuned-down, for me) economic doom-and-gloom post I made here, perhaps a year ago in December, forecasting our current situation. In his reply, I remember his satirical and witty tongue-in-cheek comment to me was, “meet you in the bread line.” Fortunately, neither of us is there, and never should be.

My point is this. I knew long ago very difficult times were ahead. And while I was somewhat well diversified, and I did fortunately make some serious adjustments to my portfolio in June of 2007, it was hardly enough. Thus, although I knew better, I still really got hammered in the markets’ recent fall, similar to how I got hammered in the dot-com bust.

Why? Because of greed.

In both bubbles, I had made so much money I felt invincible, despite well knowing the growing risks and impending turmoil ahead. And I didn’t want to miss out on that last marginal return before the eventual crash. My failure was not economics, government, regulation, ethics, or anything else but the sheer stupidity that greed breeds. And I unfortunately have a lot of company.

My second year here I got a subsidy check from the USDA. $18. I’m thinking boy howdy now Mom can have that operation!

Then I hired a new tax guy. Once he went to work I discovered all sorts of fun that reminded me of the Carter years, when taxes were high but deductions were plenty.

We deduct the cost of cat food, they being a pest control device. We deduct the cost of fuel, oil, replacement parts, heck I can buy a $250K dollar snowblower and so long as I use it to get to the horse-barn it’s entirely legit as a write-off.

Of course, since I don’t pay $250K in taxes each year it’s kind of a moot point for me, but the end result is that we’re farming the government and tax code as much as we are the land.

Old joke: How does a farmer double his income?
Answer: installs another mailbox.

– Max

Many, many good points…….we probably differ only on the weights to assign to the various actors in this wretched production. I stress Congress’ failures here because some of their number took the crucial steps that generated the housing bubble and all the associated bad loans that are at the core of all the mess we see. The CDS business ran into trouble in the mortgage side, not the corporate side. I don’t disagree that financial firms badly mishandled these instruments in retrospect. With normal loss rates on mortgages, we don’t have the problems we see now.

Let’s be very clear: there is shared responsibility all around on this mess. What prompted me to post the first time was my concern that most Americans are being fed a line of nonsense about high CEO pay and greedy Wall Street traders being the core of the problem. There are many sinners, and some of the biggest are spinning this line of nonsense on Capitol Hill and are lining up to ‘fix’ the problem. I’d rather have a root canal without anesthesia than have the likes of Barney Frank and Chris Dodd ‘fixing’ the problem.

What about the greed issue? As virgil (and others I think) have noted, this failing is widespread. Folks with regular jobs and no real estate speculation experience were buying and flipping houses to make quick money. It was stupid, and I don’t know any other explanation for it than greed. Too much leverage and too much risk were common among some Wall Street firms. Some of these guys thought they understood what they were doing and got it wrong. Some were just plain stupid/greedy. There is a big difference between these two sources of mistakes on Wall Street, although their consequences look pretty much the same.

At the end of the day, a much more widespread and conservative approach to risk-taking and investing is clearly called for at the level of the household. Wall Street has to get way more serious about modeling risks and limiting risks to much smaller levels. If you want to risk a bunch of money, invest in a hedge fund. You can make a bunch, but you can lose a bunch, too. (One of my former students has blown up two hedge funds; I wouldn’t have given the guy a nickel to invest…..the most deficient character I have ever seen in class….just awful.)

Measured risk-taking is good…….greed isn’t. We need to come out of this mess with a financial architecture that allows the former while exposing the latter to the market’s punishments.

A last point: Chicago Economics is alive and well. It has been seriously miscast in the news. Some of the harshest critics of stupid, greedy behavior have been Chicago guys…….What should be dead is mindless application in the economic policy arena of simple-minded sound bites attributed to Chicago economists by self-serving politicians.

My thanks to all who have joined in here……much better discussion than I have had at the lunch table with other academic finance profs.

And remember, there was an Army of lawyers and CPA’s advising everybody that everything was totally legal, rational,and a wise deployment of assets. So who was to believe that anything was wrong, let alone illegal?

And most of it WASN’T “illegal” it was, as Talleyrand once said in different circumstances, “far worse than a crime, it is a mistake!” Most “crimes” are by nature limited in scope (save for treason) and relatively easy to get behind one–even large financial ones. The right “mistake,” in comparison, can, as Talleyrand knew, totally ruin a nation.

Look, the psychology of the whole thing is that one never knows when the bubble will burst, so each individual is penalized financially and professionally if he doesn’t
“go with the flow” and reap the financial mega-buck rewards as long as it lasts. If not, he gets fired. Guess which choice most people make. Who among most of us is willing to sacrifice the house, pension and their children’s education by forgoing the bucks and/or being fired in favor of some nebulous “general good?”

And besides, haven’t most of the major players made out like bandits with their severance packages even AFTER the house of cards collapsed? Obviously cynicism and greed PAYS.

And just think of the psychology operative in the early stages. With luck most of the “big kids” (well, mid-level “big kids) figure they will be retired, pension, bonuses and deferred compensation packages well in hand, sitting in Sarasota at Micky Ds early in the am sipping coffee, reading the WSJ and contemplating an afternoon on the links well before the bubble bursts.

The really BIG “big kids” contemplate the South coast of France or Lake Como with digs next to George Clooney.