Guaranteed to Fail: Fannie Mae, Freddie Mac, and the Debacle of Mortgage Finance
Princeton University Press, Mar 14, 2011 - Business & Economics - 232 pages
The financial collapse of Fannie Mae and Freddie Mac in 2008 led to one of the most sweeping government interventions in private financial markets in history. The bailout has already cost American taxpayers close to $150 billion, and substantially more will be needed. The U.S. economy--and by extension, the global financial system--has a lot riding on Fannie and Freddie. They cannot fail, yet that is precisely what these mortgage giants are guaranteed to do. How can we limit the damage to our economy, and avoid making the same mistakes in the future?
Guaranteed to Fail explains how poorly designed government guarantees for Fannie Mae and Freddie Mac led to the debacle of mortgage finance in the United States, weighs different reform proposals, and provides sensible, practical recommendations. Despite repeated calls for tougher action, Washington has expanded the scope of its guarantees to Fannie and Freddie, fueling more and more housing and mortgages all across the economy--and putting all of us at risk. This book unravels the dizzyingly immense, highly interconnected businesses of Fannie and Freddie. It proposes a unique model of reform that emphasizes public-private partnership, one that can serve as a blueprint for better organizing and managing government-sponsored enterprises like Fannie Mae and Freddie Mac. In doing so, Guaranteed to Fail strikes a cautionary note about excessive government intervention in markets.
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Guaranteed to Fail falls in that difficult genre of book at once trying to appeal to a broader non-specialist audience and as well to a more informed reader seeking expert examination. This is a difficult middle ground and unfortunately I think the authors do not deliver. There is certainly no doubting the breadth of material. The reader is presented with a dizzying array of facts and figures - something that could have been well presented in better tables. Furthermore, there is no shortage of historical and policy analysis. Nevertheless I think the book comes up short. The real weakness I think is structure which is something an informed editor could have helped iron out. The introduction should have presented what exactly would be covered and the aim of the book. In missing this essential step the authors really failed to see that the text becomes a potpourri of information about the GSEs and anecdotes - issues on which they certainly have a wide breadth of expertise - but the book also fails to really set the issues in proper context. Chapter 5, for example, is just a mish mash covering the period leading up to the financial crisis and as far as I can tell provides no real insight. This could have easily been summarized in a table and appended to the first chapter which to be fair was a good introduction to the history of Freddie and Fannie. But the chapter also wanders into a non-essential description of the effects of housing on the economy, household spending and household balance sheets. It also delves into the literature surrounding the FHLB system. Again, this is testament to the depth of the authors' understanding of the issues but veers quite a bit off course. It would be a useful bit of analysis in the broader context of the housing market but does not seem on point in discussing why Freddie / Fannie were destined to fail and what should be done.
At times the authors also fail to substantiate their case. Chapter 6 goes into a discussion of the Fed's balance sheet and how the ballooning of it has complicated monetary policy. A more precise analysis is really needed here. Some very simple calculations, for example, might make the point that higher interest rates would lead to ongoing losses creating a quasi-fiscal loss that ultimately would need to be addressed. But the idea that capital losses on MBS positions would constrain the Fed is flatly dubious since the positions are valued on a hold-maturity-basis and short of defaults not covered by the GSE or Treasury would be irrelevant. In any event the authors fail to discuss the implications of central bank equity or why this would matter (inflationary finance). Nor do they highlight the ample literature on the subject or other international examples where central bank losses are relevant. This is an area where a broader analysis might be warranted but would extend the scope of the book even more.
Guaranteed to Fail also goes very quickly over topics that would seem to warrant further analysis. There is a passing reference to a rule change to the Securities Exchange Act of 1934, in August 2004, that allowed investment banks to apply greater leverage. This would seem to be a highly relevant topic since the greater investment banks gearing and expansion into mortgages - by their own hypothesis - was a precipitating factor in the housing bubble and subsequently led to catastrophic failures during the collapse. There is also little mention of the use of SPVs by commercial banks and the regulatory lapses of the Fed in allowing these vehicles which served to lever their balance sheets as well. Meanwhile the authors fail to address the more vexing question as to why there were concurrent housing bubbles globally (and some that are still inflating such as in Australia) even though Freddie and Fannie played no role there. They simply pass off any government influence in housing as somehow wasteful or counter-productive though Canada would seem to be an excellent counter-example. I think it would serve the readers to illustrate the difference in regulatory