Eisenhower famously coined the term “Military-Industrial” complex to describe the way that large military budgets drove rent-seeking behavior in defense contractors. He warned that the economic interest of defense contractors and of those who prospered when they prospered, including politicians, would distort military priorities.
The same thing happened with the GSEs and the financial industry. From a Paul A. Gigot editorial dated July 23, 2008:
Fannie Mae and Mr. Mozilo [of CountryWide] weren’t competitors; they were partners. Fannie helped to make Countrywide as profitable as it once was by buying its mortgages in bulk. Mr. Raines — following predecessor Jim Johnson — and Mr. Mozilo made each other rich.
This partnership had predictable consequences.
Yet as studies have shown, about half of the implicit taxpayer subsidy for Fan and Fred is pocketed by shareholders and management. According to the Federal Reserve, the half that goes to homeowners adds up to a mere seven basis points on mortgages. In return for this, Fannie was able to pay no fewer than 21 of its executives more than $1 million in 2002, and in 2003 Mr. Raines pocketed more than $20 million. Fannie’s left-wing defenders are underwriters of crony capitalism, not affordable housing.
So, the GSEs were basically vehicles for using implicit government backing to borrow cheap money and then skim half of the difference off into private hands.
The abiding lesson here is what happens when you combine private profit with government power. You create political monsters that are protected both by journalists on the left and pseudo-capitalists on Wall Street, by liberal Democrats and country-club Republicans. Even now, after all of their dishonesty and failure, Fannie and Freddie could emerge from this taxpayer rescue more powerful than ever. Campaigning to spare taxpayers from that result would represent genuine “change,” not that either presidential candidate seems interested.
The colossal size of the GSEs made them politically immune from regulatory oversight. Given that they had little free-market feedback to control them, because they operated under special rules, and that they used the federal government’s credit score, they desperately needed that oversight. Yet, apart from the Bush Administration (rather weakly) and a few Congressional Republicans rebelling against their House leadership, no one tried to do anything.
This is why government involvement in markets is a bad idea. It always ends up like this. We start off with some warm and fuzzy ideal like helping farmers and we wind up with Archer Daniels Midland and 80% of farm subsidies going to the 5% of farmers who are already millionaires. With the GSEs we started with a relatively small-scale project to increase home ownership, that mushroomed over three decades into giants that bought half of the residential mortgages in the country and then contaminated the financial system with their stocks, bonds and securities (all along providing unearned wealth to corporate insiders, and protected by politicians across the spectrum and by the majority of the media).
Now, instead of drawing the lesson that the government shouldn’t directly involve itself in the minutiae of economic decisions, we’re on course to expand government involvement in finance even further. This won’t end well.
I wonder who’s going to make the big bucks this time?