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?
An interesting quote from Ben Franklin, in the comments to this post:
“There are two passions which have a powerful influence in the affairs of men. These are ambition and avarice—the love of power and the love of money. Separately, each of these has great force in prompting men to action; but, when united in view of the same object, they have, in many minds, the most violent effects.”
The commenter goes on to say:
If we push money and power, government, into the same boat for individuals everything goes awry. Franklin knew it, and I think this type of issue will be hard pressed to get resolved.
Putting money and government together is pretty much the definition of economic fascism. Putting the violent power of the state and the economic power of corporations into the same hands is inherently dangerous.
I’m surprised that more people can’t see that. If nothing else it undermines the entire idea that government can regulate corporations. If the government owns the corporations, if the corporations advance the interest of politicians, then the government won’t regulate the corporations in the public interest.
This is what happened with the GSEs.
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.
The real dilemma, of course, is that such “warm and fuzzy ideal[s]” generally have much more political upside for elected officials to support than to oppose, thus making them nigh on impossible to resist. Here’s my quick and dirty analysis of the four possible outcomes of putting such a bill through Congress, and the likely political ramifications of supporting or opposing such a measure in each case:
[a] The legislation passes and works, for the most part, as advertised
If you supported/voted for the bill: At the very least you get credit for having done the right and necessary thing. If you’re lucky and/or play your hand well enough, you could even end up looking like a genius or visionary and it will advance your political ambitions down the road.
If you opposed/voted against the bill: You come off looking like a cold-blooded idiot who tried to stand in the way of noble and critical legislative action over fears that turned out to be unfounded, and become vulnerable in the next election cycle as a result. Such is the risk of being a naysayer.
Advantage: Support, by a country mile.
[b] The legislation passes, but things turn out badly anyway
Supported: At least you can tell your constituents you tried to help, and they can’t easily blame the failure on you. And in any case, they may well find themselves so preoccupied with picking up the pieces that the whole political fight and your role in it are quickly forgotten.
Opposed: You may be feted for having the foresight to oppose a measure that turned out not to work. On the other hand, for the same reason as above, your brilliant opposition could just as soon simply go down that same memory hole.
Advantage: A wash.
[c] The legislation is defeated, but the threatened parade of horribles never materializes
Supported: In all likelihood, by the time it becomes clear to all that the legislation was unnecessary, the whole political battle is so far in the rearview mirror that it neither helps or hurts your career much.
Opposed: Ditto.
Advantage: Again, a wash.
[d] The legislation is defeated, and the parade of horribles does materialize
Supported: Again, at least you can say you tried.
Opposed: You get blamed for allowing it all to happen. Not only your re-election prospects, but your whole political career and legacy are pretty much shot.
Advantage: Support.
Overall advantage: Support offers politicians lots of political upside and very little political risk. Opposition entails a lot more risk for less upside. So, unless you know your seat is safe from any serious challenge, either from within your own party or from without, supporting such a bill is a political no-brainer.
D’oh! That was me who posted the above “Anonymous” comment.