By J.D. Seagraves, on July 26th, 2008
Fannie Mae and Freddie Mac have been in the news a lot recently. But just what are these entities? Are they government agencies or private corporations? It seems that few media pundits or even politicians really know. But what everyone does seem to know—or at least, opine—is that we can’t let these institutions fail.
Why not?
To answer that question, we have to first establish just what Fannie and Freddie are, and what kind of impact they’ve had, on the economy in general and the housing sector in specific, since their inception.
Appropriately, the recent mortgage meltdown, which many experts see as a leading indicator of an emerging depression, has its roots in the Great Depression and its cousin, the New Deal. In an effort to increase home ownership, the FDR administration created the Federal Housing Administration (FHA) in 1934. The FHA set mortgage guidelines and offered federal insurance on mortgages that adhered to its criteria. The purpose of this was to “standardize” the terms of mortgage contracts so they could be easily “bundled” into securities.
Here’s what that means: if I, as a private investor, had today’s equivalent of $300,000 to invest in 1920, I’d have a few options. I could go into the stock market. I could buy commodities. I could invest in bonds. Or I could—theoretically, at least—purchase a mortgage from a bank. If I bought the mortgage, then I, and not the bank, would receive the monthly mortgage payments from the mortgagor; and I, not the bank, would have a claim on the property if the mortgagor failed to pay.
This could be an attractive investment to some people who wanted a good yield and a gradual return on their principal rather than semiannual interest payments with the principal repaid in one lump sum at the end of the loan, as most bonds work. However, the risk that an individual mortgagor would not repay the loan was great, and thus, prospective homeowners would be expected to pay a substantial premium, in terms of a higher interest rate, to compensate their lenders for the potential of total loss. Even if 99% of people repaid their mortgages dutifully, to the one investor in 100 who put up $300,000 and had his mortgagor skip town, the loss could be devastating.
Where It All Began
Enter the FHA. By offering an incentive to standardize the terms of a mortgage contract, large financial firms could “bundle” several similar mortgages together, and then sell debt instruments backed by those mortgages. Instead of investing in 100% of one mortgage, an investor could invest in a piece of ten or 100 mortgages. Not only would the default risk be spread out but so would the pre-payment risk—the risk that the borrower would repay the loan too quickly, thereby wasting the lender’s time. Thus, the premium lenders needed to charge on mortgage loans dropped, and homeownership became more affordable and widespread.
Sounds great, right? Well, the problem is that private companies did not step up to the plate and bundle these FHA-insured mortgages. The fact that they didn’t should have indicated the plan wasn’t so sound, but like most government programs, the FHA led to the creation of yet another government program: the Federal National Mortgage Association, FNMA, or cutely known as “Fannie Mae.” Fannie Mae was, at first, a government agency empowered to purchase FHA-insured mortgages, bundle them and sell the resulting debt instruments to the public. If these debt instruments went bad (i.e. if there was widespread default by the mortgagors), then it was always implied that the federal government would step in and cover them.
Between 1938 and 1968, Fannie Mae had a virtual monopoly on the secondary mortgage market. This should have come as no surprise as government has the monopoly on creating monopolies. But in an effort to inject competition into the market, Fannie Mae was privatized and empowered to buy any mortgages—not just FHA-conforming ones—and a second cutesy GSE (government-sponsored enterprise), “Freddie Mac” (the Federal Home Loan Mortgage Corporation or FHLMC), was created to compete with Fannie.
Where We Are Now
Fast forward another forty years and the chickens are finally coming home to roost. Both Fannie and Freddie are essentially bankrupt and their stock prices were headed to zero, kept afloat only by the implied government bail-out that was all but guaranteed to come. In one day, as Fannie and Freddie hit their all-time lows, a few words by Fed Chairman Ben Bernanke sent the stocks soaring, and $6 billion in market cap was added to the ailing GSEs. Republicans and Democrats, with very few exceptions, all agree that these firms must be “saved” and “not allowed to fail.” But the Austrian take on the matter is that these institutions have been positively disastrous to the freedom and prosperity of Americans.
There can be no doubt that the existence of the FHA, Fannie Mae and Freddie Mac has made homeownership more widespread. Most people take it as a given that this is a positive thing. But is it really? There are plenty of costs that come with homeownership versus renting—homeownership is not an unequivocal good.
Economic conditions in the U.S. and around the world have been destabilizing communities. Mobility is king now. People do not work at the same job for fifty years and then retire with a gold watch, proverbial or otherwise. By making homeownership artificially cheap, millions of Americans have been lured into buying when they should have been renting. This is one of the causes of the mortgage meltdown, as people who’ve lost their jobs and need to move can’t get out from under their upside-down mortgages.
The problem with government intervention into the economy is that, even if it seems to work in the short-run, it never takes the long-run into consideration. It can’t. The free market is dynamic and responds to change. If politicians who say they value the free market are true to their claims, they should at least consider allowing Fannie and Freddie to fail.
For arguments in support of increased government regulation on Fannie Mae and Freddie Mac, read G.L.C.’s blog post, “Fannie Mae & Freddie Mac: When Will the Government Learn?”
By Cheryl Grey, on July 18th, 2008
A Brief History of (Fake) Time
The original idea of daylight saving time (DST) is often credited to—or blamed upon, depending on one’s perspective—Benjamin Franklin. While it’s true the creator of Poor Richard’s Almanack did write a satirical essay on how much candle wax Parisians could save by rising and retiring with the sun, his impish solution was not to shift the clocks but to enforce his penny-pinching via such means as rationing candles, taxing shutters on windows, forbidding carriage movements after dark and firing cannon and ringing church bells at sunrise.
No, it was Englishman William Willett in 1907 who first conceived the idea of shifting everyone’s clocks so they arose earlier in April than they did in September, saving the money that would otherwise be spent on artificial lighting and extending the long lazy hours of recreation into summer’s evenings. (He was an avid golfer.) So struck was he by his genius that he spent much of his own fortune in publicizing the idea and lobbying Parliament.
But it wasn’t until 1916, a year after Willett’s death, that “Summer Time” was officially enacted—and then only because the Germans had already done so to increase factory production and save coal as part of their First World War effort. Refusing to give their enemies the advantage of time, England hastily followed suit and the remainder of the combatants joined in, with the United States last to adopt the policy in 1918.
The program was considered so successful that it was reinstated and even doubled for World War II, with the English adoption of “double Summer Time” which sprang forward two hours in April and fell back only one in September. The U.S., not to be outdone, left DST in effect for over three years. It became federal law in 1966, and we’ve enjoyed it, or been stuck with it, ever since.
The Farming Fallacy
Many individuals seem to be of the opinion that DST was adopted to assist farmers, but this is a truly urban myth. Plants, cows, tractors and other farm features aren’t particularly concerned with the hour of the day unless it’s feeding time, and therefore farmers aren’t too psyched by it, either. In fact, farmers tend to oppose DST as a needless complication in their sun-dominated lives.
The original goal of DST was to reduce the need for artificial lighting and therefore the amount of energy consumed by urban workers during evening hours. Some corroboration for the theory was finally offered in 1975 by the U.S. Department of Transportation, which oversees DST as part of interstate commerce. The results of their study concluded that DST might save 1% of electricity usage in March and April, but nobody was really certain, and studies on other fuel usage were not attempted.
A more recent study was performed in Indiana, which didn’t entirely adopt DST until 2005. University of California, Santa Barbara, scientists studied power usage changes in those areas springing forward for the first time and found that, instead of conserving energy and saving money, DST actually costs area residents an additional $8.6 million each year in utility bills, as well as increasing power station and automotive emissions.
The Dirty Little Secret
The reason’s simple. Although electric lights may not be used during those long summer evenings, the air conditioner will be, and it gobbles far more electricity than a few bulbs. So do the television, the stereo, the computer, the microwave and all those other modern high-tech gadgets that weren’t in such common usage at the time of the 1975 study. In addition, having those extra hours of summer daylight tempts many people to go driving after work—to the mall, the ballpark, the golf course, the park, the beach—racking up summer gasoline usage with gallons that might otherwise have been saved.
Sporting goods manufacturers, the leisure industry, gasoline stations, retailers and convenience stores all love DST. Every time Congress extends summer another month, it’s estimated to earn an extra $200 million in sales for the golf industry and another $100 million for BBQ grills and charcoal.
But it doesn’t save energy. And for the U.S. government to make DST a mandatory part of our energy policy is ironic at best.
By Greg Beatty, on June 10th, 2008
University, Inc.: The Corporate Corruption of American Higher Education. By Jennifer Washburn. Basic Books, 2005. 326 pages. $26.00.
 University, Inc.: The Corporate Corruption of American Higher Education is a necessary book but also a sobering, even depressing one. If you’re concerned about your health, your education or your country, you won’t enjoy what you read in these pages…but you should read University, Inc.
Science is the reason. While numerous theorists since World War II have worked to theorize and complicate the process of knowledge creation in science—Thomas Kuhn’s work comes to mind immediately—the ideal of science as a disinterested arbiter of truth remains. In this vision of what science should be, truth matters. We trust scientific reports because of this aura of dedication, even purity. In these pages Jennifer Washburn documents just how tainted science has become.
Its transformation has not come through malicious intent. Indeed, as Washburn explains, at many points throughout this transformation, science and education have been changed with the best of intentions. As Washburn points out in her historical overview of higher education articulated in the book’s second chapter, scientific research in this country has long had two fairly distinct mandates. One was to pursue pure, abstract research. The other was to engage in practical research, especially applied research that would help the people in a university’s region, as has long been the case with the nation’s agricultural colleges.
However, in progressive steps since World War II—and especially since the 1970s when economic downturns led to a general increase in federal investment in science as a way to spark economic recovery—academic research has shifted not just to the applied and practical but also to a market model. What this means, Washburn explains, is a number of things. First, following the passage of the Bayh-Dole Act in 1980, rather than new ideas flowing freely from universities outward to the community, universities have emphasized research that can be patented—and have retained the patents on these discoveries. This means that universities shift to what Washburn calls “Market-Model U.” In itself, this is not all bad. As someone who has taught in state colleges, I can attest to the waste found in some systems and the inefficiency and the dated slowness with which things are executed. If it were possible to infuse just the efficiency and pace of the finest private enterprises, this would be a good thing.
It hasn’t been possible to do only that, though, Washburn argues. Instead, as federal funding for higher education dried up, universities sought funding elsewhere, producing an increased emphasis on corporate funding. Washburn documents a second effect which is how this has chilled academic research. Stories of graduate students who, due to contractual obligations, can’t share their work, even with their own professors, should make readers blink, as should the anecdotes about faculty members stealing student work. Greed drives dishonesty in Washburn’s account.
This leads to a third damning trend: bias. Any bias in a scientific study should be disturbing, but Chapter 5, in which Washburn documents the systematic distortion of medical studies, should make readers more than a little queasy. These distortions range from the relatively benign (reporting a test drug has a positive effect when it has little or none) to the literally deadly. Deaths have been covered up, as have risks of death, so that drugs can be brought to market for profit. The conclusion is clear: whatever the ideal of science once was, it is not strong enough to stand up to temptation. Self-interest rules.
To be frank, the later chapters are not as strong as these early ones exposing abuses. The attempts to shape new Silicon Valleys and revive regions may fail, but their intentions are good and not necessarily driven by greed (except for prestige and regional pride). Washburn’s discussion of academic employment patterns is not bad, but it is insufficient. What’s more, that she really isn’t that concerned about these is witnessed by the final chapter: all the suggestions for reform focus on intellectual property and clinical research. The attempts to change the nature of education through the use of superstar education may repel some, but it needs to be put into a much larger and more detailed context. It seems more a symptom of the Information Age and what podcasts and computers offer than of the market model per se. How, for example, does MIT’s choice to put its courses online for free fit with this? In other words, the changes detailed in this book are part of a wider redefinition of the ownership of knowledge, a shift linked to everything from music downloads to Wikipedia, and needs to be put in that context.
While my objections matter, and I wish the second half of the book were better (richer, fuller, more inclusive and complex), the expose that fills University, Inc.’s chapters on science and medicine struck fear in my heart, and I suspect they’ll do the same for other readers.
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