The Christmas Eve Taxpayer Massacre
On Christmas Eve, while nobody was supposed to be watching, the Treasury Department lifted the bailout ceiling on Fannie and Freddie from an already appalling $400 billion to an unlimited amount.
In 2007, I denounced the entire bailout as little more than a looting operation. I appreciate that some consider the bailouts as necessary to prevent a wholesale liquidation/collapse of the entire economy, and I even share some sympathy with that view. However, I humbly submit that similar actions could have been taken without enormously enriching the very same parties that either caused the disaster or unwisely invested their money with the companies that did. Both sets of participants deserved to learn a very expensive lesson, not get bailed out at enormous expense to future taxpayers and national prosperity.
In 2008, I warned that the Fannie and Freddie bailouts were going to cost a lot more money than was claimed by the government, despite the fact that the then-director of the Congressional Budget Office, Peter Orszag, firmly declared that there was only a 5% chance that taxpayers could lose more than $25 billion.
Here's a blast from the past, just so that we can keep track of these things. This article is from July 23rd, 2008.
WASHINGTON — The proposed government rescue of the nation’s two mortgage finance giants will appear on the federal budget as a $25 billion cost to taxpayers, the independent Congressional Budget Office said on Tuesday even though officials conceded that there was no way of really knowing what, if anything, a bailout would cost.
The budget office said there was a better than even chance that the rescue package would not be needed before the end of 2009 and would not cost taxpayers any money.
But the office also estimated a 5 percent chance that the mortgage companies, Fannie Mae and Freddie Mac, could lose $100 billion, which would cost taxpayers far more than $25 billion.
[…] the director of the budget office, Peter R. Orszag, predicted that “a significant chance, probably better than 50 percent, that the proposed new Treasury authority would not be used before it expired at the end of December 2009.”
Mr. Orszag, at a briefing with reporters, acknowledged that pinpointing the eventual cost of the package was impossible. “There is very significant uncertainty involved here,” he said.
"Significant uncertainty?" Not to me, there wasn't. I was completely sure that these CBO estimates were laughably low and completely out of line with every known bit of housing data at that point. Foreclosures were already higher than the CBO baselines and were trending downwards, and losses were already far higher in private mortgage pools than the worst-case estimates for the Fannie (FNM) and Freddie (FRE) pools.
I'm sorry, but any analysis that begins with the proposition that the government is vastly better at the mortgage business than private industry is simply not credible, especially given that together FNM and FRE are half the entire market.
Two weeks later, in September 2008, I wrote this:
…$250 billion is pretty much my floor on the costs [of the Fannie and Freddie bailouts]. I happen to think that we’ll experience something closer to a 10% to 15% default rate [on GSE mortgage pools], which would yield a $500 billion to $750 billion loss estimate.
These estimates are reasonably close to the truth as we know it today. How did I do it? How did I manage such stunning accuracy where the CBO failed so badly?
Easy. I made the assumption that the FNM/FRE portfolios would experience the same loss rates as private portfolios and used a calculator, the FRE & FNM balance sheets, and two minutes of my time to develop a reasonably good answer. With a team of analysts and the actual portfolio information, I could have gotten much, much closer.
On Christmas Eve, the time when the most incendiary news is buried deep to avoid detection, this is what happened:
On Christmas Eve, when most Americans' minds were on other things, the Treasury Department announced that it was removing the $400 billion cap from what the administration believes will be necessary to keep Fannie Mae and Freddie Mac solvent. This action confirms that the decade-long congressional failure to more closely regulate these two government-sponsored enterprises (GSEs) will rank for U.S. taxpayers as one of the worst policy disasters in our history.
Where the director of the CBO stated that there was a 5% chance that the total cost would be in the vicinity of $25 billion, we are now faced with an exposure large enough to force the stealthy removal of a $400 billion cap on Christmas Eve.
One more time, we might ask how an outside analyst like me, using publicly available data, could be so much more accurate than the government itself, with its vast teams of analysts and better data?
The answer, unfortunately, is that my numbers are constructed from evidence and math, while the government's numbers are regularly fashioned for political advantage. These numbers often have no basis in reality; nearly everybody knows it. Yet the NYTimes continues to breathlessly report the ersatz numbers (as they did above), failing to ever circle back on the errors once the numbers are proven to be dangerously wrong.
For example, the most recent full-length article in the New York Times about Peter Orszag goes into great depth about his deep policy experience, budgetary skills, family life, and workout habits, but not his stunning inability to spot a multi-hundred-billion-dollar black hole (obviously in sight at the time of this article) that so many in the blogosphere immediately saw.
In a culture where we worship power, but apparently not the ability to get to within the nearest few hundred billion as a budget director, I suppose this is not much of a surprise. Still, it tells us something about our chances of being faithfully guided to safe shores by our promising young leadership. They're not good.
In this long sordid tale, marked by the constant use of fuzzy numbers that overstate our economic health and understate our fiscal losses, we find little to bolster our confidence in either our existing processes or rules. Once again I call for honest numbers as the only meaningful way to gain a true picture of our state of health, so that we can more readily assess the scope of the problem and craft acceptable responses.
I will also note here that without the massive subsidization of the US housing market by the government through Fannie and Freddie, it is unlikely that the enormous housing bubble would have developed to the extent that it did. I see that there's some pressure now to assign blame to loose underwriting standards in the subprime markets, but one cannot ignore the $4 trillion growth in the balance sheets of FNM and FRE. They provided an unending wall of fresh liquidity, without which the bubble never would have attained its deathly heights.
Instead of now squandering an additional half trillion dollars on blown mortgages - all just paper losses attached to depreciating assets - our nation could have afforded to completely revamp our electrical grid, install wind and solar power to an enormous degree, and put solar water collectors on nearly every rooftop, thereby greatly helping our future prospects while providing productive jobs today.
But we're not doing that, and most likely we'll never be able to, because we chose instead to provide ourselves with a housing bubble, an endless stream of bogus loss estimates, and the protection of the investment portfolios of the very richest people in the land.
If I were an incumbent in office, I’d be very, very worried about keeping my job.
The way out of this remains the same: The losses for this fiasco need to be assumed by those who made the bad decisions. Otherwise there's no justice, no fairness, and no opportunity to learn a good lesson from a bad time. Moral hazard is corrosive, not just because it fosters future mistakes, but because it undermines the rule of law by making it clear that there's a different set of rules in play, depending on who you are.
I am practically desperate at this point to see my nation and my government stop wasting money trying to resurrect already-destroyed capital and begin investing in the energy and educational infrastructure that we really need.
I am going to spend 2010 working as hard as I can to continue spreading the message about our true predicament and the solutions and actions that could help us build a better future. Let's work on this together.
Otherwise, the Christmas Eve taxpayer massacre will simply be the opening salvo to another lost decade. A decade that I am not willing to lose.