Myths still lin­ger­ing from the fi­nan­cial cri­sis

The Washington Post Sunday - - BOOK WORLD - RE­VIEW BY SI­MON JOHN­SON Si­mon John­son is a pro­fes­sor at MIT’s Sloan School of Man­age­ment and the au­thor of “13 Bankers.”

Fan­nie Mae and Fred­die Mac haunt our fi­nan­cial sys­tem and threaten our econ­omy. Or do they? Bethany McLean has writ­ten an in­sight­ful guide to one of the fas­ci­nat­ing true-fi­nan­cial-crime cases of our time. Writ­ing with the easy, in­ci­sive style that has brought her great suc­cess (“The Smartest Guys in the Room” and “All the Devils are Here”), McLean dis­pas­sion­ately ex­plodes three myths.

The first myth is that these gov­ern­mentspon­sored en­ter­prises caused the fi­nan­cial cri­sis of 2008. You can see to whom this nar­ra­tive would ap­peal— if Fan­nie Mae and Fred­die Mac made them do it, pow­er­ful peo­ple in the pri­vate sec­tor are es­sen­tially blame­less. Re­peal the Dodd-Frank fi­nan­cial re­form leg­is­la­tion, lift the re­stric­tions im­posed on big banks, and you can­have the boom back, ac­cord­ing to mem­bers of the House Fi­nan­cial Ser­vices Com­mit­tee.

But as McLean shows, Fan­nie and Fred­die did not lead the push into sub­prime mort­gages. They were not the in­no­va­tors of reck­less de­riv­a­tives. And it was not their losses that threat­ened to bring down the fi­nan­cial sys­tem.

The sec­ond myth is that Fan­nie Mae and Fred­die Mac have been forces only for good. Fan­nie Mae was founded in the 1930s to sup­port the U.S. hous­ing mar­ket by guar­an­tee­ing home loans, and this form of gov­ern­ment in­ter­ven­tion is a ma­jor rea­son we have 30-year fixed-rate mort­gages that we can pre­pay when­ever we want (for ex­am­ple, when in­ter­est rates fall). But Fan­nie Mae be­came a ma­jor force in Washington, hir­ing politi­cians, con­gres­sional staffers and any­one else who mat­tered — Democrats and Repub­li­cans alike. It never lost a po­lit­i­cal fight.

And, as profit-seek­ing and pub­licly held com­pa­nies, what Fan­nie and Fred­die wanted from the 1970s on was what ev­ery­one else in big fi­nance wanted: per­mis­sion to take on big risks, backed by very lit­tle loss-ab­sorb­ing eq­uity cap­i­tal. The ex­ec­u­tives were very highly paid, and cred­i­tors re­ceived a great deal of pro­tec­tion. The gains for home­own­ers and for so­ci­ety are de­bat­able. And the tax­payer ended up on the hook.

The third myth is that gov­ern­ment guar­an­tees are free or easy. Henry M. Paul­son Jr., then trea­sury sec­re­tary, fa­mously told Congress on July 15, 2008, “If you’ve got a bazooka, and peo­ple know it, youmay not have to take it out.” He was ar­gu­ing that giv­ing the gov­ern­ment greater abil­ity to fully back Fan­nie and Fred­die could make such ac­tion un­nec­es­sary. Un­for­tu­nately, Paul­son was proved wrong when, in early Septem­ber 2008, he placed Fan­nie and Fred­die into con­ser­va­tor­ship, pre­vent­ing the firms from de­fault­ing on their obli­ga­tions.

McLean is right on all counts. Un­wind­ing Paul­son’s bazooka ef­fect is a huge, un­re­solved public pol­icy ques­tion, with­out easy an­swers. Dis­rupt­ing the hous­ing mar­ket is never wise. Yet mud­dling along with the cur­rent ar­range­ment is ask­ing for trou­ble; re­float­ing the ex­ist­ing con­ser­va­tor­ship struc­tures would be foolish; and let­ting “too big to fail” banks take over the busi­ness and fur­ther in­crease their im­plicit gov­ern­ment guar­an­tee would be in­sane.

SHAKY GROUND The Strange Saga of the U.S. Mort­gage Giants By Bethany McLean Columbia Global Re­ports. 148 pp. Pa­per­back, $12.99

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