Home / Contact

REPORT DEAD LINKS --- we can't keep this site up-to-date without your help

The Failure of Freddie and Fannie. The Fed outfoxed Congress.
From: http://www.primeronmoney.com/freddyandfannie.html

It is simple:
1. The Federal Reserve Banks collected the fees for gazillions of dollars of mortgage loans.
2. Fannie and Freddie bought those loans and took all the risks of default by the buyers.

Q. Why would Freddie and Fannie buy those loans and the risk that went with them, while the Federal Reserve wanted to get rid of them?
A. The Fed is smarter than Freddie, Fannie and Congress. Consider the following: One good but often overlooked thing about having the bankers run the money system is that if they lose money on bad loans -- that money theoretically comes out of the banker's pockets (because the bankers own the banks). If the government ran the system and owned the banks -- all losses would come out of the pockets of the taxpayers. Of course what happened in the financial and real estate price meltdown of 2008 shows that in any case -- the taxpayers will probably pay the bill for the losses caused by unpaid debts. In that 2008 case -- the government basically pumped taxpayer money into private banks and corporations, thus shielding them from losing money.
  1. Many people understand that the fractional reserve system (the underlying system we use now) gives the managing or owning institution -- whether the Fed or Congress -- a system that has enormous leverage built into it. For every dollar of capital invested by the owners of the system - those owners can make loans adding up to ten times (or much more) the amount of the invested capital. In other words -- if a Federal Bank opens its doors with one million dollars of invested capital -- it has the right to lend out $10 million at whatever interest is currently in vogue.
  2. What is not so well understood is that "leverage" almost always works both ways -- In this case, it (a) magnifies the opportunity for profit -- but it (b) also magnifies the opportunity for loss if the loan goes bad. The (b) part is very good in my opinion.
  3. Under the present system, The Fed has been able to escape the penalties for bad loans. The establishment of Freddie Mac and Fannie Mae (such cute, benign-sounding names) allows the Fed to sell off whatever loans they consider risky.
  4. I don't think there is any hope of stopping the fractional reserve system -- but I do think it is possible to have it work for the common good -- by making sure that unpaid loans AUTOMATICALLY penalize the banks who are the original lenders. There should be a natural control built into the system. Such a control would almost guarantee that inefficient lenders would be driven out of the system. This control can be accomplished by passing laws that demand the banks hold onto all loans they make for the duration of each loan.
  5. Originally, it was thought that the enormous leverage would work to keep the Bankers prudent, conservative and cautious because for every dollar of bad loans they made, they would have to call back TEN dollars of loans and they would therefor lose the continuing interest on that 10 dollars -- a worse fate can hardly be imagined.
  6. Somewhere along the line, it appears that bankers forgot the downside of the leverage and thereby took chances that were not prudent.
  7. But then, they covered themselves by gulling the government into setting up Freddie and Fannie -- patsies that would buy up the shaky loans, thus shielding the Fed from the downside of the leverage.
  8. Once Freddie and Fannie were established, that natural control was eliminated and banks basically did not have to worry about the soundness of the loans they issued. Thus, they made bad loans, sold them to Freddie and Fannie and watched them take the losses.

    The Fed simply outfoxed Congress -- Freddie and Fannie should be abolished -- let the banks run the risk of bad loans. It will keep them on their toes.

    Read the following from the NY Times -- Paulson must be the Fed's man in the White House
    WHITE HOUSE MEMO    : Rescue of Mortgage Giants Displays Paulson's Clout / By SHERYL GAY STOLBERG
    Treasury Secretary Henry M. Paulson Jr. has led President Bush where he would not usually go: into government intervention in the markets.http://www.nytimes.com/2008/09/09/business/09bush.html?th&emc=th