Sunday, October 05, 2008

Avoiding the Tailspin

Behind every failure there is the moment of coercion. With Fannie Mae, it was the moment in which Angelo Mozilo, then the head of Countywide Financial - now defunct - told Daniel Mudd, the head of Fannie Mae, that Fannie Mae would either buy all the subprime mortgages that Countwide wanted to sell it, or they would take all their business directly to Bear Stearns and similar firms.

Charles Duhigg reports the following conversation in the New York Times:
“You’re becoming irrelevant,” Mr. Mozilo told Mr. Mudd, according to two people with knowledge of the meeting who requested anonymity because the talks were confidential. In the previous year, Fannie had already lost 56 percent of its loan-reselling business to Wall Street and other competitors.

“You need us more than we need you,” Mr. Mozilo said, “and if you don’t take these loans, you’ll find you can lose much more.”

Then Mr. Mozilo offered everyone a breath mint.
These and many similar pressures forced Fannie Mae to contradict its own judgement and lap up subprimes. It's easy for us on Sunday morning to say that Mr. Mudd shouldn't have gotten drunk on Saturday night. But actually they put a funnel down his throat and poured the beer down for him.

Different pressures were coming from Congress. Duhigg summarizes them as wanting Fannie Mae to support more affordable housing. Here's another key moment:
“When homes are doubling in price in every six years and incomes are increasing by a mere one percent per year, Fannie’s mission is of paramount importance,” Senator Jack Reed, a Rhode Island Democrat, lectured Mr. Mudd at a Congressional hearing in 2006. “In fact, Fannie and Freddie can do more, a lot more.”
This is the moment when unthreatened people realize that they've caught the wrong guy - the perpetrator is not Fannie Mae, but the new financialized economy itself. But everyone was caught in the squeeze. And everyone did the wrong thing.

The argument for regulation is not that citizens, especially leading bankers, need to be under tighter government control. The argument is that regulation sets standards such that a few especially aggressive operations don't drag everyone else down.

Another example is retail underpricing. France still has a lot of local bookstores because the maximum legal discount is 5 percent. The Fnac, France's equivalent of Borders and Circuit City rolled into one, can't get people to avoid their local and cross town for a 40 percent discount. The same goes for bread and a lot of other products where quality matters to society, and so does a healthy distribution network that keeps neighborhoods thriving.

Why can't we figure this out in the US?

For an economist's version of this argument, see Robert Frank, who has to again state a case for minimum collatoral standards that should be obvious. Why isn't it obvious?

My gut feeling is that it's the prevalence of the threats.

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