Take just the Fannie and Freddie bailout by the government for the moment and concentrate on that. (Don't those names - Fannie and Freddie sound so cute and innocent?? How could anything be wrong with such sweet sounding entities?) It's not terribly difficult to understand, though many economists (and even more journalists) would use all sorts of jargon and lose most listeners/readers. A very good review and analysis of that situation is available by an economist with a solid reputation for making the complex understandable without oversimplifying and thereby distorting the facts.
Now that you've read his conclusion, you can read the entire relatively short article that shows why Frank Shostak can say the above without any slight of hand tricks. You will see for yourself that both of these government created entities (Fannie Mae by FDR in 1938 as part of his New Deal and Freddie Mac more recently in 1970) have been distorting the home mortgage market for years and that this distortion starts with the implied government guarantee that goes along with the mortgage-backed securities they sell to investors. Because of this guarantee, the funding costs for Fannie and Freddie have been extremely low and they easily sold their securities ("debt issued"), viewed by investors around the world as almost as good as US Treasury Bills (debt). Significant amounts of investment in these two have come from China, Japan and even Russia. The best corporate bonds (AAA) cost these companies far more to entice investors than Fannie and Freddie's cost of funding. Let's be clear, it is this government guarantee that effectively enhances the values of the Fannie and Freddie investment products, which enables them to be more attractive than those of companies without such a guarantee - such as even the highest rated corporate bonds (AAA). And the money definitely poured into Freddie and Fannie over the past almost 2 decades - $1.77 trillion dollars combined assets for the two entities in the second Quarter of 2008, up from $160.2 billion in first Quarter in 1990. The two of these Congress-created "companies" own or guarantee $5.4 trillion in outstanding home-mortgage debt, of which major amounts of write-off have occurred with the growing number of foreclosures and defaults. As a result, Fannie and Freddie stock prices began falling a few months ago and, not surprisingly, made raising capital (getting investment) more difficult for both of them.
[T]he seizure of Fannie Mae and Freddie Mac (FF) by the government cannot help the housing market or the economy. Most people hold the mistaken view that the government has extra real resources that can be used in emergencies. This is erroneous. The government is not a wealth generator; it can only consume and redistribute real wealth. What is needed to revive the economy is a growing pool of real savings.Neither the US Treasury nor the US central bank can create real savings. In order to keep the failing FF going, the taxpayers will be forced to foot the bill. This means a further squandering of the already depleted pool of real savings. Only wealth generators can revive the economy by accumulating enough real capital. In this regard, no government or central-bank policies can replace wealth generators.- Advertisement -
The only way wealth generators can act effectively is when they are not disturbed, i.e., in a free-market environment. The sooner the government allows them to move ahead, the sooner we will have economic improvement. Any government or central-bank policies that are intended to improve on the free market — in particular during difficult economic times — are likely to make things much worse and prolong the economic crisis.
What gets lost for most people is that the selling of debt (of which mortgages are a major type) has great similarity to selling of actual goods and services, particularly to sales on a time-payment financed basis. Everything works well as long as individual homeowners pay on their mortgages regularly or even pay them off early - just as when time-payment buyers of a product or service meet their payments. In this manner companies that sell debt are entirely similar to all other companies that sell a product or service valued by others. They both get a loan from the bank or private investors (selling bonds is one method of getting such loans) to finance and expand their business and they pay the loan off with their income. The problem arises when large numbers of people accept ("take out") mortgages which they fail to repay - for whatever reason, making it impossible for the company (debt seller) to continue to reimburse those who have financed its debt. Just as with any company selling non-debt goods or services, if those, who have purchased through time-payment financing, renege on their payments, the company will not be able to make its own payments to its investors and bond holders. In the case of mortgage companies, to the extent home-buyers default on their mortgage payments, the investors/financiers of those mortgages gain less of their return on investment than promised and may even lose some or all or the principal itself. The banks that invested are using the money of those with various savings accounts in their institutions; other investors are mutual funds with investments from individuals directly or through retirement funds. So in then end it is the small and/or individual investor who loses.
And then while you're at it, I highly recommend "What's Behind the Financial Market Crisis?", a highly readable explanation of why the current situation is not a cyclical phenomenon and how the results to be expected from the "bailouts and socialization of the mortgage agencies" - direct taxpayer responsibility for Fannie and Freddie - will make even more clear these latest symptoms showing that "the financial system is now fully infected with moral hazard."