Monday, September 08, 2008
Reference: Fannie Freddie blind to the bubble, Bangkok Post, September 8, 2008
An article in the Bangkok Post says that mortgage dealers Fannie Mae and Freddie Mac in the USA are in the pickle they are in today because they failed to heed warnings by economists that home prices in America had formed a bubble that was about to burst (Fannie Freddie blind to the bubble, Bangkok Post, September 8, 2008). This analysis is misleading. Bubble theory in economics is an illusion because the so called bubbles in prices are invisible until they burst. In other words bubble analysis makes sense only after the fact. Economic forecasters who make a living by forecasting bursting bubbles are no different from fortune tellers because when you take all of their forecasts into account including the ones that were wrong, you will find that they are mostly wrong. Mortgage lenders who specialize in home loans do not hold a diversified loan portfolio and therefore face unique risk when home prices fall. These two large mortgage institutions were created by government fiat and are very tightly regulated in a way that denies them the benefits of diversification. This is the core of the problem and the government is to blame. The more urgent issue in the US government's takeover of these firms is that America runs a large trade deficit and the accumulated deficit is held by other countries as claims against American financial assets including mortgage securities. Without a full reassurance from the US government there could be a run on these assets that could cause a financial meltdown in the US housing and banking industries. These circumstances taken together imply that the problem is the government's own making and it is only fitting that they should step forward and take full responsibility for its resolution.