Tuesday, September 23, 2008

The Panic of 2007

The Wall Street Journal today ran an article by a well-respected economist blaming much of the financial turmoil on Fannie Mae and Freddie Mac, the two mortgage subsidizing giants that were backed by Congress. If the article is correct, the current calls for increasing government regulation on the financial world may be misguided. Something drastic may need to be done in the short term to prevent a deep recession, but the real moral of the story could be that government involvement in market activity is more a cause of problems than a solution most of the time.

The validity of the article's premise rests mainly on a single number: $1 trillion.
... the vast accumulation of toxic mortgage debt that poisoned the global financial system was driven by the aggressive buying of subprime and Alt-A mortgages, and mortgage-backed securities, by Fannie Mae and Freddie Mac.
...
They became the largest buyers of subprime and Alt-A mortgages between 2004 and 2007, with total GSE exposure eventually exceeding $1 trillion. In doing so, they stimulated the growth of the subpar mortgage market and substantially magnified the costs of its collapse.
This is an astounding argument for libertarianism, but the problem is that the $1 trillion number is difficult to verify.

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