Spreading oil over government ripples

In today's Wall Street Journal, Gerald F. Seib observes that bad news for the economy is good news for Democrats:

...the collapse of a big bank and the scare over the viability of mortgage giants Fannie Mae and Freddie Mac -- seem likely to reinforce the basic dynamic of the campaign year: Voters think the country is in a mess, and they are more inclined to trust Democrats to clean things up.

To make matters worse for Republicans, the financial scares have reinforced the specific argument that government intervention in the economy, a natural inclination for Democrats, sometimes may be necessary. Even the Bush administration, resistant to intervene in markets, and reluctant to ride to the rescue of investors in the specific case of the housing mess, stepped up over the weekend to offer a virtual government guarantee that Fannie and Freddie would stay solvent.

It grows ever harder for Republicans to campaign against government intrusion in the marketplace the more Republicans themselves appear to be losing faith in letting markets work. And if voters want intervention in the economy, why not get the real deal with Democrats? In sum, it is hard to imagine new economic scares represent anything but more bad news for Republicans, who tend to get the blame for things that go wrong simply because they have controlled the White House for the past seven years.

To add irony to insult, the current Fannie Mae/Freddie Mac crisis is the predictable result of government involvement in the business sector in the first place. As I've argued more times than I can remember, government involvement with business creates problems -- and invites more "solutions" in the form of ever more government involvement in business. In this case, an outright government takeover.

I'm not an economist. But Greg Mankiw is one of the country's leading economists, and right now he is saying I told you so!

This was his warning in 2003 when he was the chairman of the Council of Economic Advisers:

WASHINGTON (CBS.MW) - The notion that the U.S. government would bail out Fannie Mae and Freddie Mac if they ran into financial trouble "creates a source of systemic risk for our financial system," a top White House economic adviser warned Thursday.

Fannie Mae and Freddie Mac, government-sponsored enterprises created by Congress to help fund home mortgages, enjoy special privileges, such as lines of credit with the Treasury Department.

Those special privileges "feed market perceptions that GSE debt has the backing of the U.S. government," said Gregory Mankiw, chairman of the administration's Council of Economic Advisers. "This notion is inaccurate." Read Mankiw's remarks.

Mankiw's view was, of course, pooh-poohed at the time. But his warning was as ominous as it was accurate:
Due to the enormous size of the mortgage-backed securities market, any problems at Fannie Mae and Freddie Mac would have a ripple effect, Mankiw said.

"This risk is a systemic issue also because the debt obligations of the housing GSEs are widely held by other financial institutions," he said.

When ripple effects are caused by government, people naturally demand government solutions. Naturally, the Democrats benefit. That's because they're perceived as being "better qualified" to spread government miracle oil on the government-troubled waters. It's a classic conflict of interest.

This is not to let the Republicans off the hook. I'm sick of having to vote for people whose promise is essentially that they'll try to make socialism work even though they know philosophically that it does not. Still, they're better than people who not only know socialism doesn't work, but believe that's the whole idea. (Not a bug, but a feature.)

(And I'm glad to see evidence that McCain is taking economics lessons, of the free market variety....)

MORE: Don't miss Arnold Kling's analysis -- "Bailing Out Fannie and Freddie." Here's his conclusion:

The Treasury plan shows that the response to a failure of central planning is likely to be more central planning. Intellectually, those of us who prefer markets have a good case. Politically, we are in the process of getting steamrollered. The Treasury plan is being attached to a housing bill that was rife with corporate welfare and unsound subsidies. It ought to be vetoed, but instead it will be fast-tracked.

As a homeowner and a taxpayer, what you should want to see is a sensible housing finance system, without excessive regulation and without expensive subsidies. Instead, what we are likely to see is much more regulation. To offset the costs of these controls, we also can expect an even more Byzantine structure of government subsidies.


Government creates a need for more government.

posted by Eric on 07.15.08 at 09:24 AM


The reason that nothing works is that the problems that respond to direct solution have long ago been solved.

What's left is problems that respond to direct solutions with perverse side effects, for instance by getting worse.

Unintended consequences have, as a result, an evolutionary advantage over fixes.

Which is why conservatives are mostly right, and liberals mostly wrong.

Ron Hardin   ·  July 15, 2008 5:55 PM

My Econ professor in B-school, back in the mid-90's railed against Freddie Mac and Fanny May for these reasons - moral hazard with taxpayer dollars. He predicted that someday, this would blow up in our faces. Looks like the Clintonite appointees are the agents of doom for these institutions.

Of course, my prof had been in the Reagan Treasury Department.

Whitehall   ·  July 15, 2008 8:24 PM

Sanity is optional.

Beck   ·  July 19, 2008 8:49 PM

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