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Can you summarize this article and wrtite down some important points regarding GDP?
NEW YORK â Striving to revive the world economy while simultaneously responding to the global climate crisis has raised a knotty question: are statistics giving us the right âsignalsâ about what to do? In our performance-oriented world, measurement issues have taken on increased importance: what we measure affects what we do. If we have poor measures, what we strive to do (say, increase GDP) may actually contribute to a worsening of living standards. We may also be confronted with false choices, seeing trade-offs between output and environmental protection that donât exist. By contrast, a better measure of economic performance might show that steps taken to improve the environment are good for the economy. Eighteen months ago, French President Nicolas Sarkozy established an international Commission on the Measurement of Economic Performance and Social Progress, owing to his dissatisfaction â and that of many others â with the current state of statistical information about the economy and society. On September 14, the Commission will issue its long-awaited report. The big question concerns whether GDP provides a good measure of living standards. In many cases, GDP statistics seem to suggest that the economy is doing far better than most citizensâ own perceptions. Moreover, the focus on GDP creates conflicts: political leaders are told to maximize it, but citizens also demand that attention be paid to enhancing security, reducing air, water, and noise pollution, and so forth â all of which might lower GDP growth. The fact that GDP may be a poor measure of well-being, or even of market activity, has, of course, long been recognized. But changes in society and the economy may have heightened the problems, at the same time that advances in economics and statistical techniques may have provided opportunities to improve our metrics. For example, while GDP is supposed to measure the value of output of goods and services, in one key sector â government â we typically have no way of doing it, so we often measure the output simply by the inputs. If government spends more â even if inefficiently â output goes up. In the last 60 years, the share of government output in GDP has increased from 21.4% to 38.6% in the US, from 27.6% to 52.7% in France, from 34.2% to 47.6% in the United Kingdom, and from 30.4% to 44.0% in Germany. So what was a relatively minor problem has now become a major one. Likewise, quality improvements â say, better cars rather than just more cars â account for much of the increase in GDP nowadays. But assessing quality improvements is difficult. Health care exemplifies this problem: much of medicine is publicly provided, and much of the advances are in quality. The same problems in making comparisons over time apply to comparisons across countries. The United States spends more on health care than any other country (both per capita and as a percentage of income), but gets poorer outcomes. Part of the difference between GDP per capita in the US and some European countries may thus be a result of the way we measure things. Another marked change in most societies is an increase in inequality. This means that there is increasing disparity between average (mean) income and the median income (that of the âtypicalâ person, whose income lies in the middle of the distribution of all incomes). If a few bankers get much richer, average income can go up, even as most individualsâ incomes are declining. So GDP per capita statistics may not reflect what is happening to most citizens. We use market prices to value goods and services. But now, even those with the most faith in markets question reliance on market prices, as they argue against mark-to-market valuations. The pre-crisis profits of banks â onethird of all corporate profits â appear to have been a mirage. This realization casts a new light not only on our measures of performance, but also on the inferences we make. Before the crisis, when US growth (using standard GDP measures) seemed so much stronger than that of Europe, many Europeans argued that Europe should adopt US-style capitalism. Of course, anyone who wanted to could have seen American householdsâ growing indebtedness, which would have gone a long way toward correcting the false impression of success given by the GDP statistic. Recent methodological advances have enabled us to assess better what contributes to citizensâ sense of well-being, and to gather the data needed to make such assessments on a regular basis. These studies, for instance, verify and quantify what should be obvious: the loss of a job has a greater impact than can be accounted for just by the loss of income. They also demonstrate the importance of social connectedness. Any good measure of how well we are doing must also take account of sustainability. Just as a firm needs to measure the depreciation of its capital, so, too, our national accounts need to reflect the depletion of natural resources and the degradation of our environment. Statistical frameworks are intended to summarize what is going on in our complex society in a few easily interpretable numbers. It should have been obvious that one couldnât reduce everything to a single number, GDP. The report by the Commission on the Measurement of Economic Performance and Social Progress will, one hopes, lead to a better understanding of the uses, and abuses, of that statistic. GDP Fetishism - Project Syndicate 2/8/10 4:05 PM http://www.project-syndicate.org/commentary/stiglitz116/English Page 2 of 3 The report should also provide guidance for creating a broader set of indicators that more accurately capture both well-being and sustainability; and it should provide impetus for improving the ability of GDP and related statistics to assess the performance of the economy and society. Such reforms will help us direct our efforts (and resources) in ways that lead to improvement in both. Copyright: Project Syndicate, 2009. www.project-syndicate.org Reprinting material from this website without written consent from Project Syndicate is a violation of international copyright law. To secure permission, please contact [email protected]. tvselvakumaran 05:30 30 Sep 09 The official consensus Professor Martin Feldstein's latest article, "The G-20's Empty Promises" on Project Syndicate needs careful consideration. In his article, Professor Feldstein essentially adopts the "official consensus" of the economics profession on the current economic crisis. This official consensus, in its various mainfestations, has also been elaborated on by other famous economists, notably Professor Robert Lucas in his article in the Economist in early August, and by Professor Paul Krugman in his recent article in the New York Times Magazine. One characterizing feature of this official consensus is a confidence (a.k.a. triumphalism) in the certainty of outcomes predicted by modern economic theory. The main precepts of this official consensus are (i) Professor Ben Bernanke, the Chairman of the Board of Governors of the Federal Reserve, has at his disposal all the theoretical tools of economics that are necessary and sufficient to deal with the current economic crisis. As Professor Lucas explains it in his Economist article, if one were able to predict in advance exactly when a market crash would occur, it would imply that the market entertains arbritrage opportunities. Hence, it is not possible to predict financial crises in advance. However, except for the precise timing of the occurrence of financial crises, macroeconomic theory could explain the workings of the economy completely. In particular, to avert the recurrence of the Great Depression, certain actions were needed to be taken by the Fed -- the specifics of these actions were all clearly understood by the economics profession. However, it was politically untenable to take these actions before there was a financial crisis. Once the financial crisis occurred though, Professor Bernanke could intervene in the markets and take the necessary actions (in the Fall of 2008). These actions include the injection of several trillion dollars into the economy and making the availability of credit the cheapest possible. The actions taken by the Fed have now resulted in the economy avoiding a recurrence of the Great Depression. This is, in brief, what Professor Lucas has stated in his Economist article. (ii) Thus in Professor Lucas' interpretation of things, the collapse of Lehman Brothers, for example, was necessary, in order to justify the intervention of the Federal Reserve in the functioning of the markets. The collapse of Lehman Brothers was, although regrettable, an unavoidable event. But, on the whole, monetary policy, even if it is a profligate one, would be necessary and sufficient to prevent the recurrence of the Great Depression, in Professor Lucas' view. Furthermore, the old wisdom of the Chicago School that government should be kept minimal at all times continues to hold, even in light of the current economic crisis. The Keynesians led by Professor Krugman, on the other hand, believe that Lehman Brothers should never have been allowed to fail. In their view, when the Fed's fund rate is at zero, monetary policy is largely ineffective for sustaining and stimulating economic activity. This is because of liquidity traps caused by businessmen who don't see economic opportunities that would induce them to borrow the cheap money available from the banks. Hence the government should step in to provide massive fiscal assistance to the economy by taking on spending directly, even if it means assuming trillions of dollars of public debt. (iii) Professor Krugman scored a lot of points by pointing out that the current state of economic theory, highly influenced as it is by the efficient market hypothesis of the Chicago School, indicated that a crisis of such magnitude as the current economic crisis could not happen at all. This fundamental failure to recognize that an enormous crisis could indeed happen, calls for the overthrow of the policy that markets provide the best social gain when they are completely free from government interference. From first impressions, it might seem that the views of the monetarists and Keynesians are vastly different. However, it is important to note that in the view of the Keynesians too, once large scale government spending as prescribed by the Keynesians is instituted, there is again enough assurance that modern economic theory (although with a heavy Keynesian tilt) would be sufficient to deal with the current economic crisis. (iv) In this regard, perhaps it is relevant to refer here to Professor Robert Shiller's latest article, "Re-inventing Economics" on Project Syndicate. Professor Shiller points out that the free market ideology fails to identify bubbles. Because of the belief that markets know best on all occasions, bubbles cannot occur according to the free market ideology. Professor Shiller's approach pursues a different branch of the Keynesian school of thought than the big spenders. Rather than advocate large government spending to avert a depression, Professor Shiller proposes using techniques from behavioral psychology to predict bubbles in advance. In this way, the socially harmful effects of massive misallocations of capital that arose in the case of the housing bubble or the tech bubble could be prevented in the future. In his other recent article, "Echo Chamber of Boom and Bust" in the New York Times, Professor Shiller elaborates further on the techniques that one could use for studying bubbles. Briefly, the process by which confidence or panic spreads in markets is very similar to the process by which diseases spread among populations. This outlook allows for introducing methods that scientists use to study epidemics into the study of bubbles. (v) The Keynesians have also managed to re-write the conventional wisdom on the advantages of a strong dollar. Through the works of Professors Barry Eichengreen, Jeffrey Sachs and Ben Bernnake, a consensus has developed that attempting to support the gold standard was a major cause for the prolongation of the Great Depression. This has resulted in a viewpoint among economists that a devaluation of the dollar at present would help to reduce global imbalances by restoring the American manufacturing industry. The implications of this viewpoint were analyzed by Professor Feldstein in his July 2009 article "America's Saving Rate and the Dollar's Future" on Project Syndicate, with the conclusion that devaluation of the dollar would necessarily lead to a better future for GDP Fetishism - Project Syndicate 2/8/10 4:05 PM http://www.project-syndicate.org/commentary/stiglitz116/English Page 3 of 3 America. Lost in this new interpretation is the fact that a stable dollar provides many economic benefits for America. The equity premium for American companies taking more risks globally, the transaction charges for providing market making facilities in global markets, and the provisions of liquidity for the currency of international trade are major drivers of economic growth for America, which derive from the dollar being the global reserve currency. (vi) Some other Keynesians have gone beyond questioning just the free market ideology. For example, in his latest article, "GDP Fetishism" on Project Syndicate, Professor Joseph Stiglitz proposes a broad set of economic indicators like health, well-being and sustainability rather than a narrow focus on GDP growth. Yet other developments imply that the rest of the world is steadily moving away from using the dollar as the main reserve currency. To finance this new global reserve system, the IMF has created $250 billion worth of Special Drawing Rights (SDR), and the IMF has indicated its intention to triple this allocation of $250 billion in the future. It would need a strong commitment from the policy-makers in America to re-claim for the dollar its position as the predominant global reserve currency. However, judging from the writings of American economists like Professor Feldstein, it appears that the consensus among professional economists favors devaluing the dollar instead. (vii) The official consensus is a result of a grand compromise between the Chicago School economists and the Keynesians.The conservative economists of the Chicago School would like to avoid the embarassment of getting publicly criticized for the failures of the efficient market hypothesis that this current economics crisis has severely exposed. So famous conservative economists like Professor Lucas have reached out for a consensus by indicating their willingness for a compromise. This compromise involves among other things, (a) foregoing raising concerns about the government's mismanagement of Fanie Mae and Freddie Mac, and (b) lending support to the Fed and the Treasury in their efforts to stabilize the economy, even if the methods that the Fed and the Treasury employ are highly inefficient. What are the Keynesians compromising on? Well, the Western liberal tradition has been intellectually bankrupt ever since the late 1960s. It is only the free market ideology of the Chicago School that has served as the driver of wealth creation in the advanced countries during the last four decades. Hence, the official consensus is a convenient compromise for the Keynesians to avoid asking difficult questions about the future of the Western liberal tradition. Instead, they would like to enact much drama in the media about the resurrection of their hero, John Maynard Keynes. (viii) One other characterizing feature of the official consensus in the economics profession is a collective tendency to "Blame It All On Obama". The conservative economists blame President Obama for not focusing adequately on America's ballooning national debt. The liberals, led by Professor Krugman, fault President Obama for getting distracted from the left's free spending ways by concerns on the size of the fiscal deficit. In the confusion that has ensued, President Obama's own team of economics advisors has fallen back on the official consensus in the economics profession. Availing themselves of the security provided by this official consensus, President Obama's economics team has misled the President thoroughly in economic matters. To begin with, the President is only empowered to administer the nation's affairs for a four year term. The projections put out by the Congressional Budget Office (CBO) for the deficits in the next decade are only a non-authoritative guidance for where the nation's finances would be, if current policies hold for the next decade. Instead, the democrats have been behaving as if the $9 trillion of additional public debt that the CBO projects for the next decade is already a given certainty. In particular, they have not been careful to mention clearly in public discussions how much of this extra spending can be attributed to the President's own spending plans in his current four-year term. Neither have they shown any concerns for taking the Fed and the Treasury to taks for their highly inefficient methods to stabilize the economy. Because of these instances of neglect, the public is not willing to trust the government in financial matters. President Obama has rapidly lost his approval ratings. Professor Lawrence Summers, Professor Christina Romer, Professor Austan Goolsbee and Professor Peter Orszag are directly responsible for this abuse of public trust. (ix) The official consensus has also prevented economists from recognizing that President Obama's universal message of tolerance and justice, which has been received very favorably all around the world, actually opens up vast areas of economic opportunity for America. Unfortunately, it does not matter, for the economists, whether George W. Bush or Barack Obama is in office. The most they can do is re-work their models to favor Keynesian policies, and to argue that the policies they propose arise directly from their number-crunching methods. One might be tempted to attribute this widespread consensus among economists to stick to a narrow theoretical interpretation of the current economic crisis, to the certainty afforded by the mathematical models, which have become indispensible through the course of the 20th century, for the development of economic theory. However, this would be a big mistake. The official consensus in the economics profession is primarily a result of undue influences of power and money. It is much less a result of mathematically based economic theory. In the longterm, this attitude among economists of sticking to an official consensus is going to do serious damage to the American economy. Some other aspects of the official consensus have been explained very well by Professor Kenneth Rogoff in his recent article, "The Confidence Game" on Project Syndicate. I recommend that the reader go through that article. The official consensus is the single largest threat to a robust recovery in the global economy. The official consensus also gravely misinterprets the events of the Great Depression. The implications of this misinterpretation bear directly on the economic health of America.
Economist claim that terrorist attacks can be viewed as another type of trade barrier. Do you agree? Why?
After reading The African Business Journal article about Boko Haram in, "Boko Haram and its impact on the Nigerian Economy." Do you think this terrorist organization and it's action in Nigeria is having an impact on Nigeria's import/export industry (trade)?
If so, what type of affect do you think the terror group has on Nigeria's import/export business?
Boko Haram and its Impact on the Nigerian
Economy
By Angus Gillespie
Despite emerging from the murky shadows within Nigeria just a dozen years ago,
Boko Haram has quickly earned itself an infamous reputation for being one of the
most callous and violent radical Islamist groups in African history. In fact, itâs
already been tagged a terrorist group by western countries such as the United
States. Over the past 12 to 15 months, Boko Haram has unleashed a massive
wave of violence, fear and chaos throughout the northern African country â so
much so, that itâs know seen by many as having a noticeable impact on the way
the country operates, and by extension, is hindering its economic well being to a
widening degree.
Founded in 2002, Boko Haram is an ultra extremist Islamic cult focusing primarily
on the edict that Western education is forbidden. Military operations were
launched in 2009 to support their cause in creating an independent Islamic state.
It also has roots that can be traced to the northern part of Cameroon and parts of
Niger. The Boko Haram leadership has international connections to Al-Qaeda.
Suspected Boko Haram militants have killed dozens of Nigerians in recent weeks
and there is no sign of the violence abating. In one attack, gunmen disguised as
soldiers fired on a crowd in a church compound. The radical sect is known for
attacking churches, schools, and police stations. Tourists are also considered fair
game. Violence linked to the Boko Haram insurgency has resulted in an
estimated 12,000 killings since 2002, although that figure has gone up
considerably since 2009 when the group began to heavily arm itself as a militia.
Making matters worse for the Nigerian government of Goodluck Jonathan is that
some of the attacks come amidst reports some army generals have been aiding
the rebel militants, on the belief that a national coup is going to take place.
Nigerian media sources have reported that as many as 10 generals and five
other senior military officers have already been tried before the courts for
supplying arms and information to Boko Haram. However, at least one Nigerian
military spokesman called the reports âfalsehoodsâ.
This contradicted Interior Minister Abba Moro said it was âgood newsâ that the
army had identified soldiers who were undermining the fight against the
insurgents, and that it sent a strong message to other serving officers.
Boko Haram has waged an increasingly bloody insurgency since 2009 in an
attempt to create an Islamic state in Nigeria.
One small town that has been hard hit by the violence is Attagara, where the
village church came under attack leaving at least 20 people dead.
Nigeriaâs government has been facing mounting pressure both at home and
abroad to do more to tackle the group and bring about the release of more than
300 schoolgirls kidnapped by the group on April 15.
President Jonathan originally declared a state of emergency in May of last year in
the three northern states where Boko Haram is, and has been, most active â
Borno, Adamawa and Yobe.
Boko Haram retaliated by stepping up its bombing campaign in cities and
launching mass attacks on small towns and villages.
Media correspondents in those regions say that since the infamous kidnapping of
more than 300 schoolgirls, the attacks have become an almost daily occurrence.
The campaign to free the girls that began in their home village has now gone
global, with the U.S., Canadian and British governments offering support to help
with the rescue. Itâs believed about 55 girls have managed to escape their
captors since being taken hostage in April. The government has ruled out
swapping the girls for detained insurgents associated with Boko Haram.
President Jonathan has promised to address the poverty that helps fuel the
uprising â but only once the insurgency is put down. The World Bank says twothirds
of 170 million Nigerians struggle in poverty in Africaâs biggest oil producer.
Despite the fact there is so much poverty and lack of widespread education,
Nigeria remains Africaâs largest economy â thanks in large part to the massive oil
reserves that are often exploited by international corporations. That said, to put
things into perspective, only about 3% of the worldâs oil supply is found in the
country. More recent successful business sectors have included the likes of
banking, telecommunications and a burgeoning film industry. Agriculture and
services have also been two traditional economic staples for the country,
although neither has shown much in the way of expansion over the past 10 to 20
years. To its credit, the country has also been diversifying the core economic
drivers away from energy and agriculture. The nationâs GDP is now $490 billion,
just shy of the economies of countries like Norway and Sweden.
When an organization managed to get the president of the country to declare a
state of emergency, it stands to reason it has the ability to unwieldy a
tremendous amount of damage on the country, be it through violence or
economic crippling.
Economic Impact
Since Boko Haram emerged from the shadows about four years ago, once armed
militarily, one of the first obvious economic concerns was the almost immediate
drop in foreign direct investment (FDI), with the concern being whether the
government had the wherewithal to deal with the serious insurrection and stave
off the many decades of political instability the country has faced. According to
the World Investment Report (WIR) 2013, FDI flows into Nigeria dropped by 21%
in just one year â from $8.9 billion in 2011 to $7 billion in 2012. The loss of $1.9
billion for a country in desperate need of money â such as Nigeria â was a
staggering blow.
The monumental decline in FDI over such a short period of time sent ripple
effects throughout the international community, creating a negative domino
effect. Itâs a rock heading downhill that continues to gain momentum, and it will
be up to Jonathan and his government not only to slow it down, but to stop it
altogether, or it will begin all over again.
FDI into Nigeria has a direct impact on trade, while also ensuring progression of
economic development to the south. FDI inflow also supplements the available
domestic capital by stimulating the productivity of domestic investments.
Someone troublesome is the high codependency ratio between the inflow of FDI,
the Nigerian oil sector, and the countryâs GDP.
A scientific study found that a unit increase in FDI into the Nigerian oil sector will
increase the countryâs GDP by approximately 16 units. This shows that the
Nigerian oil and gas sector, which is the mainstay of the economy, has a high
rate of exposure to foreign direct investment.
Between the lack of jobs, and the increasing violence with the likes of terrorist
groups such as Boko Harm, there has been a mass movement of Nigerian
citizens looking to settle in areas not impacted by the violence. The trouble is
this: the areas not affected by the violence are most often areas that have
nothing in terms of sustainable economic activity that would allow a person or a
family to survive. Living in the dangerous regions is where thereâs hope for
employment.
The rush to escape from the northern part of the country that has been hard hit is
already affecting the profitability of businesses in the region. Itâs no reached the
point where accredited banks have begun closing down some branches due to a
huge decrease of economic activity. On top of that, a number of employees at
these businesses are demanding to be reassigned to areas that are less volatile.
As noted many times before, a lot of the current problems with terrorist uprisings
can easily be pinpointed to a lack of government leadership due to the constant
political insecurity, and especially so in the northern region.
Once the banks and other businesses decide to pack up and move elsewhere, it
leaves the region in a state of economic depletion, and one that wonât easily be
regained. Itâs always quicker destroying something than it is building it up. The
people of Nigeria are hoping President Jonathanâs government takes drastic
action to bring about more stability in the country and soon. Or, it will be a long
road to recovery for a nation that can already ill afford this type of economic
setback.
More than $21 billion of foreign direct investment poured into Nigeria in 2013, up
28% from the year before. The country does not want to see that slide backwards
due to political instability and the onset of widespread violence. The country has
attracted the most foreign direct investment in sub-Saharan Africa since 2007,
according to Ernst & Young. But all of that could be quickly eroded if the violence
is not snuffed out.
Many financial analysts seem to be of the opinion that the impact on foreign
investment will largely be determined by geography. As example, investors may
pull out funding from manufacturing and infrastructure investments in northern
Nigeria, which has been ravaged by violence. But the resource rich southern
region has been spared from violence to this point. This could be one of the
factors as to why Nigeriaâs stock market has been seemingly unaffected by all the
recent turmoil. The benchmark equity index has only declined about 1% since the
kidnappings in mid April; so for all intents and purposes, it has been business as
usual.
So just how bad is it in Nigeria? It is perhaps best summed up in a balanced
report by an analyst with Ernst & Young.
âNigeria epitomizes this almost bipolar view of Africa,â says Henry Egbiki, West
Africa regional leader at Ernst & Young. âFor many of us already doing business
on the continent it is an exciting, dynamic, high octane growth market; for some
others, often on the outside looking in, it seems chaotic, unstable, and uncertain.
The reality is obviously less cut and dried than either of these extremes.â
The next 12 to 18 months will be critical for the government and how it responds
to the upswing in violent outbreaks by radical groups such as Boko
Haram. Humanitarian groups and countries will be looking on from a human
rights point of view, but you can also bet that the international investment
community will be keeping a close watch as well.
Let's change it up a little. You may have to dig a little for this one. Fannie Mae and Freddie Mac are two banking giants that have been in news because of their role in the 2008 financial crisis. Due to this many in the government believe that the two companies should be put out of business. On the other hand, there are many who believe the companies should remain as they are. See The Case For Keeping Fannie and Freddie Alive. The argument both ways is in a sales pitch for the two contrary opinions. how would you convince someone either way on the issue of Fannie and Freddie? A reference is required to support your post
On just one major piece of economic policy, President Obama and House Republicans share the same basic opinion: kill off government-backed mortgage giants Fannie Mae and Freddie Mac.
This rare bit of consensus might also prove to be a devastating mistake.
Fannie and Freddie which guarantee mortgages were placed under federal conservatorship in 2008 as the housing bust reached its apex. The firms are roughly within $42 billion of repaying the $187.5 billion they received from taxpayers, but Obama and much of Congress plan to wind them down in the belief that another federal bailout will never again be necessary.
We can't leave taxpayers on the hook for irresponsibility or bad decisions by some of these lenders or Fannie Mae or Freddie Mac, Obama said in a speech this month. We've got to encourage the pursuit of profit, but the era of expecting a bailout after you pursue your profit and you don't manage your risk well, that puts the whole country at risk. And we're ending those days. We're not going to do that anymore.
But the political debate has been lopsided thus far focused on putting Fannie and Freddie into the grave, while largely ignoring what their demise could mean for homebuyers and the economy a sharp jump in interest rates, and a drop in the availability of mortgages.
Senate Majority Leader Harry Reid (D-NV) has objected to plans to end both companies.
These are the government organizations that have made homeownership so easy, Reid recently told Nevada Public Radio. I don't agree with the president. He says he wants to get rid of them. I'm going to look closely at his recommendations because on their face, I don't like them.
Mostly, economists and investors are framing the issue in the same way as Reid.
It boils down to a tradeoff between shifting risk away from the government and taxpayers, versus keeping mortgages inexpensive and widely available, said Jed Kolko, the chief economist at the real estate firm Trulia. When push comes to shove, it's hard to do both.
Their executives received outlandish bonuses during the boom, only to foist the eventual losses caused by years of mismanagement onto the public. It rightfully enables sucker punches from Capitol Hill that voters approve of, even though the rescue kept the entire housing sector alive. Of the $1.75 trillion worth of mortgages originated last year, about 90 percent were made through the federal government.
This point matters because Fannie and Freddie ensure that the housing market does not seize up during a recession, said Ken Fears, an economist for the National Association of Realtors. Even if more private capital is needed in the mortgage industry, having the government participation creates liquidity that keeps the entire sector operating during tough economic times, Fears said.
Lawmakers tend to assume that the markets can transition over five or 10 years to a mortgage industry with a modest government backstop, or no taxpayer support at all. Before retiring at the end of May as a managing director for bond investor PIMCO, Scott Simon said that this amounted to a fantasy.
The private market can make mortgages, but they would trade at much higher yields and the down payments would be much higher because the private market cannot make competitive, fixed-rate mortgages with 20% or less of a down payment on the loans, Simon told National Mortgage News. Most of the people who think we should shut [the GSEs] down have a pure philosophical belief and they don't care what the outcome is. Or they simply don't understand anything about how housing finance works.
Fannie and Freddie help the economy with their guarantees, Simon reasoned but exposed taxpayers to their risks by having their own investment portfolios.
As of now, all profits from both companies go to the Treasury Department, per changes made last year to the terms of the conservatorship. In the original terms, Treasury received a 10 percent dividend from Fannie and Freddie. But Fannie and Freddie are now required to fork over all of their earnings forever to Treasury, a windfall that suddenly reduced the budget deficit.
A group of investors led by the hedge fund Perry Capital challenged this arrangement in a U.S. District Court lawsuit filed last month, claiming that they deserve a share of the proceeds after taxpayers have been repaid.
Because Fannie and Freddie are now generating cash, it would in theory be possible for the government to use these profits to create a capital cushion that prevents the need for a future taxpayer bailout.
By keeping the two companies under government control, taxpayers would benefit from the sale of about $200 billion worth of equity, investors in Fannie, Freddie, and other real estate assets explained in the background. The profits would be enough to create a capital cushion to insulate against a future downturn, without having to seek capital in the private market that could push mortgage interest rates higher.
But this requires Obama and GOP lawmakers to save Fannie and Freddie, precisely what they have vowed not to do. Obama wants a government insurance fund to replace them, while Republican congressmen favor an end to any Washington involvement with guarantees.
House Financial Services Committee Chairman Jeb Hensarling (R-TX) would eliminate almost all federal involvement in the mortgage market. His policy assumes that the rusty tin standard of 30-year, fixed-rate mortgages would soon fade away, as more homebuyers would settle for variable-rate mortgages. Interest rates on a 30-year, fixed mortgage currently average 4.4 percent, a figure that could instead swing violently over time depending on inflation and the Federal Reserve. When the Fed attempted to tamp down inflation between 1980 and 1982, rates soared above 16 percent with the government backstop in place.
Obama would like to preserve the 30-year, fixed-rate mortgage. He has endorsed adopting a more limited government backstop as outlined in a bipartisan Senate bill co-sponsored by Tennessee Republican Bob Corker and Virginia Democrat Mark Warner.
The Corker-Warner bill would also unwind Fannie and Freddie, bringing their dominance to an end. In their place would be private financial institutions that would pay into a government insurance fund. Mark Zandi, the chief economist for Moody's Analytics, estimated that the plan would cause mortgage rates to increase by as much as 1.25 percent in the near-term. This estimate assumes a 20 percent down payment and a credit score of 750, slightly above the current U.S. average.
But of course, lawmakers have not discussed the potential tradeoffs in the early stages of mortgage reform. Unless voters have a clearer picture of the consequences, some say it could produce the same kind of boondoggle caused by Obamacare in 2010.
I don't think there has been much of a sales job to the public on what a new mortgage finance system looks like, said Brian Gardner, senior vice president of Washington research at the investment bank Keefe, Bruyette & Woods. I don't think you shove this down the throat of the electorate, as we saw with the health care overhaul.
