The Investment World and Public Policy
Public policy is determined by elected governmental officials and appointees who are responsible to them. This is the nature of accountability and representative government.
As citizens we are all free to criticize and vote for our favorite choices. One person, one vote.
At "A Dash" we are disturbed by recent commentary that suggests that trading in financial markets should dictate public policy decisions. No one elected the financial managers nor the pundits. Their interests are not necessarily aligned with the overall economy, the housing market, nor (especially) the GSE's — Fannie and Freddie.
The dividing line is clearly stated in this article by Zac Bissonnette at Blogging Stocks. He contrasts the opinions of two people whom we admire, Barney Frank and Warren Buffett. Here is the analysis:
I believe Fannie and Freddie are better off than the market thinks. Over the long term the market is a very rational distributor of resources, but in the short term it can fall prey to hysteria. Sometimes you need to deal with that.
Part of the problem is rumormongering by short-sellers. Our hope is that just by making U.S. financial support available, we'll quiet the fears and eliminate any need for that support.
After a favorable mention of Buffett's viewpoint, he concludes as follows:
We are planning a series of articles in the interaction between financial markets and public policy decisions. At this point we have some observations on the current issue, but it is a work in progress. Comments are welcome.
Having said this, we urge discussants to consider a few facts:
- Many government officials, especially Barney Frank and Hank Paulson are extremely intelligent and able — whether one agrees with them or not.
- Government officials have a different set of considerations and must be accountable to the electorate.
- Government often creates agencies that are quasi-public, in an effort to use free markets to improve performance. These include, with widely varying degrees of success, the TVA, the U.S. Postal Service, Amtrak, the GSE's and many others. Local governments embark on similar initiatives, outsourcing tasks from trash collection to operating tollways.
- The blend of public purpose and private enterprise responsiveness creates a tension for the managers of these enterprises — being profitable without sacrificing public purposes.
- Investors in these enterprises — whether stockholders or bondholders — have done so with the assumption that they are partnering with the government. Breaking this trust undermines future government efforts for such partnerships. It is similar to the moral hazard argument. Do we, as a society, wish to discourage future partnerships?
- Wall Street pundits should be more careful in concluding that those in government are less intelligent or less able than they are themselves. They might consider that other smart people may draw different conclusions from the same set of facts.
With these facts in mind there are certain conclusions that stand out. These conclusions are observations about likely behavior, not opinion about what should be done.
- Government actors wish to preserve and enhance existing institutions. They see these as the best likely solution to public problems — especially in housing. Crushing existing partners, whether they be shareholders or bondholders, is not their idea of a solution.
- The Bush Administration does not want the nationalization of the mortgage market as part of its legacy.
- McCain does not want a perceived government takeover of Fannie and Freddie as an election issue.
- Democrats want to be seen as doing something positive for housing, which means expanding Fannie and Freddie capabilities.
- Everyone in government would prefer a solution that did not require a government takeover of GSE's.
- Wall Street pundits have — just recently — started judging GSE's according to private bank rules — capital ratios, FAS 157, and the like. To government types, this is like changing the rules of football scoring in the middle of the game — field goals count for 2 and touchdowns for 9.
- The pervasive Street commentary has served to reduce financing options. There is a drumbeat of opinion that more capital is needed, even when official rules say that it is not. The relentless selling of FNM and FRE has restricted the ability to raise new capital in private markets.
- The Street consensus is that common stock in GSE's must go to zero and management must be fired. This is inconsistent with the public purpose perceived by government leaders.
- Dissident leakers in government have aided in the Street perspective.
What has happened is that Wall Street, unelected and unaccountable, has voted on the nature of Treasury policy regarding Fannie and Freddie. The actual government officials do not agree. News accounts show that Freddie is exploring options with widely differing effects on current shareholders.
Will Wall Street opinion force the final decision? We doubt it, but no one can know. We suspect that the specific solution recommended by Jim Cramer and others will not gain acceptance. If Cramer is right, the market is in for tough sledding for the next few months.
The alternative viewpoint is that Paulson will find a way to infuse lending and enhance the GSE's as players in mortgage markets. It is a challenge. If he succeeds, he will win high marks from economic historians.
Those studying public policy will ask questions about the role of markets in shaping public policy. There are other recent examples for this interesting topic.
[No position in FNM or FRE.]