THE SAPIENT SPARROW: conservatism for commoners

"What has always made the State a hell on earth has been precisely that man has tried to make it his heaven."–Holderlin


Yesterday, Mr. Greenspan testified that, “It was the global proliferation of securitized U.S. subprime mortgages that was the immediate trigger of the current [financial] crisis”.  He went on to say that Congress and U.S. Government Sponsored Agencies (GSEs) were responsible for this proliferation.  Curiously enough, there was no mention of Wall Street—no Goldman, no AIG, no Lehman.  An excerpt from his testimony follows:

“Of far greater importance to the surge in demand, the major U.S. government sponsored enterprises (GSEs), Fannie Mae and Freddie Mac, pressed by the U.S. Department of Housing and Urban Development(1) and the Congress to expand “affordable housing commitments,” chose to meet them in a wholesale fashion by investing heavily in subprime mortgage-backed securities. The firms purchased an estimated 40% of all private-label subprime mortgage securities (almost all adjustable rate), newly purchased,

1 In October 2000, the U.S. Department of Housing and Urban Development (HUD) finalized a rule “significantly increasing the GSEs’ affordable housing goals” for each year 2001 to 2004. In November 2004, the annual housing goals for 2005 and beyond were raised still further. (Office of Policy Development and Research, Issue Brief No. V and others).

and retained on investors’ balance sheets during 2003 and 2004.(2) That was an estimated
five times their share of newly purchased and retained in 2002, implying that a significant
proportion of the increased demand for subprime mortgage backed securities during the
years 2003-2004 was effectively politically mandated, and hence driven by highly inelastic demand. The enormous size of purchases by the GSEs in 2003-2004 was not revealed until Fannie Mae in September 2009 reclassified a large part of its securities portfolio of prime mortgages as subprime.
To purchase these mortgage-backed securities, Fannie and Freddie paid whatever
price was necessary to reach their affordable housing goals. The effect was to preempt
40% of the market upfront, leaving the remaining 60% to fill other domestic and foreign
investor demand. Mortgage yields fell relative to 10-year Treasury notes, exacerbating
the house price rise which, in those years, was driven by interest rates on long-term
In testimony before the Senate Banking Committee in February 2004, the Federal
Reserve expressed concern “about the growth and the scale of the GSEs’ mortgage
portfolios, which concentrate interest rate and prepayment risks at these two institutions.
Unlike many well-capitalized savings and loans and commercial banks, Fannie and
Freddie have chosen not to manage that risk by holding greater capital. Instead, they have
chosen heightened leverage, which raises interest rate risk but enables them to multiply
the profitability of subsidized debt in direct proportion to their degree of leverage.” The
testimony goes on to say that, “[t]hus, GSEs need to be limited in the issuance of GSE

2 FHFA Annual Report to Congress 2008, (Revised) Historical Data Tables 5b Part 2 and 14b Part 2.  (Originally published May 18, 2009, updated to include a significant reclassification effective September 3, 2009.)

debt and in the purchase of assets, both mortgages and nonmortgages, that they hold.” I
still hold to that view.”

Simply put, the massive tentacles of Big Government invaded the private sector with the intent of engineering a “socially just” housing market.

Of course, the housing market is only one private sector that the tumor of Government has, over time, penetrated.  Like a spinal cancer, Big Government has woven itself tightly into the very nervous system of the country.  Reducing it, let alone removing it, will take deft and steady hands relentlessly wielding a honed scalpel.  But as difficult and time-consuming as such an operation is, the alternative, i.e., to allow the tumor to grow, is crippling and, finally, deadly.

Paul Volker is not a huge fan of such an operation.  His solution is to bleed the patient in the hope of shrinking the tumor as a result.  Indeed, we have come to expect such a solution from the Social Democrats presently in power.  The VAT that Mr. Volker mentioned yesterday, (the same VAT that we can expect the Obama Deficit Reduction Panel to recommend), is the leech with which the patient is to be bled.

Fortunately, not all economists subscribe to this magical cure.  They point out that a VAT will further increase the size of Government, while concurrently reducing consumption and more deeply crippling our economy.  These economists agree that the deficit cannot be taxed away.  Instead, spending must be cut.  We in the real world know this is true.  However, we do not trust that Big Government politicians of either party will embrace such an operation.  It is a given that the Social Democrats reject spending cuts.  But, there are certain Republicans who also reject cuts, at least any that are meaningful.  Their message is, “trust us to manage Big Government more effectively”.  These do not want to surgically remove the tumor, they just want to monitor it and possibly excise a bit around its edges.  The patient is well beyond these measures.

Enter Rep. Paul Ryan (R-WI) with his economic “Roadmap”.  It has the potential to shrink Big Government without causing major chaos.  For it to be workable, however, true Conservatives who believe in smaller government must be elected in 2010.  In the interim it is important for Conservatives to educate the voting public about the differences between a “benefit” and an “entitlement” program.  Furthermore, they need to continue to hammer de-funding and/or refusing to fund the newest entitlement program, the ACA, until such time as it can be repealed.  Finally, Conservatives need to communicate not only the content of Ryan’s “Roadmap”, but also why it is superior to the redistribution policies of the Social Democrats.

Malignant tumors are both serious and dangerous.  They strangle life, they paralyze and they kill.  Big Government is a malignant tumor, one that should not be treated with leeching, palliative care and life support equipment.


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