Bill Emmott - International Author & Adviser

Article

Good News - America Chooses Well By Nationalisation
Corriere della Sera - September 10th 2008

The nationalisation by the American government of two huge mortgage-lenders, known as Fannie Mae and Freddie Mac, is a piece of unequivocally good news, a ray of sunshine through dark economic clouds. The reason why it is good news, both for America and for the European economies, has little to do with the technicalities of the government takeover, or of the mortgage market. The reason it is good news is because it suggests that America is not going to copy Japan.

            Japan is the only other big industrial economy that, since 1945, has faced the bursting of a financial bubble, of prolonged deflation and of a collapse of the whole banking system. As a result of the financial crisis it essentially stagnated for a whole decade, since when its economy has recovered but only weakly. Since America accounts for more than 25% of world GDP, and since European banks and pension funds are heavily connected with American financial markets, it is vital for us all that America should not repeat the Japanese experience.

            Or, rather, that it should not repeat the Japanese mistakes. The first Japanese mistake was to be timid in cutting interest rates once the crisis began. America’s Federal Reserve has already shown that it has learnt that lesson by slashing its official interest rates during the autumn of 2007 and early in 2008. The second mistake, however, was that the Japanese finance ministry and Japanese banks tried to hide the true magnitude of their losses and of the bad debts the banks were accumulating, in the belief that admission would cause panic and that it would be possible for the economy to grow its way out of trouble. Instead, this just prolonged and deepened the agony by spreading mistrust and rumours throughout the financial system.

            It was only in 1997-99, a full seven years after Japan’s financial crisis began, that the Japanese government showed that it really recognised the size of the problem and the need for a solution, by nationalising three big banks and by using vast amounts of public money to recapitalise the other banks. The good news of America’s nationalisation of Fannie Mae and Freddie Mac is that this recognition of the size of the financial problem and the true weakness of the housing market has happened only 13 months after the crisis began.

            For sure, this is good news that reflects bad trends. These two companies, which were set up by the government in 1938 and 1970 respectively but then placed with private shareholders, provide guarantees or direct finance for about half of all America’s residential mortgages, worth about $5 trillion. They are only allowed to finance or guarantee good quality mortgages, so they were not involved with the subprime, low quality business where this crisis began. But the continued decline in house prices has raised the default rate even on good quality mortgages, creating big losses for Fannie Mae and Freddie Mac and deterring investors from providing them with new funds.

            Without a government rescue, the supply of funds for the mortgage market was bound to decline, forcing prices lower and adding to everyone’s losses. This nationalisation should stop that downward spiral, though only through the injection of a lot of taxpayers’ money into the rescued firms: perhaps $100 billion, but conceivably as much as $500 billion. The rescue will therefore add to America’s budget deficit, though at 2.4% of GDP the deficit is not currently all that large. It is bound, however, to get larger during the next year or two as the new president will inevitably want to provide some sort of fiscal stimulus, and there may be further bank rescues to come.

            So this good news does not mean that the bad news is over. America could still sink into a recession. But it means that the American government is acknowledging the true state of the financial system and is willing to act, decisively, when necessary to prevent difficult times turning into disastrous ones. That is extremely reassuring.


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