Fannie Meltdown?

The Wall Street Journal has a short report today on the testimony by former Fannie and Freddie executives, as well as their government regulators, in front of the Congressionally-mandated Financial Crisis Inquiry Commission – most recently, the Commission heard from Greenspan and the central bankers.

A Congressional panel heard clashing views about what caused the failure of Fannie Mae on Friday, one that blamed the “impossible” balancing act of the company’s competing missions, while a former regulator blamed management failures.

“I sought to balance the fine points of mission and business insofar as I could understand them,” said ex-Fannie Chief Executive Daniel Mudd before a panel investigating the financial crisis. By September 2008, when the government took over Fannie and its smaller rival, Freddie Mac, as mounting losses threatened to wipe out thin capital reserves, “that was no longer possible…and I am sorry for that,” he said.

But Armando Falcon, the former head of the company’s federal regulator, said the collapse of the companies “was clearly a failure of management” and reflected a “deeply rooted…culture of arrogance and greed.”

Mr. Falcon asked how a business “with the most generous government subsidies possible” could be run “into the ground.”

For fifteen years now, I’ve worked out in the gym in the basement of the Fannie Mae foundation, next door to the main Fannie Mae headquarters.  I’ve had many conversations with Fannie Mae executives and analysts and risk managers and lots of other professionals there, in the locker room and on the gym floor.  My take is pretty simple.  The model is one of classic crony-political capitalism, as everyone has noted for years, in which shareholders and managers and directors internalized gains in the short to medium term, and externalized losses in the catastrophic long term.  Okay, everyone knows that, even presumably Fannie and Freddie’s Political Enabler in Chief, Barney “Roll the Dice Some More” Frank, whose presence at the table of rewriting financial regulation without a backward glance at his own behavior is proof positive of why public choice theory will never go out of relevance.

More interesting, though, is the form of self-deception that permeated the executives I would chat with in the gym.  They seemed to have completely and utterly sincerely internalized a version of bait and switch – one, I’d suggest, that turns out to be at the heart of much of crony capitalism when conducted in a moralizing, but indulgent, society like that of the US (rather than say, Carlos Slim in Mexico).  It’s bait and switch between doing good and doing well.  When you’re doing good, you’re also entitled to do well.  When you’re doing well, it’s because you’re doing good.  Worse, when you’re not doing well, you console yourself (and those taking the losses on your behalf) that you’re still doing good.  And if you’re doing well, but not doing good, there is a powerful assumption that if you’re making money, all must be good too.  Mixed motives, especially when they are motives that in ordinary life are not all that well aligned, create powerful perceptual distortions:

The hearing brought forward a paradox: For years, Fannie fended off efforts to restrict its growth by arguing that it had the best risk-management tools and brightest minds. But on Friday, executives said that their business model doomed their ability to manage a national and sustained housing meltdown.

At first glance, this attempt to have it all – no contradiction between doing good and doing well!  Hooray!  We live in a non-tragic world where you can have your cake and eat it, too! – would seem to violate the first principle of Mankiw’s 10 principles of economics for children:  tradeoffs and no free lunch.  But in a society that holds to some public ideal that says that naked crony capitalism is still not okay – where some fig leaf covering self-dealing from the public fisc is still needed – this form of self deception is still crucial, as a matter of affect.  (As someone told me in the gym a couple of months ago, they didn’t screw up – their regulators did, by not stopping them from fulfilling their misaligned incentives.)