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GM Joins Fannie and Freddie

The opportunity to pursue private profits backstopped by an implicit government guarantee is an invitation to take on excessive risk.

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However, it is difficult to argue that Americans are undersupplied in cars. Right now, there are almost two people for every passenger car in the U.S. In order to steadily expand automobile ownership, new credit must reach borrowers of lower and lower quality. That is, instead of simply providing a counter-cyclical buffer in the business cycle, the government’s interventions may work to deepen structural problems of loose credit that generate unsustainable patterns of demand. That, in turn, raises the chances that a future GM will have to be bailed out. The cost structure of GM requires a level of new car sales that can only be sustained through questionable lending practices.  Rather than shed fixed costs and radically downsize the company into a smaller, profitable manufacturer, the government’s strategy seems to be winning back market share and boosting final sales through aggressive discounting and the easing of credit standards.  GM’s second quarter earnings of $1.3 billion are a reflection of this strategy.  Edmunds notes that the average discount to sticker price on GM car sales in the second quarter was 15.7 percent.  This was 15 percent greater (2 percentage points) than the industry average final sale discount.  Incentives to buyers averaged $3,691 per GM car, which is 38 percent more than the $2,762 average per car incentive provided by the rest of the industry. 

One of the lessons from the recent crisis is that the U.S. had far too much consumption generally, and far too much of its income devoted (on a relative basis) to the specific consumption of housing and cars. As everyone knows, a big part of the problem was that it was just too easy for consumers to obtain financing for these products. With households still struggling to keep up with old debt obligations, a rational public policy would acknowledge that consumers are likely to want fewer new houses and cars in the future. Yet, the fact that the U.S. still owns the majority of GM clearly complicates what should otherwise be a fairly straightforward recalibration of resources and capital within the economy. 

Rather than reviving the old patterns of demand, resources need to be reallocated into other (new) sectors to ensure a fresh and sustainable recovery. It’s hard to image how resuming the patterns of the old debt binge will lead to robust economic growth in the future.  If anything, that trajectory probably increases the likelihood of us facing another financial crisis sooner.

Unfortunately, the same schizophrenic policy outlook that applies to GM also pertains to housing. If you combine the market shares for Fannie, Freddie, and the Federal Housing Administration, the federal government guaranteed roughly 97 percent of all home mortgages in the first quarter of 2010. While these agencies have been widely viewed as essential for stabilizing the housing market, their sheer dominance now raises concerns about the long-term sustainability of the housing sector, as well as the ultimate costs for the taxpayer.

Taxpayers have already committed roughly $150 billion to the bailout of Fannie and Freddie – all in the name of subsidizing homeownership. The Congressional Budget Office projects that losses could balloon to $400 billion over time, while other analysts suggest the taxpayer hit could be closer to $1 trillion, if default and foreclosure rates stay high. And there’s no ceiling on the federal government’s assistance, since the Obama administration announced last Christmas Eve that there should be “no uncertainty about the Treasury's commitment to support these firms as they continue to play a vital role in the housing market during this current crisis.”

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