As we see news of the possible (and increasingly likely) bailout of Freddie Mac and Fannie Mae by the US Treasury, I am reminded of something that I have been writing about nuclear energy, ie that it should be financed by the State, and I’d like to extend on why I think there are fascinating similarities between the two topics, however distinct they may seem.
My point about nuclear is that it is a capital intensive form of power generation, ie that the main component of the cost of the electricity produced is the long term amortisation (or financing) of the upfront investment. That means that the single most important driver of the cost of nuclear energy is the interest rate applied. In turn, that suggests that the easiest way to lower the cost of nuclear energy is to give it access to State funding, given how the State will always be the entity that has access to the lowest borrowing.
Well, the argument that led to the creation of Fannie Mae and Freddie Mac is the exact same: their purpose is to make funding available to the mortgage market by refinancing lending banks cheaply. The single most important driver of the ability to purchase a house (at a given price) is the interest rate that applies to the borrowing – for the same reason that the money need to be put up upfront and repaid over a very long period. Thus lower interest rates make housing more affordable, all others things being equal. And the reason that funding is cheaper when provided by Freddie or Fannie is because these are “Government-Sponsored Entreprises”, ie they are seen as quasi-public entities (even though they are privately-owned) and they can thus raise funds at, or close to government rates, ie much cheaer than traditional banks. By giving a good chunk of the difference to homebuyers, it lowers the cost of purchase for them.
In both cases, government uses its innate financial strength (backed, ultimately, by its ability to (i) raise taxes or (ii) print money, ie in both cases to raise/capture money from its citizens) to support an industry by allowing it to reduce its main cost – and thus make a strategic good (housing or electricity) cheaper for the population.
This brings up several questions:
- given that power generation is such a fundamentally important sector (everything in our lives depend on electricity; brownouts are totally unacceptable to the population and politicians rightly know it), why is public ownership of power generation seen as such a bad light (I know that the US has of local authority-owned and regulated utilities, but the general point stands). As a corollary, why is the idea of a State-owned nuclear plant company not supported in any meaningful way? Why is EDF, the French-owned utility that has pushed the nuclear model furthest, seen as a target to be broken up rather than a model to emulate?
- why is government intervention in the power sector seen as an almost evil thing when the exact same kind of intervention in the financial sector is seen as desirable and normal?
- more importantly, why is, en either case, no distinction made between the role of the government as financier of the sector, and its role as regulator of the sector?
As I wrote about State-owned nuclear plants, I’m sure that many objected not on the grounds of “socialism” or “government incompetence”, but simply on grounds that there are other risks associated with nuclear: how to deal with the waste, how to manage safety, control of the uranium chain, single-point-of-failure in the grid, etc… and that these risks need to be dealt with as well. While I personally think that these risks can be managed because there are technical solutions and by having a strong regulator which enforces those solutions, I understand the arguments of those that say that governments – especially governments subject to the overwhelming influence of big corporations’ lobbying and money – will not be able to properly do that job in a sustained way.
But the exact same point can be made about the mortgage industry (and banking more generally). There are other risks in that industry than mere access to liquidity, and other issues than the cost of funding. The current real estate bust proves that beyond any doubt: poorly regulated banks can do a lot of stupid things with other people’s money, and entities with access (implicit or, as has now been made clear, explicit) to the government purse will do stupid things on an even larger scale, especially if they can personally profit along the way.
You should look at Fannie Mae and Freddie Mac as a nuclear plant operator fully funded by the government and yet not regulated in any meaningful way in what it does with spent waste – and, of course, fully expecting that the government will pick up the tab of dealing with that waste.
Just like many could live with nuclear if the issue of waste were properly dealt with – and paid for, the exact same logic should apply to mortgage finance: the “waste” has to be dealt with – in that case, the waste being overly risky loans to customers that would not otherwise be touched without that possibility of dumping them on others. There is a reason subprime loans are now called “toxic waste” – that’s exactly what they are. They are the logical, inevitable consequence of a financial system where liquidity was provided, without supervision, beyond the needs of acceptable customers and thus spilled into bad loans. Poor quality lending is the inevitable result of out-of-control lending bubbles. This is like telling nuclear plants to operate to the limit, for maximum profit, without any restriction of any kind, and in particular without having to worry about the spent fuel.
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Government that work properly provide carrots (cheap funding) and sticks (regulation of the underlying activity so that their noxious consequences are dealt with by the industry and not dumped on others). The finance industry has managed to grab the carrots while blocking the sticks. The nuclear industry is (more or less) under the stick, but has no access to the carrots.
In both cases, government is not properly doing its job. Of course, this is not because government is naturally incompetent, but because sustained ideological campaigns pushed for such results, for the benefits of very narrow groups: management creditors and (to a lesser extent) shareholders of financial institutions in one case, and the fossil fools and finance industry and in the other (the main result of current energy policies is the dominance of coal- and gas-fired power plants and the enrichment of the traders of gas, electricity and related infrastructure).
We need to make government able to do its job, which means using both the stick and the carrot. If you want cheap mortgages (a worthy goal of public policy), regulate the hell out of banks, and nationalize Freddie and Fannie; if you want cheap electricity, allow public funding of power plants (which, btw, will also heavily favor wind and other renewable energies) and make sure that all forms of generation are fully regulated for hteir externalities.
Instead, we’re getting the worst of both worlds right now.
And the investor class might want to note that they are being wiped out right now in the financial sector, and that the most valuable utilities in Europe are nuclear-heavy (and State-controlled) EDF and GDF-Suez. Smart public policy makes sense even for capitalists
