Fannie, Freddie and Minimum Wage

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Dean Baker
The Guardian Unlimited, July 28, 2008

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The US Congress has come to the aid of struggling workers and overcompensated Wall Street executives.

Congress voted to save Fannie Mae and Freddie Mac from bankruptcy last week. It seems that the top management at these institutions had somehow failed to see the largest housing bubble in the history of the world. As a result, the bad loans from the collapse of the bubble would put these giants of the mortgage market out of business without government handouts.

Also last week, the minimum wage was increased by 70 cents to $6.55 an hour. The minimum wage is scheduled to increase by another 70 cents, to $7.25 an hour, next summer.

We all understand the motivation for raising the minimum wage. Tens of millions of workers working at wages at or near the minimum struggle to support families. These increases in the minimum wage will allow low-paid workers to keep pace with rising food and energy costs and hopefully be better able to make ends meet.

By contrast, the bailout of Fannie and Freddie is a bit harder to explain. These companies are at the centre of the secondary mortgage market in the United States. The vast majority of mortgages issued to homebuyers are not held by the banks that issue them. Typically, they sell them off in the secondary mortgage market. This allows the banks to get money to make more mortgages.

Fannie Mae created this secondary mortgage market when the government set it up in 1938. Freddie Mac was set up in 1968 as second institution to provide the financing needed to maintain a secondary mortgage market.

In 1968, Fannie Mae was privatised, with private stockholders allowed to profit from its operations. Freddie Mac was established as a private corporation, although both Freddie and Fannie have always enjoyed an implicit guarantee that the government would back up its debt if they ever found themselves in trouble.

The congressional bailout was making good on that guarantee. If the government did not stand behind Fannie and Freddie's debt and allowed their bondholders to suffer losses, then future loans to Fannie and Freddie, or new mortgage institutions, would carry much higher interest rates to reflect the risk of default. These higher interest rates would in turn be passed on to homebuyers in the form of higher mortgage interest rates.

A big jump in mortgage rates would probably be not be desirable at any point, but especially not at a time when the housing market is facing its biggest crisis since the beginning of the Great Depression. So there could be little question that the government would honor Fannie and Freddie's debt.

But, we had a lot of options here. We could have wiped out the shareholders. After all, these are companies that are essentially bankrupt. That is why they are coming to the government for a bailout. Private lenders, recognising the massive losses they are incurring from foreclosures on mortgages they own or guarantee, would soon stop lending or demand sharply higher interest rates, without the government stepping in to back up their debt.

If you own stock in a bankrupt company, you lose your investment. At least that is the way it is supposed to work.

Then we have the issue of executive compensation. One of the main reasons that most workers have seen little benefit from economic growth over the last three decades has been that so much money has been redistributed upwards to the people who run companies like Fannie and Freddie.

Last year, Richard Syron, the CEO of Freddie Mac pulled down $19.8m in compensation.  This is an interested number. With the new minimum wage hike, a full-year minimum wage worker would earn $13,100 a year. That means that in 1,511 years and five months, a minimum wage worker will earn as much as Syron did last year. That's good news, because before last week's increase, a minimum wage earner would have been forced to work 1,692 years and three months to equal Syron's pay.

Of course, this comparison is unfair because it doesn't consider their differences in productivity. A minimum wage worker might clean a building or run a check out counter, in other words, provide a benefit to the economy.

Syron, a man whose only job is to follow the housing market, was too incompetent to notice the largest housing bubble in the history of the world. As a result, he kept pumping in credit to hugely over-valued housing markets, allowing prices to become even more over-valued. With house prices now plummeting, tens of millions of families are seeing their life savings vanish before their eyes. Syron's productivity is considerably below that of the custodian or the checkout clerk.

Last week, government action helped to support the pay of both minimum wage workers and Bill Syron. And almost everybody in Congress thinks this is fair.

 


Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of The Conservative Nanny State: How the Wealthy Use the Government to Stay Rich and Get Richer (www.conservativenannystate.org). He also has a blog, "Beat the Press," where he discusses the media's coverage of economic issues. You can find it at the American Prospect's web site.