Downsizing Blog
A Tale of Two Frauds
Print
The President has announced a government crackdown on Medicare and Medicaid fraud. The effort appears to be an attempt to make it easier for Americans to swallow the health care “reform” he’s trying to shove down their throats. As House Republican leader John Boehner correctly asked, “Why can’t we crack down on fraud without a big-government takeover of health care?”
As I’ve noted before, improper payments made by Medicare and Medicaid is may well be $50 billion more than the already appalling $100 billion annual figure the president cited. Administrative efforts to reign in fraud and abuse are welcome, but won’t solve the huge and fundamental inefficiencies of these programs. Because the law requires government health care programs to quickly get payments out the door, Uncle Sam will always be engaged in a costly game of “pay and chase.”
The broader problem is that government programs aren’t subject to market discipline. Policymakers and administrators have little incentive to be frugal because they face little or no negative consequences when playing with other people’s money.
Most of us have noticed how good private companies can be at reducing fraud. I recently received a call about questionable charges on my Discover credit card. After quizzing me on a list of purchases made with my card in the past 24 hours, it became clear that someone had gotten control of my account. Discover immediately closed the account, opened an investigation, and removed me from any liability for the fraudulent charges.
What amazed me is that I only had about $300 worth of charges on my card. It’s not a big account and thus not a big money maker for Discover. Yet, within 24 of a string of suspicious charges, the company was right on top of it before I even realized anything nefarious was going on. Private markets don’t always work this well, but government programs almost never do.
Posted by Tad DeHaven on March 11th, 2010
Fannie, Freddie, Peter, and Barney
Print
Last week, after Rep. Barney Frank (D-MA) said that holders of Fannie Mae and Freddie Mac’s debt shouldn’t be expected to be treated the same as holders of U.S. government debt, the U.S. Treasury took the “unusual” step of reiterating its commitment to back Fannie and Freddie’s debt.
If ever there was case against allowing a few hundred men and women to micromanage the economy, this is it.
Fannie and Freddie, which are under government control, are being used to help prop up the ailing housing market. If investors think there’s a chance Uncle Sam won’t back the mortgage giants’ debt, mortgage interest rates could rise and demand for housing dampen. Therefore, Frank’s comments caused a bit of a stir. However, with the government bailing out anything that walks or crawls, investors apparently weren’t too concerned with Frank’s comments as the spread between Treasury and Fannie bonds barely budged.
As I noted a couple weeks ago, the Treasury is in no hurry to add Fannie and Freddie’s debt and mortgage-backed securities to the budget ($1.6 trillion and $5 trillion respectively). Congress certainly isn’t interested in raising the debt ceiling to make room. And as Arnold Kling points out, putting Fannie and Freddie on the government’s books would actually force the government to do something about the doddering duo.
All of which points to what an unfunny joke budgeting is in Washington. Take a look at what current OMB director Peter Orszag had to say about the issue when he was head of the Congressional Budget Office:
Given the steps announced by the Treasury Department and the Federal Housing Finance Agency on September 7, it is CBO’s view that the operations of Fannie Mae and Freddie Mac should be directly incorporated into the federal budget. The GSEs’ revenue would be treated as federal revenue and their expenditures as federal outlays, with appropriate adjustments for the manner in which credit transactions (like a mortgage guarantee) are reflected in the federal budget.
Note that Orszag wrote that statement less than two years ago. And since then, the bond between the government and the mortgage giants has only gotten tighter.
The same people that say Fannie and Freddie shouldn’t be on the government’s books are often the same people who once dismissed concerns that the two companies were headed toward financial ruin. In 2002, Orszag co-authored a paper at Fannie’s behest that concluded that “the probability of default by the GSEs is extremely small.”
Another one of those persons, Congressman Frank, has his fingerprints all over the housing meltdown. In 2003, a defiant Frank stated that “These two entities – Fannie Mae and Freddie Mac – are not facing any kind of financial crisis.” Frank couldn’t have been more wrong. Yet there he remains perched on his House Committee on Financial Services chairman’s seat, his every utterance so important that they can move interest rates.
Posted by Tad DeHaven on March 10th, 2010
Reassessing FHA Risk
Print
As the Federal Housing Administration edges closer to a taxpayer bailout due to the large number of risky mortgage loans it has insured, it continues to insist that no such bailout will be required. However, a new study from a group of economists at New York University finds that the FHA’s assurances might not be based in reality.
According to the study, the actuarial analysis FHA used to determine it won’t need a bailout seriously understates its exposure to risk:
- More FHA mortgages are underwater than the FHA’s analysis identifies, and unemployment is naturally particularly high in areas where FHA borrowers are furthest underwater. Therefore, potential default costs are underestimated.
- FHA’s analysis relies on house values that are inaccurate. Overvalued houses means the FHA could end up recouping less than expected on defaults.
- Underwater FHA mortgages that were “streamlined” into new FHA mortgages are not properly accounted for, which further underestimates risk.
- The FHA got clobbered on a previous no-downpayment assistance program. However, the current homebuyer tax credit can effectively eliminate downpayments on FHA loans, but its analysis doesn’t take this into consideration.
One of the study’s authors, Prof. Andrew Caplin, writes the following on his website:
Rather than looking to structure the markets of the future, they [policymakers] have stumbled along in business as usual mode, waiting for kind fate to save them. It may. Then again, it may not. Either way, this is not a good way to run a business, or a government for that matter.
How does he see this story playing out?
My best guess is that it will end with a crash in the housing finance sector, with the federal government forced by popular revulsion at mushrooming losses to remove itself almost entirely from the housing finance equation. The Resolution Trust Corporation will look like an amateur warm-up act…The bottom line is simple. The continuation of “business as usual” is re-creating the essential problem that made the sub-prime crisis so disastrous. Once again, taxpayers have been forced to subsidize the private purchase of massive amounts of residential housing, and to offer guarantees against future losses, without any effort to reduce costs should their funding help turn some markets around. Warren Buffett made huge profits for his shareholders by investing in under-valued assets. By contrast, our leaders are making massive losses for taxpayers by investing in over-valued assets.
See this essay for more on the problems with housing finance and government intervention.
Posted by Tad DeHaven on March 9th, 2010
