Reflections on the Financial Crisis

Abstract

I am going to make several unrelated points, and then I am going to discuss how we got into this financial crisis and some needed changes to reduce the risk of future crises. Some Observations First, we should close down as promptly as possible Fannie Mae and Freddie Mac. There never was a reason for those two institu-tions, other than to avoid the congressional budget process. The ben-efit that people got from Fannie and Freddie came from the subsidy to the mortgage interest rate. Congress could have passed that sub-sidy over and over again. They avoided passing it by taking the pro-gram off budget. That led to a benefit to members of Congress who participated in the profits of Fannie Mae and Freddie Mac. It is an example of bad government policy. Second, looking ahead, the debt of the United States as a share of GDP is going to go from 40 percent to at least 60 percent. If you look at Japan, Italy, or Belgium, that doesn’t seem like a startling number. The difference is that much of that debt is owed to foreigners. Looking ahead, get used to the idea that we’re going to have to export more and probably see consumption grow at a slower rate. After years of rising expenditure on consumption in the United States, we are going to have to learn to tighten our belts a bit. That’s not going to be an easy thing to do politically; woe to the president who presides over that period.

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