Victory of new-age apparatchiks

Under whatever form of political system we live in, it would be unrealistic to expect a free market in its purest form.

Although free market extremism is not the pragmatic way to go forward, the fact of governments having their way in the affairs of markets can sometimes be frightening.

In the past, various government-led attempts to find the right equilibrium of social objectives and business objectives have often met with little success. From the Soviet model of state-owned enterprises to semi-capitalist models (mixed economy) in Asia, Middle East and Latin America, these attempts have failed or have had debatable success in terms of costs and benefits.

Ironically, the American experiment in the national mortgage market seems to be once again proving why market manipulation is not the way forward in bringing greater benefit to greater numbers. But the modern-day market apparatchiks of the US administration are not yet ready to admit their failure, for obvious reasons.

The stakes are too high. The two Government Sponsored Enterprises (GSEs), Fannie Mae and Freddie Mac, which are in the eye of the current financial crisis, jointly own or guarantee about $6.1 trillion of the $12 trillion US mortgage market. And that has international relevance, in case you ask.

This week the House of Representatives overwhelmingly passed a rescue of these mortgage lenders. The Senate and the president already have signalled their approval. The Government Budget Office bailout could cost US taxpayers $25 billion.

These two GSEs were supposed to be part of the solution to the mortgage market's problems which began in last summer. Now it appears that they have become bigger problems by themselves.

Fannie Mae was created in 1938 as part of Roosevelt's New Deal. The collapse of the national housing market in the wake of the Great Depression discouraged private lenders from investing in home loans. Fannie Mae was established in order to provide local banks with Federal money to finance home mortgages in an attempt to raise levels of home ownership and the availability of affordable housing.

The failure of these mortgage giants once again proves that the masquerading of public companies as private enterprise or vice versa can result in disastrous consequences.

"The illusion that the companies were doing virtuous work made it impossible to build a political case for serious regulation. When there were social failures the companies always blamed their need to perform for the shareholders. When there were business failures it was always the result of their social obligations," former Treasury Secretary Lawrence Summers wrote recently. Very plausible.

The business logic of these two GSEs itself should tantamount to heresy in terms of market logic. Both organisations relied on an implicit Federal guarantees of their obligations to borrow at lower interest rates than their competitors, giving them an unfair advantage in the marketplace. Now, the logic behind their bailout looks murkier than their business model. It is certainly indicative of serious problems in the US financial markets.

The difficulties at the two mortgage financiers represent a further unravelling of the US financial system. Under the given circumstances, the mandarins of Fed and Treasury can get away with the argument that these two cannot be allowed to fail. But the lingering question is: don't they deserve to?