Unexpectedly Intriguing!
September 15, 2008

In July, Barry Ritholtz put his finger on what's really behind today's series of crises affecting the banking industry in the United States: a "blind denial about running a good business":

Some people are discussing these financial issues as if they were a random black swan event. But that's incorrect; these events are the result of a long series of missteps in central banking, government actions, corporate errors, and risk mismanagement.

A very solid case in point is represented by the U.S. government's recent takeover of mortgage lenders Fannie Mae and Freddie Mac. Both institutions had, increasingly since the 1990s, relied more and more on political connections to create a favorable operating environment in which they could generate greater profits.

In essence, both Fannie Mae and Freddie Mac went out of their way to staff their executive suites with people with government and political connections rather than people who knew the business well - a pretty clear indication that they thought those kinds of connections that can influence how regulations get set and enforced mattered more than running a viable business.

That emphasis on political connections to promote profits is represented in the following chart, which reveals the amount of political contributions received by members of the U.S. Congress over the twenty years from 1989 to 2008 as recorded by OpenSecrets.org (HT: Greg Mankiw): Top 25 U.S. Congress Recipients of Contributions from Fannie Mae and Freddie Mac, 1989-2008

What's remarkable is that even though the Republican Party was in the majority in Congress over much of this 20 year period, the Democratic Party members named in the chart above raked in over twice as much money from donors affiliated with both Fannie Mae and Freddie Mac. The Democrats named above collected $966,778, or 70% of all these political contributions, while the top Republican Party recipients collected just $419,648 over this 20 year period.

Most of those contributions, especially in the "Presidential" category, have come in very recent years, when both businesses were subject to increased scrutiny due to extreme accounting scandals.

Now, here's the sad truth: both Fannie Mae and Freddie Mac's executives' focus on political connections paid off for them, at least for a while. So successfully, in fact, that they thought the rules they had rewritten at their direction would protect them from the risk of backing loans of ever worsening quality. And now, they're using the same connections to try to get out of the hole they dug for themselves.

We can't say whether either of these enterprises are too big to fail and should have been bailed out by the federal government. But we do think that a reasonable trade to make in return for the government bailing them out is for those most politically connected in the executive suites of Fannie Mae and Freddie Mac would be to serve some quality time in a different kind of federal institution. Taking away their golden parachutes just isn't going to be enough.

And would it really be too much to ask for the same outcome to be shared by the biggest and most influential recipients of their largess in the U.S. Congress?

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