Treasuries and the GSEs

Don Boudreaux links to Garrett Jones’ review of Mark Zandi’s new book Paying the Price, and excerpts it at length. In the Cafe Hayek post, the second to last paragraph of the excerpted material deals with how Jones believes the GSEs, namely Fannie Mae and Freddie Mac, were involved and, at least partially, responsible for the financial crisis. I’ve already summarized the case for why these public-private firms are really a minor facet of the crisis.

That discussion has certain parallels to Robert Murphy’s comment on David Beckworth’s point about private demand for U.S. treasuries. Murphy focuses on the fact that in 2011 the Fed purchased 77-percent of long-term treasuries, in an effort to skew private holdings of public debt towards short-term bonds, as evidence that the Fedmust be a major propping force of the U.S.’ domestic sovereign bond market. While I think there is a lot of sense in Murphy’s argument — as I’ll repeat on Monday —, the underlying factor in Beckworth’s story is also accurate: during periods of depressed economic activity, safe sovereign bonds are usually purchased to accumulate safe assets that earn higher returns than simply holding cash (adjusted for inflation, real interest on U.S. debt is either close to zero or below it, but the inflation adjusted returns on holding cash are even lower). Depending on whatever other evidence is available, the Fed’s actions can be interpreted as an effort to crowd out private investors in the long-term public debt market, which is certainly consistent with the Fed’s intentions.

The role of the GSEs were similar: they bought large amounts of mortgage-backed assets, but private actors were buying even more. Loan originators were being propped not only by government institutions, but also by investment banks and other financial firms that accumulated mortgage backed assets because they were perceived to be relatively safe assets (safe enough to be considered as collateral for short-term credit transactions; a role that treasuries play in lieu of these kinds of private assets). When compared to the role played by private sector banks, it’s clear that GSEs did not play the major part in stimulating the boom. They do deserve some blame, but it’s not useful to single them out, as if there weren’t alternative institutions/firms ready to take their place.