November 28, 2008


President-elect Obama has named Harvard economist (and ex-Harvard president an ex-secretary of Treasury) Larry Summers to direct his National Economic Council.

Here’s Summer’s take on why Fannie Mae and Freddie Mac got so out of control:

"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.

Government budget discipline was not appropriate because it was always emphasized that they were 'private companies.' But market discipline was nearly nonexistent given the general perception -- now validated -- that their debt was government backed.

Little wonder with gains privatized and losses socialized that the enterprises have gambled their way into financial catastrophe."

Summer’s solution: divide these firm’s activities into sharply focused components, some with a public purpose, other private. Then spin them off.

[See the August 23 post for more details on how mission-muddle provided cover for these organizations' unsound, bigger-is-better strategies.]


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