Viral V. Acharya

The financial collapse of Fannie Mae and Freddie Mac in 2008 led to one of the most sweeping government interventions in private financial markets in history. The bailout has already cost American taxpayers close to $150 billion, and substantially more will be needed. The U.S. economy--and by extension, the global financial system--has a lot riding on Fannie and Freddie. They cannot fail, yet that is precisely what these mortgage giants are guaranteed to do. How can we limit the damage to our economy, and avoid making the same mistakes in the future? Guaranteed to Fail explains how poorly designed government guarantees for Fannie Mae and Freddie Mac led to the debacle of mortgage finance in the United States, weighs different reform proposals, and provides sensible, practical recommendations. Despite repeated calls for tougher action, Washington has expanded the scope of its guarantees to Fannie and Freddie, fueling more and more housing and mortgages all across the economy--and putting all of us at risk. This book unravels the dizzyingly immense, highly interconnected businesses of Fannie and Freddie. It proposes a unique model of reform that emphasizes public-private partnership, one that can serve as a blueprint for better organizing and managing government-sponsored enterprises like Fannie Mae and Freddie Mac. In doing so, Guaranteed to Fail strikes a cautionary note about excessive government intervention in markets.

There is virtually universal agreement that the fundamental cause of the global economic and financial crisis of 2007-09 was the combination of a credit boom and a housing bubble, but it is much less clear why this combination of events led to such a severe financial crisis.Manufacturing Tail Risk argues that what made this economic shock unique and led to such a severe financial crisis was the behavior of many of the large, complex financial institutions (LCFIs) that today dominate the financial industry. These LCFIs ignored their own business model of securitization and chose not to transfer credit risk to other investors. Instead, they employed securitization to manufacture and retain tail risk that was systemic in nature and inadequately capitalized.This book provides a brief history of how the U.S. financial system evolved into its current form. It presents the manner in which banks built tail (systemic) risk exposures in large measure to get around capital requirements, in contrast to their earlier business models, and it explains how lax regulation contributed to these outcomes. It also examines alternative explanations for the financial crisis. The authors conclude that global imbalances and loose monetary policy were relevant proximate contributors to the crisis by producing an asset-price bubble in the United States that ultimately led to the financial crisis.It concludes with a discussion of possible remedies to charge banks for manufacturing tail risks and to contain such propensity in the first place. And while the focus is on the United States, the authors review risk-taking and realized losses by LCFIs in other parts of the world.