I think that Obama should demagogue the federal bailout of Fannie Mae and Freddie Mac. Details below.

If you don’t know the policy issues, start with this overview from Slate or Wikipedia. (More commentary here.) Most of the good and great think that this bailout is absolutely necessary. I don’t think it is and, moreover, the politics of the issue line up nicely for Obama. Imagine that he said something along these lines:

For too long President Bush and the Republicans in Congress, led by Senator McCain, have put the interests of the rich and powerful ahead of the interests of working Americans. For too long, Bush and McCain have sought to comfort the rich, have tried to help Wall Street instead of Main Street. Our current recession was caused by the failed economic policies of Bush and McCain.

Yet, this week, they have gone a bailout too far. They propose to spend hundreds of billions of dollars bailing out their rich friends on Wall Street and in China. They want you, working Americans, to back up the promises made by Fannie Mae and Freddie Mac.

But why should we? Why should regular Americans like you and me be on the hook for their failed policies? Why should our tax dollars go to Wall Street Banks and International Sovereign Wealth Funds? They invested stupidly. They should face the consequences of their mistakes.

When you make a mistake, does the federal government bail you out? No. Why should we bail them out? McCain and Bush want to send your money to China and to Wall Street.

And so on.

Sensible economists will hate this sort of talk. In polite company, we aren’t supposed to demagogue Wall Street, much less China. But the politics are fairly compelling. First, it changes the topic from Palin to the economy. Obama is on much more favorable ground with the latter. Second, such a speech focuses the debate more on the Bush administration and McCain’s support of it. Every day that McCain defends an economic policy of the Bush administration is a good day for Obama. Third, normal independent voters do not really understand why we need to bailout Fannie Mae and Freddie Mac in the first place. If Obama can frame the debate in terms of their money going to rich Wall Streeters or, even better, foreigners, he wins. Fourth, because he is just a candidate, Obama does not need to act on any of this now. Once he takes office in January, he can decide, in light of new information, what the best course of action is.

Moreover, there are a few folks, like me, that argue (example here) that the bailout is actually bad policy. To simplify greatly, Fannie and Freddie sold a bunch of bonds to greedy (stupid) people that said, “We promise to pay you X in the future. And note that this promise is not backed by the US government.” The stupid/greedy buyers bought those bonds because the yield was high (i.e., the bonds were cheap). The buyers thought that, even though the bonds were explicitly not backed by the US (it said so on the actual pieces of paper), there was still an “implicit” federal guarantee.

Well, tough, There wasn’t. You are out of luck.

What would happen? Well, for starters, we would not be bailing out rich people from their financial mistakes. Surely that is a good thing! Going forward, they will invest more wisely. Second, those rich people will not lose everything. The bonds of Fannie and Freddie are backed by millions of home mortgages, the vast majority of which are perfectly sound. Even if we allowed Fannie and Freddie to “fail,” their bonds are still worth at least 80 cents on the dollar, and probably more than 90 cents. Poor Bill Gross and the Bank of China need to take a 10% haircut. Boo hoo!

The sophisticated concern is that, without Freddie and Fannie, the US mortgage market would seize up, that you would not be able to get a loan for the house you want to buy at an interest rate you like. Probably true. First, that is a good thing! Fannie and Freddie (and all the other investors who made house financing so easy) distorted the housing market. Their actions made rates too low and terms too easy. That is a big reason we are in so much trouble. Every credit boom is followed by a credit bust. Better a market with higher rates and larger down payments then one we need to bail out again in 10 years. Second, don’t underestimate the creative powers of capitalism. There is hundreds of billions of dollars in money waiting to be invested in the US housing market at the right terms. Give them a chance to lend money at 8% on houses were the buyer has put down 20% and is borrowing 3 times her (honestly documented) income and they will line up around the block. We need to clear away the dead wood of our current financial system and allow a new one to arise it is place.

Yet the point here is not that preventing a bail out is, substantively, good policy. The point is that arguing against the bail out — demagoguing against the Bush/McCain economy and the pay-outs to their rich supporters — is great politics.

Can we demagogue the bail out? YES, WE CAN!

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