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Economic Growth

Government

Clearing the Air on "Too Big To Fail"

With Occupy Wall Street continuing to build steam, Cato's Mark Calabria chose to engage in a little friendly fire. I like to believe that libertarians and progressives could come together to rewrite the rules of a rigged system, but Calabria seems interested in thickening the fog of war rather than clearing the air.

Cato's Mark Calabria leveled a strange charge at Joseph Stiglitz, suggesting that in 2002 Stiglitz and his coauthors (Jonathan and Peter Orszag) "sold their work to the highest bidder defending the system" of socialized losses and privatized gains. The paper analyzed the taxpayer risk of guaranteeing the debt of Government-Sponsored Enterprises (GSEs—primarily Fannie Mae and Freddie Mac) and found that under one of the two capital standards, the expected costs to taxpayers would be very low.

Of course, in 2011 this appears laughably naïve, given the many billions of dollars of support to Fannie and Freddie in the wake of the housing bust. However, Calabria's charge is utterly bizarre for several reasons. First, Stiglitz, Orszag, and Orszag specifically address the importance of "too big to fail" in taxpayer risk. Second, Calabria ignores the fact that risks grew considerably since the publication of the paper. Third, Calabria abuses some math in order to make it appear that the authors downplayed the potential costs.

Far from avoiding the question of "socialized losses and privatized gains," Stiglitz, Orszag, and Orszag rightly point out that the risk to taxpayers is far from limited to GSEs. They write,

"In the absence of Fannie Mae and Freddie Mac, mortgage risk would likely be held by large banks and other types of financial institutions, which themselves benefit from the perception that they are 'too big to fail.' Fannie Mae and Freddie Mac are among the largest financial institutions in the country. Even in the absence of a GSE charter it is likely that they would continue to benefit from their size, since the government has intervened on behalf of other large institutions in the past."

CEPR / October 17, 2011