Monday, July 14, 2008

Freddie Mac, Fannie Mae, & Cheap Furniture

A friend of mine that works at a hedge fund called me on Friday. He wanted my opinion on the Freddie Mac/Fannie Mae situation. My immediate reaction was – “Good news – the free market works.” Over the weekend, I thought about it some more, and here’s what I think now -

“Good news – the free market works.”

I remember just after college, another close friend (“Mike”) started working as a manager at Heilig-Meyers Furniture in North Carolina. Heilig-Meyers was a chain that focused on lower income consumers – mostly anyone that needed a chair to sit on and a coffee table to eat off of while watching Jerry Springer… (Mike also informed me that the furniture protection upsell is a crock, but I digress….) Their specialty was extending credit to lower-income purchasers. I remember reading one of their credit agreements once – 24% interest for those lacking the cash to complete the transaction. Additionally, Heilig-Meyers sold credit life insurance at a value above the price paid for the purchased furniture to prevent downside risk against “unpaid indebtedness.”

So if I have this right, Heilig-Meyers would sell furniture to non-creditworthy individuals on credit, include additional debt insurance payments for an amount higher than the value of the purchased goods, and charge an interest rate that reflects the appropriate risk level of the consumer to which they were extending credit. Hmmm…. Sounds familiar for some reason. This may be shocking news, but Heilig-Meyers went bankrupt in 2000.

I wonder what would happen if a mortgage company provides financing for a house to individuals lacking the appropriate credit at an appraisal value above market value, and include additional payments on top of the loan for private mortgage insurance for the total loan amount. And, what if the home mortgage lenders had fair confidence that default risk for these loans would be covered by the US government? Oh wait, that’s happening…

Why is it hard for the market to understand that people and companies respond to incentives? (Check out "THE ARMCHAIR ECONOMIST: Economics and Everyday Life" by Steven E. Landsburg for more on this.)

(More info about eventual lawsuits against Heilig-Meyers’ practices can be found here – some interesting reading. How do companies even get this large following such company practices?)

Digg!


1 comment:

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