Drezner: Pondering the Mortgage Buyout

The U.S. Treasury Department's takeover of Fannie Mae and Freddie Mac is one of those mega events that simultaneously calls for instant analysis (and lots of it) and time out for a deep breath or two. The move is so vast in its implications and says so much about how the world has changed, it's about as hard to take in as a view of the grand canyon. In the spirit of deep breathing, here are four thoughts to keep in mind about the buyout:

1. History is bunk. From a historical perspective, the U.S. buyout of these august institutions is head-spinning. To understand just how head-spinning it is, consider this sentence from a Russian business web site that appeared on Monday: "The Russian stock market's rise can be traced to positive news on the nationalization of U.S. mortgage agencies Fannie Mae and Freddie Mac."

For any reader who has a firm memory of the Cold War, this sentence is astounding. For one thing, Russia actually has a stock market. Second, the United States is now engaging in state intervention on an unprecedented scale-and with a Republican president making the decision, no less. Third, Russian capital markets are intertwined enough with American capital markets for a U.S. bailout to boost Moscow's bourse. This might be because Russia's sovereign wealth funds hold significant amounts-in the tens of billions-of Fannie Mae and Freddie Mac bonds.

Do not listen to people who claim that there is a new Cold War brewing between the United States and Russia. During Cold Wars, countries desperately try to avoid economic interdependence. As yesterday's reaction to the news suggests, Russia cannot avoid being part of the global economy.

2. It's the globalization, stupid. The easy political analysis of the takeover is to say that the U.S. federal government is taking this step to appease homeowners. It is certainly doing so, but it is also trying to soothe financial markets and-more important-please foreign creditors. China is far and away the largest foreign investor in long-term U.S. government agency debt-more than $375 billion. In the past month Chinese officials had warned about the implications of a collapse of the two housing giants.

Beijing was not the only foreign government to raise hackles about the status quo-other foreign officials voiced their concerns directly to Treasury Secretary Henry Paulson. Senator Chuck Schumer told the Wall Street Journal that, "There was a real fear that foreign governments would start dumping Fannie and Freddie...and not buy the bonds."

As long as the United States runs a current account deficit of more than $500 billion a year, it will need the trust of foreign capital and foreign governments. Judging by the global market reaction, seizing Fannie Mae and Freddie Mac helped preserve that goodwill abroad. One reason this happened on a Sunday was so that Asian stockmarkets would have the first opportunity to respond.

3. Goodbye, Washington consensus. For decades, the United States has been preaching about the benefits of minimal government intervention in the marketplace. Deregulation, privatization, trade liberalization, the message was always the same: trust markets more and governments less.

One can debate the merits of this takeover, but it is hard to dispute that the political optics have changed. Governments across the developing world had already rebelled against many aspects of the Washington consensus, but this move will make it harder for U.S. officials to preach the virtue of markets to others. If Fannie Mae and Freddie Mac are "too big to fail" in the U.S. economy, how many national champions are there in the developing world that merit similar claims?

4. Individuals still matter. The credit crunch makes it easy to talk about the power of structural factors and the massive pressure that impersonal capital markets can impose on governments. Don't be fooled, however. As scary as the current situation might seem, it would be even scarier if Henry Paulson was not Secretary of the Treasury.

Paulson matters domestically and internationally. Consider that his predecessors in the Bush administration were John Snow and Paul O'Neill. Neither man earned the trust of George W. Bush, and it is likely that neither man could have gotten Bush to sign off on the takeover. As the New York Times reports, however, Paulson was able to secure Presidential approval with a minimum of fuss.

Bush is not the only powerful actor to trust Paulson. One China watcher told me recently that last year, the leadership in Beijing decided that Paulson was the person they could trust in Washington. Top Chinese officials have been more willing to be candid and direct with him. This does not mean that Paulson takes orders from Beijing. He simply has better information at his fingertips.

Had this crisis happened in 2005, the outcome could have been very different. Foreign purchases of Freddie Mac and Fannie Mae securities might have dried up, and the political leadership in Washington might have been found wanting as well. The credit crunch would have morphed into a Category Five meltdown.

That could still happen.The initial market reaction was positive, but initial reactions can prove illusory. Because so many central banks have a stake in the current plan working out, however, the situation looks more hopeful than it did last week.