If Conrad were alive today he just might author a companion issue to the first. Yet instead of a journey into the savage heart of Africa, Kurtz would find himself in the bowels of FannieMae, there to find his dark and evil soul.
A stretch? Not to most Americans when they eventually come to understand that core operation which, when coupled with Greenspan’s gross mis management of the Fed cooked up what we are served today. That would be the Fannie/Freddie horror show.
We highlighted these GSE’s (gov’t sponsored enterprises) in an earlier post to explain their designed purpose and how that became corrupted through connections to Congress. Pressure was exerted from the majority of Democrats in the House for Fannie/Freddie to lower standards to access low-income families. The political dividend was obvious. Franklin Raines, the Clinton-appointed head of Fannie from 1998 to 2004 made it a priority to make mortgages easier to get, with little credit, few assets and next to nothing down.
As background, Jonah Goldberg of the National Review notes that, "The fine print to this noble intent was an ill-conceived loosening of standards." For example, the Clinton administration reinterpreted the Carter-era Community Reinvestment Act to politicize lending practices. Goldberg continues, "Under the CRA the government forced banks to prove they weren’t ‘redlining’ - discrimination against minorities - by approving loans to minorities and various left-wing ‘community group’ shakedown artists whether they were bad risks or not." (A young Obama got his start with exactly these sort of groups) It was extortion but no problem; the banks were happy to pass the risky loans to a Fannie being transformed by Raines from the stable institution FDR intended into the equivalent of a hedge fund. Fannie accepted this stuff, bundled it together with good loans, and sold the lot to Wall St types who in turn were happy to oblige since Fannie was deemed to be too big to fail.
This worked perfectly for Raines who enriched himself to the tune of some $40million. Yet things began to get a tad dicey - in 2005 Fannie revealed that it had overstated earnings by $10.6 bln and that it didn’t really know what was going on. The Bush administration pushed for reforms for what had become largely a Democratic cash cow; those efforts were rebuffed by Congress with Barney Frank and Chris Dodd in the lead. Why? Because Fannie and Freddie had spent millions on campaign contributions to these clowns and their pals.
Also in 2005 McCain sponsored legislation to thwart what he later called "the enormous risk that Fannie and Freddie pose to the housing market, the overall financial system and the economy as a whole." It went down in defeat, naturally.
Oh, and we almost forgot - Obama, the Senate’s second-greatest recipient of donations from Fannie and Freddie after Dodd, did nothing. My, my.
Robert Craven
Sunday, September 21, 2008
Friday, September 19, 2008
A Personal Dilemma
We are in a dilemma this pm. Certainly we know that government intervention of any sort is suspect, that the foundation to government planning which Hayek so well illustrated means a limited group of individuals deciding the relative importance of different ends, thus the relative importance of different groups and persons. A rescue was fashioned for Bear but Lehman was abandoned; the world’s largest insurance company was acquired wholesale and now quite likely the mother-of-all-bailouts is just around the corner by the way of an RTC-like rescue of Wall Street firms in the main; that is, Paulson’s proposal to create a government-financed agency to take the most toxic assets (such as subprime mortgage backed securities) off the balance sheets of the US banking system. Together with today’s government’s blanket guarantee of the $3.4 trillion money market mutual funds the socialism of the financial sector appears to be proceeding apace.
This new entity would, unlike the RTC of the 80's, put taxpayers at risk. That is because the new entity would purchase illiquid assets at a discount from solvent institutions, then eventually try to sell them back to the market at a profit. Maybe so, maybe not. With the original RTC the government wasn’t exposed; the assets fell into its hand from failed institutions.
We have illustrated the perils, the addiction provided to abusers when gains are privatized but losses are socialized. Hey, why not? Yet today we are told that results of the cataclysmic sort will result if we don’t. Clearly in the case of some investment banks, certainly in the case of the auto makers their whining is just that. The fact I spent 25 years working for investment banks gives me a bit of a leg up over a salvage diver; still, when Bernanke warns Congress as he did today that without a bailout of a new order, we will have a financial meltdown, I just don’t know; I find it dangerous to doubt that. Can we make a case today as we have the past several that government intervention is always a bad thing? What if he’s right? In letting the system purge itself, our remedy all along, could it be that the heaves would prove fatal?
What startled us this week, specifically Wed evening is that the funding market for major world-wide institutions froze up. Not the bond market. Not the stock market. The O/N and short-term market, that which in the past provided liquidity for major operating institutions. This market provides funding for day-to-day operations; it has been around for 50 years. Normally the Royal Bk of Scotland (for purposed of illustration) is flush funds; these are lent out O/N or for short periods to Washington Mutual (for purposes of illustration) which is normally in need of short-term funds. If the RBS suddenly fears it won’t get it’s three day loan back, it will refuse to lend. That is what happened this week. But there was mass panic Thursday morning and the market locked up - nothing, only distrust. Even credit-worthy borrowers could not obtain their working capital. We agree that this would cause a rapid succession of failures; Paulson and Bernanke understood that.
If financial mastodons like AIG and the rest of these clowns are too large and too interconnected to fail yet not too smart to get themselves into situations where they need to be bailed out, then why let private firms engage in such activity in the first place? (I didn’t say that.)
Robert Craven
This new entity would, unlike the RTC of the 80's, put taxpayers at risk. That is because the new entity would purchase illiquid assets at a discount from solvent institutions, then eventually try to sell them back to the market at a profit. Maybe so, maybe not. With the original RTC the government wasn’t exposed; the assets fell into its hand from failed institutions.
We have illustrated the perils, the addiction provided to abusers when gains are privatized but losses are socialized. Hey, why not? Yet today we are told that results of the cataclysmic sort will result if we don’t. Clearly in the case of some investment banks, certainly in the case of the auto makers their whining is just that. The fact I spent 25 years working for investment banks gives me a bit of a leg up over a salvage diver; still, when Bernanke warns Congress as he did today that without a bailout of a new order, we will have a financial meltdown, I just don’t know; I find it dangerous to doubt that. Can we make a case today as we have the past several that government intervention is always a bad thing? What if he’s right? In letting the system purge itself, our remedy all along, could it be that the heaves would prove fatal?
What startled us this week, specifically Wed evening is that the funding market for major world-wide institutions froze up. Not the bond market. Not the stock market. The O/N and short-term market, that which in the past provided liquidity for major operating institutions. This market provides funding for day-to-day operations; it has been around for 50 years. Normally the Royal Bk of Scotland (for purposed of illustration) is flush funds; these are lent out O/N or for short periods to Washington Mutual (for purposes of illustration) which is normally in need of short-term funds. If the RBS suddenly fears it won’t get it’s three day loan back, it will refuse to lend. That is what happened this week. But there was mass panic Thursday morning and the market locked up - nothing, only distrust. Even credit-worthy borrowers could not obtain their working capital. We agree that this would cause a rapid succession of failures; Paulson and Bernanke understood that.
If financial mastodons like AIG and the rest of these clowns are too large and too interconnected to fail yet not too smart to get themselves into situations where they need to be bailed out, then why let private firms engage in such activity in the first place? (I didn’t say that.)
Robert Craven
Thursday, September 18, 2008
The New Despotism
The British Labour government which followed the end of WWII, after some period of dormancy, has taken life in these United States. F.A. Hayek warned in The Road To Serfdom that those six years of socialist government in England would provide only despair. He explained that the attempts at economic planning would lead to a new form of despotism, "A despotism exercised perhaps by a conscientious and honest bureaucracy for what they sincerely believe is for the good of the country...but it is nevertheless an arbitrary government..... In deciding the relative importance of the different ends, the planner also decides the relative importance of the different groups and persons." The socialist government, "must of necessity take sides, impose its valuations on people and instead of assisting them in the advancement of their own ends, choose the ends for them."
We praised Paulson but just hours after that writing he and Bernanke came to the aid of the world’s largest insurer. We are told that the failure of AIG could have brought the financial world to its knees and perhaps all of us with it. This stretch is based on AIG’s being on the hook for $441 billion of "credit default swaps" - contracts to reimburse holders of mortgage-backed and other debt securities if that paper goes bad, a relatively new invention of Wall St, something in which AIG took a fling. That is, AIG got in trouble through poor management and risk taking in the provision of default insurance on securities it turns out it did not understand. As taxpayers all we get out of this deal is that we are now in the insurance business. Well, ok, the government drove a hard bargain; if AIG rebounds the taxpayer could make a killing, but, that is neither here nor there. Why the ad hoc decision, why take sides with AIG and abandon Lehman, why protect AIG employees and toss others out in the street? Because AIG sold more swaps to more banks and investment companies than Lehman did. Again thanks to the government’s arbitrary decision the banks and others which actually held these sweet-pea securities are now off the hook.
The Fed invoked a loophole which allows it to lend (rescue) non banks under "unusual and exigent" circumstances. The Fed apparently has the authority to rescue a pizza parlor if things get touchy in that industry. Decisions are being made ad hoc after firms find themselves in hot water. Certainly we have witnessed the undermining of the free market system - arbitrary swings of human judgment not grounded on any set of principles; there is no adherence to a rule of law. We have no rule of law then we have no democracy. "Nothing distinguishes more clearly conditions in a free country from those in a country under arbitrary government than the observance in the former of the great principles know as the Rule of Law," Hayek explains. "Stripped of all technicalities this means that all its actions are bound by rules fixed and announced beforehand - rules which make it possible to foresee with fair certainty how the authority will use its coercive powers...to plan one’s individual affairs on the basis of this knowledge."
Robert Craven
We praised Paulson but just hours after that writing he and Bernanke came to the aid of the world’s largest insurer. We are told that the failure of AIG could have brought the financial world to its knees and perhaps all of us with it. This stretch is based on AIG’s being on the hook for $441 billion of "credit default swaps" - contracts to reimburse holders of mortgage-backed and other debt securities if that paper goes bad, a relatively new invention of Wall St, something in which AIG took a fling. That is, AIG got in trouble through poor management and risk taking in the provision of default insurance on securities it turns out it did not understand. As taxpayers all we get out of this deal is that we are now in the insurance business. Well, ok, the government drove a hard bargain; if AIG rebounds the taxpayer could make a killing, but, that is neither here nor there. Why the ad hoc decision, why take sides with AIG and abandon Lehman, why protect AIG employees and toss others out in the street? Because AIG sold more swaps to more banks and investment companies than Lehman did. Again thanks to the government’s arbitrary decision the banks and others which actually held these sweet-pea securities are now off the hook.
The Fed invoked a loophole which allows it to lend (rescue) non banks under "unusual and exigent" circumstances. The Fed apparently has the authority to rescue a pizza parlor if things get touchy in that industry. Decisions are being made ad hoc after firms find themselves in hot water. Certainly we have witnessed the undermining of the free market system - arbitrary swings of human judgment not grounded on any set of principles; there is no adherence to a rule of law. We have no rule of law then we have no democracy. "Nothing distinguishes more clearly conditions in a free country from those in a country under arbitrary government than the observance in the former of the great principles know as the Rule of Law," Hayek explains. "Stripped of all technicalities this means that all its actions are bound by rules fixed and announced beforehand - rules which make it possible to foresee with fair certainty how the authority will use its coercive powers...to plan one’s individual affairs on the basis of this knowledge."
Robert Craven
Tuesday, September 16, 2008
The Purge and the US Taxpayer
The US government through the person of Hank Paulson drew the line this weekend on European-style state capitalism, forcing failing street firms to go cold turkey, calling the bluff of those who maintained that without a rescue our economy would implode. As Jeff Randall of the Telegraph put it, "In throwing Lehman to the dogs....Paulson is betting heavily that dire warnings of contagion, systematic risk and domino effect are little more than special pleading from hitherto Masters of the Universe who would like the taxpayer to save their over-priced skins."
Observers in the press today including Barron’s, the FT and WSJ agree with our earlier assessment that the trigger to all this mess can be traced to Greenspan’s mismanagement of the Fed. "The Fed kept interest rates too low for too long, creating a subsidy for debt and a global commodity price spike," notes the WSJ. "The excess liquidity and capital flows this spurred became the fuel for the wizards on Wall St who created new financial instruments that in turn fueled the housing bubble." Indeed, these seers worked out so many ways and instruments to make billions off the less-than-prime mortgage market that we could never keep up, really didn’t have a clue what they were talking about. As it turns out, neither did they.
So the purge begins. It will be painful yet it marks the beginning on the path to sobriety. Since the key problem as Paulson noted yesterday is based on housing prices which are in decline, we will see the end of the tunnel only when these prices stabilize. In the meantime, we may heed the WSJ’s suggestion for another Resolution Trust Corporation to buy, stabilize and liquidate these assets, just as the first one did during the 80's S&L crisis aftermath.
Over the next few weeks we can be more confident as taxpayers that the Treasury heard the message. We can be less confident however that the Fed has learned anything. We highlighted earlier how the Fed put us at risk in the Bear deal. Now we know that last weekend Bernanke opened the Fed lending window even further, and to institutions which are not even deposit takers, which were before not entitled to Fed largess. And in doing so the Fed now accepts all kinds of new risky collateral, including for the first time, equities in exchange for taxpayer’s credit. This is something to monitor closely in the days ahead.
Robert Craven
Observers in the press today including Barron’s, the FT and WSJ agree with our earlier assessment that the trigger to all this mess can be traced to Greenspan’s mismanagement of the Fed. "The Fed kept interest rates too low for too long, creating a subsidy for debt and a global commodity price spike," notes the WSJ. "The excess liquidity and capital flows this spurred became the fuel for the wizards on Wall St who created new financial instruments that in turn fueled the housing bubble." Indeed, these seers worked out so many ways and instruments to make billions off the less-than-prime mortgage market that we could never keep up, really didn’t have a clue what they were talking about. As it turns out, neither did they.
So the purge begins. It will be painful yet it marks the beginning on the path to sobriety. Since the key problem as Paulson noted yesterday is based on housing prices which are in decline, we will see the end of the tunnel only when these prices stabilize. In the meantime, we may heed the WSJ’s suggestion for another Resolution Trust Corporation to buy, stabilize and liquidate these assets, just as the first one did during the 80's S&L crisis aftermath.
Over the next few weeks we can be more confident as taxpayers that the Treasury heard the message. We can be less confident however that the Fed has learned anything. We highlighted earlier how the Fed put us at risk in the Bear deal. Now we know that last weekend Bernanke opened the Fed lending window even further, and to institutions which are not even deposit takers, which were before not entitled to Fed largess. And in doing so the Fed now accepts all kinds of new risky collateral, including for the first time, equities in exchange for taxpayer’s credit. This is something to monitor closely in the days ahead.
Robert Craven
Sunday, September 14, 2008
Monday Morning End to Wall St Socialism?
Last week found the Treasury literally on its knees begging the UK bank Barclays to rescue Lehman. Reports this am are that the Treasury, Fed and other regulators (working overtime at our expense) have given up on finding a buyer for an intact Lehman and now look to sell off parts of the firm, winding down the balance. Well find out soon enough, probably tomorrow.
Here we go again. What is this all about? What does this mean to US taxpayers? Is the preservation of these investment banks in the public’s interest?
One may consider the simplicity of the Chrysler bailout or the complexity of Wall St deals; they reflect the same change of order - government-sponsored socialism directed at frail or failing private industry. "We’re too big to fail," regulators are told by victims of poor judgement or other nuisances. Those who have losses want help; naturally a disaster of unimaginable consequences will be the result if they don’t get it. And most of the time - in the case of Wall St, because of the complicity, the near incestuous, clubby connection between the Federal Reserve, Treasury and the street’s major firms, and the pressure from major offshore investors such as China or the Saudis - they get it.
This time Treasury Secretary Paulson has resolutely stuck to his position that no taxpayer money goes to the Lehman bailout. Not really. Some of it already has. Still, this statement delivers hope. And if there is to be a change in government largess toward Wall St types it is because the growing public outrage is deafening. One may argue with the Treasury’s role but the Fed’s involvement, a mission-creep far from its original mandate of price stability, the role of Wall St deal maker at risk, is to some observers like retired St Louis Fed president Bill Poole, nothing if not appalling.
In March the Fed - in our view without any authority to do so - stepped in to manage the sale of a distressed Bear Stearns. The Fed extended a loan of $29bln to JPMorgan as an enticement for them to buy Bear. As collateral Morgan offered troubled mortgage-backed securities that were marked-to-market at $30bln but no one really knows what they are worth (at this writing there is no market for these securities). That is the problem for the taxpayer. The Fed will lose something, maybe eventually a lot. The Fed is a government bank and usually earns a surplus which is remitted to the Treasury. The losses will come out of that surplus, a taxpayer loss.
Next was the Fannie/Freddie bailout. This one was not so much the moral stretch due to the quasi governmental nature of both yet it will still cost us a fortune.
Finally, we will hear from other Wall St firms in the near term, perhaps next week as they too cry for help.
Why is it that we as taxpayers are asked to socialize the losses of fat cats whose third home was bought on the back of our recent mortgage, the same clowns who are now in a panic? Part is as noted above - the incestuous relationship between Wall St and its regulators, especially the Fed; it is done by reflex, aiding your pals. The factor driving the panic is the recent boom in what one keen observer called financial instruments of mass destruction - derivative securities. These are such things as "default swaps" and other arcane exercises that banks, hedge funds and other use to bet for or against certain market moves. The value of these instruments is in the trillions of dollars; most of this activity is unregulated. The fear is due to the size and complexity of it all. One party’s inability to honor its commitment could topple the rest. Or so we are told.
This fear is not as real as it is manufactured, and by guess who? Wall St types. A boatload of observers outside the club maintain otherwise - painful yes but a cataclysm? No way. One of the most credible of these being professor Alan Meltzer, a veteran economist at Carnegie Mellon. "I’ve heard this so many times," says Meltzer. "I don’t believe it." Janet Tavakoli, a Chicago-based consultant on derivative securities scoffs at the idea. Let’s find out she says, "It’s a good time to have a test case."
How then did we get into this mess? Greenspan’s mis-management of the Fed provides the beginning (see our Sep/2 sketch). The US government’s lack of understanding and lack of regulation of the derivatives market provides the ending. So things got tough for the financial masters of the universe. They now look to us for sustenance. As taxpayers we can no longer enable this behavior. Firms that may fail after doing stupid things should fail. There will certainly be more pain for the speculator, including the homeowner, but, the adjustment will be accelerated and then we can recover with a clean slate and a healthier economy. Finally, the government’s role is not to dole out our money to failing firms but to come to better understand the "maneuverings" of Wall St types and affect reasonable regulations aimed to prevent the mess in the first place. Where is Henry Gonzalez when we most need him?
Robert Craven
Here we go again. What is this all about? What does this mean to US taxpayers? Is the preservation of these investment banks in the public’s interest?
One may consider the simplicity of the Chrysler bailout or the complexity of Wall St deals; they reflect the same change of order - government-sponsored socialism directed at frail or failing private industry. "We’re too big to fail," regulators are told by victims of poor judgement or other nuisances. Those who have losses want help; naturally a disaster of unimaginable consequences will be the result if they don’t get it. And most of the time - in the case of Wall St, because of the complicity, the near incestuous, clubby connection between the Federal Reserve, Treasury and the street’s major firms, and the pressure from major offshore investors such as China or the Saudis - they get it.
This time Treasury Secretary Paulson has resolutely stuck to his position that no taxpayer money goes to the Lehman bailout. Not really. Some of it already has. Still, this statement delivers hope. And if there is to be a change in government largess toward Wall St types it is because the growing public outrage is deafening. One may argue with the Treasury’s role but the Fed’s involvement, a mission-creep far from its original mandate of price stability, the role of Wall St deal maker at risk, is to some observers like retired St Louis Fed president Bill Poole, nothing if not appalling.
In March the Fed - in our view without any authority to do so - stepped in to manage the sale of a distressed Bear Stearns. The Fed extended a loan of $29bln to JPMorgan as an enticement for them to buy Bear. As collateral Morgan offered troubled mortgage-backed securities that were marked-to-market at $30bln but no one really knows what they are worth (at this writing there is no market for these securities). That is the problem for the taxpayer. The Fed will lose something, maybe eventually a lot. The Fed is a government bank and usually earns a surplus which is remitted to the Treasury. The losses will come out of that surplus, a taxpayer loss.
Next was the Fannie/Freddie bailout. This one was not so much the moral stretch due to the quasi governmental nature of both yet it will still cost us a fortune.
Finally, we will hear from other Wall St firms in the near term, perhaps next week as they too cry for help.
Why is it that we as taxpayers are asked to socialize the losses of fat cats whose third home was bought on the back of our recent mortgage, the same clowns who are now in a panic? Part is as noted above - the incestuous relationship between Wall St and its regulators, especially the Fed; it is done by reflex, aiding your pals. The factor driving the panic is the recent boom in what one keen observer called financial instruments of mass destruction - derivative securities. These are such things as "default swaps" and other arcane exercises that banks, hedge funds and other use to bet for or against certain market moves. The value of these instruments is in the trillions of dollars; most of this activity is unregulated. The fear is due to the size and complexity of it all. One party’s inability to honor its commitment could topple the rest. Or so we are told.
This fear is not as real as it is manufactured, and by guess who? Wall St types. A boatload of observers outside the club maintain otherwise - painful yes but a cataclysm? No way. One of the most credible of these being professor Alan Meltzer, a veteran economist at Carnegie Mellon. "I’ve heard this so many times," says Meltzer. "I don’t believe it." Janet Tavakoli, a Chicago-based consultant on derivative securities scoffs at the idea. Let’s find out she says, "It’s a good time to have a test case."
How then did we get into this mess? Greenspan’s mis-management of the Fed provides the beginning (see our Sep/2 sketch). The US government’s lack of understanding and lack of regulation of the derivatives market provides the ending. So things got tough for the financial masters of the universe. They now look to us for sustenance. As taxpayers we can no longer enable this behavior. Firms that may fail after doing stupid things should fail. There will certainly be more pain for the speculator, including the homeowner, but, the adjustment will be accelerated and then we can recover with a clean slate and a healthier economy. Finally, the government’s role is not to dole out our money to failing firms but to come to better understand the "maneuverings" of Wall St types and affect reasonable regulations aimed to prevent the mess in the first place. Where is Henry Gonzalez when we most need him?
Robert Craven
Thursday, September 11, 2008
Fannie & Freddie
Background: The Federal National Mortgage Assoc (Fannie) and the Federal Home Mortgage Corporation (Freddie) were created as conduits between the home buyer (borrower) and a greater pool of funds than just the immediate lender could supply. Roosevelt birthed Fannie as a pure government agency in 1938 to spark the depression era home market. Johnson privatized Fannie in 1968 to get it off the books; Freddie was created two years later, also off the books. It was understood that these two were not a direct US credit but had "drawing rights", an opaque near guarantee.
Business types, shareholders and politicians working together through Fannie and Freddie naturally exploited public backing. Both became a profit center in their own right and as part of that, the past few years accumulated sub-par mortgages on speculation. Bad behavior was encouraged by Congress because the mortgage giants returned some of their profits directly as campaign funds or as "contributions" to favored constituents.
Democrat Barney Frank, chairman of the House Financial Services Committee, could be called the patron saint of these two. From the WSJ : "He encouraged the companies to guarantee more ‘affordable’ mortgages, thus abetting their disastrous plunge into subprime and Alt-A loans. He also pushed for, and got, an increase in the conforming-loan limits to allow Fan and Fred to securitize and guarantee larger mortgages. And he pressured regulators to ease up on their capital requirements -- which now means taxpayers will have to make up that capital shortfall."
The chartered purpose of both Fannie and Freddie is simply to buy loans from original lenders, take on the mortgage default risk, place a guarantee on that paper and then package it and sell it to institutional buyers. But because both took unnecessary risks it left them in bad shape for doing their real job. All the while Bernanke assured us there was no problem, telling Congress a few months ago that Fannie and Freddie were "adequately capitalized" and in "no danger of failing". Not quite. Both were insolvent, or close to it with an absurdly slender capital cushion given their exposure - perhaps roughly half the US market, that is, they hold or back more than $5trillion in mortgages.
Treasury Secretary Paulson sought powers in July to mount a rescue operation. Paulson was motivated by pressure from China, other sovereigns and central banks which had bought Fannie and Freddie debt by the truck load because the interest was higher than the rock low interest on direct US debt. These folks suddenly found themselves massively exposed. Thus, Paulson pulled the trigger Sep/6, taking control of both, firing incompetents, suspending dividends. The Treasury, all of us, own almost 80% of their stock.
Implications: As Alaska Governor Palin noted over the weekend, both now represent a substantial burden to taxpayers. The Congressional Budget Office has already placed $25 billion of estimated costs for Fannie and Freddie over fiscal ‘09 and ‘10. The final price tag will run much higher. The WSJ puts the figure at $200 billion. Our friend Bill Poole (former St Louis Fed Pres) reckons taxpayer losses will approach $300 billion.
Robert Craven
Business types, shareholders and politicians working together through Fannie and Freddie naturally exploited public backing. Both became a profit center in their own right and as part of that, the past few years accumulated sub-par mortgages on speculation. Bad behavior was encouraged by Congress because the mortgage giants returned some of their profits directly as campaign funds or as "contributions" to favored constituents.
Democrat Barney Frank, chairman of the House Financial Services Committee, could be called the patron saint of these two. From the WSJ : "He encouraged the companies to guarantee more ‘affordable’ mortgages, thus abetting their disastrous plunge into subprime and Alt-A loans. He also pushed for, and got, an increase in the conforming-loan limits to allow Fan and Fred to securitize and guarantee larger mortgages. And he pressured regulators to ease up on their capital requirements -- which now means taxpayers will have to make up that capital shortfall."
The chartered purpose of both Fannie and Freddie is simply to buy loans from original lenders, take on the mortgage default risk, place a guarantee on that paper and then package it and sell it to institutional buyers. But because both took unnecessary risks it left them in bad shape for doing their real job. All the while Bernanke assured us there was no problem, telling Congress a few months ago that Fannie and Freddie were "adequately capitalized" and in "no danger of failing". Not quite. Both were insolvent, or close to it with an absurdly slender capital cushion given their exposure - perhaps roughly half the US market, that is, they hold or back more than $5trillion in mortgages.
Treasury Secretary Paulson sought powers in July to mount a rescue operation. Paulson was motivated by pressure from China, other sovereigns and central banks which had bought Fannie and Freddie debt by the truck load because the interest was higher than the rock low interest on direct US debt. These folks suddenly found themselves massively exposed. Thus, Paulson pulled the trigger Sep/6, taking control of both, firing incompetents, suspending dividends. The Treasury, all of us, own almost 80% of their stock.
Implications: As Alaska Governor Palin noted over the weekend, both now represent a substantial burden to taxpayers. The Congressional Budget Office has already placed $25 billion of estimated costs for Fannie and Freddie over fiscal ‘09 and ‘10. The final price tag will run much higher. The WSJ puts the figure at $200 billion. Our friend Bill Poole (former St Louis Fed Pres) reckons taxpayer losses will approach $300 billion.
Robert Craven
Tuesday, September 2, 2008
Greenspan and the Home Mortgage Crisis
American homeowners are not a happy bunch. First, the party began to end two years ago; next some Wall St types got caught with their pants down early this year, then home prices really took a dive. Credit vanished. Finally, as taxpayers homeowners just might be asked to bail out the very clowns that helped get them into this mess. What in the world is going on? Where did this all start?
Professor Anna Schwartz (92 and still working at the National Bureau of Economic Research) is a revered figure in central banking circles. She with Milton Friedman wrote the joint opus - A Monetary History of the United States, which revolutionized thinking about the great depression. The book was a bombshell, turning conventional wisdom upside down. What Friedman/Schwartz demonstrated was that incompetent Fed officials caused the depression, not the free market. I met Schwartz in Oct/93 as the two of us testified before the House Banking Committee. And what does she have to say now? According to Schwartz the original sin of the Greenspan Fed was to hold rates at 1% from 2003 to 2004, long after the dotcom bubble was over. "Rates of 1% were bound to encourage all kinds of risky behavior," says Schwartz.
By "risky behavior" Schwartz means that of both lenders and borrowers in the housing market, and the lenders’ Wall St counterparts. Looking for higher yields in the artificially low rate environment of ‘03 and ‘04, encouraged by politicians to direct more lending to poorer neighborhoods, encouraged by the lack of supervision (50% of subprime loans were made by state chartered but not federally supervised companies), encouraged too by Wall St, lenders increased risky subprime lending through nontraditional loans. Brokers originated the loans with little concern for quality and lenders went along as they could simply peddle the loans to Wall St underwriters who in turn packaged the loans as securities to sell to unwary investors. We all know what happened next.
Greenspan has looked to clear his name by blaming the period of artificially low rates and the bubble this created on the Asian saving glut which supposedly created stimulus beyond the control of the Fed. Schwartz says this is nonsense. "This attempt to exculpate himself is not convincing. The Fed failed to confront something that was evident. It can’t be blamed on global events," she says. And in fact Greenspan did not understand the situation. His skill has always been a remarkable ability to charm politicians coupled with a gift to say absolutely nothing at great length with no real position of any kind. He got where he did because of his political promiscuity; his "strength" is that he could be trusted not to rock the establishment boat, which includes maintaining a near incestuous relationship with Wall St. His skill at predicting events tied to policy change is about nil. CNBC one described Greenspan’s forecasting record as "the worst". Worth mag in 1995 said that, "...most of his predictions have turned out to be wrong." Indeed, as a private economist and a hired gun for Charley Keating’s Lincoln S&L (his fee was $40,000) Greenspan told California banking regulators that Lincoln management, "...was seasoned and expert...with a long tack record of outstanding success." He told the regulators that Keating’s S&L would pose no risk of loss to federal insurers (i.e. taxpayers). In fact, Lincoln cost the taxpayer $3 billion bucks. Keating was convicted of securities fraud, conspiracy and racketeering.
Chairman Bernanke’s intellectual honesty detaches him from the Greenspan mold yet he has for the most part carried on the tradition. His Fed remains too close to Wall St and financial institutions - responding to their needs to the detriment of the wider economy. The Fed overreacted to the crisis, misjudging the importance of financial stability to the overall economy and created a deeper inflation problem as a result. Another acquaintance of ours - Bill Poole, until recently head of the St Louis Fed, called the Bernanke-Paulson decision to take some of the banks’ diciest loans onto it own balance sheet "appalling," the worst mistake of a generation.
Well, most of us recall the Chrysler debacle of 1979. It like Bear Stearns was "too big to fail". Free market thinkers worried not that the bailout would fail but that it would work. It did, thus lowering any resistance to future flights of Wall St socialism. Of course Fed seers argued that Bear was so connected to the financial system in opaque ways that the radiating consequences would be a catastrophe. We doubt that is true. We do know that the Fed now has a mandate to be the deal makers for Wall St’s brand of socialism - socializing losses while privatizing gains.
And so the irony is that the mortgage crisis is in large part the fault of the Fed’s own reckless monetary policy. Low real interest rates for too long created a subsidy for debt that spurred the housing and credit bubbles that have now burst. Prices got higher than they should have been. The only healthy recovery is to let those prices settle on their own, to let those firms which reaped great benefits now accept the consequences of their overreaching. Fed-Treasury interference in the process of price discovery will only prolong the process and increase the odds that losses are in fact dumped onto taxpayers - a very real possibility.
Robert Craven
Professor Anna Schwartz (92 and still working at the National Bureau of Economic Research) is a revered figure in central banking circles. She with Milton Friedman wrote the joint opus - A Monetary History of the United States, which revolutionized thinking about the great depression. The book was a bombshell, turning conventional wisdom upside down. What Friedman/Schwartz demonstrated was that incompetent Fed officials caused the depression, not the free market. I met Schwartz in Oct/93 as the two of us testified before the House Banking Committee. And what does she have to say now? According to Schwartz the original sin of the Greenspan Fed was to hold rates at 1% from 2003 to 2004, long after the dotcom bubble was over. "Rates of 1% were bound to encourage all kinds of risky behavior," says Schwartz.
By "risky behavior" Schwartz means that of both lenders and borrowers in the housing market, and the lenders’ Wall St counterparts. Looking for higher yields in the artificially low rate environment of ‘03 and ‘04, encouraged by politicians to direct more lending to poorer neighborhoods, encouraged by the lack of supervision (50% of subprime loans were made by state chartered but not federally supervised companies), encouraged too by Wall St, lenders increased risky subprime lending through nontraditional loans. Brokers originated the loans with little concern for quality and lenders went along as they could simply peddle the loans to Wall St underwriters who in turn packaged the loans as securities to sell to unwary investors. We all know what happened next.
Greenspan has looked to clear his name by blaming the period of artificially low rates and the bubble this created on the Asian saving glut which supposedly created stimulus beyond the control of the Fed. Schwartz says this is nonsense. "This attempt to exculpate himself is not convincing. The Fed failed to confront something that was evident. It can’t be blamed on global events," she says. And in fact Greenspan did not understand the situation. His skill has always been a remarkable ability to charm politicians coupled with a gift to say absolutely nothing at great length with no real position of any kind. He got where he did because of his political promiscuity; his "strength" is that he could be trusted not to rock the establishment boat, which includes maintaining a near incestuous relationship with Wall St. His skill at predicting events tied to policy change is about nil. CNBC one described Greenspan’s forecasting record as "the worst". Worth mag in 1995 said that, "...most of his predictions have turned out to be wrong." Indeed, as a private economist and a hired gun for Charley Keating’s Lincoln S&L (his fee was $40,000) Greenspan told California banking regulators that Lincoln management, "...was seasoned and expert...with a long tack record of outstanding success." He told the regulators that Keating’s S&L would pose no risk of loss to federal insurers (i.e. taxpayers). In fact, Lincoln cost the taxpayer $3 billion bucks. Keating was convicted of securities fraud, conspiracy and racketeering.
Chairman Bernanke’s intellectual honesty detaches him from the Greenspan mold yet he has for the most part carried on the tradition. His Fed remains too close to Wall St and financial institutions - responding to their needs to the detriment of the wider economy. The Fed overreacted to the crisis, misjudging the importance of financial stability to the overall economy and created a deeper inflation problem as a result. Another acquaintance of ours - Bill Poole, until recently head of the St Louis Fed, called the Bernanke-Paulson decision to take some of the banks’ diciest loans onto it own balance sheet "appalling," the worst mistake of a generation.
Well, most of us recall the Chrysler debacle of 1979. It like Bear Stearns was "too big to fail". Free market thinkers worried not that the bailout would fail but that it would work. It did, thus lowering any resistance to future flights of Wall St socialism. Of course Fed seers argued that Bear was so connected to the financial system in opaque ways that the radiating consequences would be a catastrophe. We doubt that is true. We do know that the Fed now has a mandate to be the deal makers for Wall St’s brand of socialism - socializing losses while privatizing gains.
And so the irony is that the mortgage crisis is in large part the fault of the Fed’s own reckless monetary policy. Low real interest rates for too long created a subsidy for debt that spurred the housing and credit bubbles that have now burst. Prices got higher than they should have been. The only healthy recovery is to let those prices settle on their own, to let those firms which reaped great benefits now accept the consequences of their overreaching. Fed-Treasury interference in the process of price discovery will only prolong the process and increase the odds that losses are in fact dumped onto taxpayers - a very real possibility.
Robert Craven
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