The Great Recession is over. Remember, the recession ended in June 2009 getting close to two years ago.
To many, it sure doesn’t feel like it. Since the second quarter of 2009, over the last six quarters, real GDP has grown by 4.5%. The average year-over-year growth rate for the five quarters since the recession ended is 2.3%. This is way below historical experience.
The reason: housing usually leads the economy into a recession, and, housing usually leads the economy out of the recession.
Not so this time.
And, this is why we are in the mess we are in. Housing is not going to rebound any time soon.
For one thing, banks and thrift institutions (what are they?) really don’t want to provide financing for mortgages. They really don’t want to hold mortgages. For another, the mess with Fannie Mae and Freddie Mac is so uncertain and confused and uncomfortable that they want to have as little to do with mortgages as possible.
In order to understand this I had to go through the mortgage process myself last year. I have no problem getting a loan. I went to the bank where I do most of my business and asked about getting a loan. Sure, they said, and arranged a meeting with the mortgage banker they do business with who approved my loan and all of a sudden my mortgage is with Fannie Mae and I am making payments to the mortgage servicing subsidiary of a major bank somewhere far to the west of Philadelphia. Never in my life have I had a mortgage in the hands of Fannie Mae. Oh, well…
This is, to me, the paradigm of the banking industry. Banks, especially smaller banks, don’t want to hold mortgages on their balance sheets. And, this is just what we wanted it. In the late 1960s and early 1970s when I was in Washington, D. C. and we were creating the mortgage-backed security the idea was to get mortgages out of the commercial banks and thrift institutions and into the hands pension funds and insurance companies who needed long-term assets. Then the depository institutions could lend more.
Why did we create the mortgage-backed security? So, politicians could get re-elected. If more families in America could own their own home through things the government did, then they would be more likely to vote back into office the people that were responsible for their owning their own home.
Likewise with lower income housing, after all, the number one job of politicians is to get re-elected.
So, the United States government got into the business of inflating the housing sector so that
more-and-more American families could own their own home.
How successful was this? Well, in the early 1970s, no mortgages were traded on any capital market in the world. Michael Lewis’ incredible book, “Liar’s Poker”, related to the middle- to late-1980s, and was a large part about the market for mortgage-backed securities which had become the largest component of the capital markets. And, as they say, the rest is history.
But, housing was always the fulcrum on which economic cycles turned. The basic reason was that housing construction could easily be started up and stopped and started up again. The longest post-World War II recessions (before the Great Recession) were one year and 4 months in length and there were only two of them. In order to slow down economic growth and fight inflation, the Federal Reserve would raise interest rates and this would cause mortgage lending to slow down or stop for a time. After sufficient time the Federal Reserve would lower rates once again, mortgage lending would pick up and economic growth would expand once more.
Business lending always lagged the movements in mortgage lending.
It seems as if mortgage lending and housing construction has tapped out. The credit inflation of the housing industry of the last sixty years cause sufficient dislocations that it is going to take a while for the United States economy to re-structure so that the housing industry can pick up once again.
Financial institutions are still facing major, major problems related to the housing industry, not counting the major problems relating to commercial real estate. Commercial banks are slowly accepting the fact that they are going to have to buy back many troubled mortgages, especially mortgages that were sold to Fannie Mae and Freddie Mac. Bank of America has paid back a little, but more is expected. JPMorgan Chase also has a large exposure. What is the hole? Standard & Poor’s has estimated that banks will have to buy back around $60 billion in bad mortgage loans which they sold to others. Some estimates place this total as high as $150 billion. (http://dealbook.nytimes.com/2011/02/09/banks-could-face-60-billion-tab-on-bad-loans/?ref=todayspaper)
In addition to this, the latest statistics indicate that more than one in four mortgages outstanding are underwater, that is, these mortgages are on homes that have a market value less than the amount owed on the mortgage. Homeowners facing this situation are still walking away from their obligations. Who picks up the difference? And, housing prices still remain weak in many markets within the nation.
About one in four individuals in America are either unemployed or under-employed. Savings can only go so far in keeping up payments on the home mortgage. And, 30 states have run out of money in their unemployment trust funds and are borrowing from the United State government to cover the shortfall. How long is this going to continue to be covered?
Manufacturing businesses are only running at three-fourths of capacity, up slightly from historical lows. With so much idle capacity, businesses are not interested in purchasing more capital and hiring more workers to create jobs and incomes. Purchasing seems to be very skewed…basics and luxuries…and computers. This is not very encouraging for a near term pickup.
With little or no housing pickup, expectations for a strong business pickup are pretty low. And, the Fed’s QE2 is not going to have a major impact on the reduction in unemployment or under-employment!
People have one way out of this dilemma in the short run. Inflation!
Inflation may not put the people back into a job, but it can cause housing prices to rise and this can buy them out of the underwater situation. Still, commercial banks, I believe, want to have as little to do with holding mortgages as possible. And, if they originate, or get their mortgage banking friends to originate mortgages, who are they going to sell them to?
Even so, all this will just postpone the housing problem until another time, just like we have done for the last sixty years. We just see high levels of under-employment, low levels of capacity utilization, high amounts of inflation, more debt and more debt, and where does this end?
The Great Recession is over. However, the Great Recovery is nowhere in sight.
Showing posts with label freddie mac. Show all posts
Showing posts with label freddie mac. Show all posts
Thursday, February 10, 2011
Wednesday, December 15, 2010
Housing Still in Cumulative Downward Cycle?
Why would financial institutions want to put home mortgages on their balance sheets right now?
Answer: they really don’t want to add mortgages to their balance sheets.
The consequence is that very tight credit standards exist for mortgages at the present time, a time when credit standards have usually been increasing as the economy comes out of a recession. A Federal Reserve report covering the third quarter of 2010 showed that 13 percent of bank loan officers stated that they were working with tighter requirements. Only 4 percent stated that they were working with easier ones.
Banks, of course, are not issuing non-governmental mortgage-backed securities. In fact, the amount of mortgage-backed securities outstanding has plummeted beginning in 2008. Federal Reserve statistics indicate that privately issued pools of home mortgages fell by $310 billion in 2008, by almost $340 billion in 2009 and have fallen by about $230 billion in 2010.
Agency- and GSE-backed mortgage pools are increasing but at a rate way below previous levels.
In 2008, home mortgages totaled over $11.1 trillion; at the end of the third quarter of 2010, there was only about $10.6 trillion in home mortgages outstanding in the United States, a 4.5 percent drop.
It is apparent that financial institutions do not want to hold mortgages on their own balance sheets and if they cannot securitize them and sell them then they just don’t originate them.
There appears to be two reasons contributing to this behavior. First, delinquencies and foreclosures are still increasing at near record rates. Trying to work out loans that are delinquent and carrying out the process of foreclosure takes time and human resources, resources that could be used to originate mortgages. Second, home owners do not seem to be borrowing if they don’t have to. Mortgage applications have fallen by more than a third from the levels reached in late 2008 and show an almost continuous decline in 2010. Why should home people move if they don’t have to and home prices continue to decline?
Furthermore, Fannie Mae and Freddie Mac have gotten very aggressive demanding that commercial banks buy back defaulted loans if it can be shown that the mortgages Fannie and Freddie acquired were not originated under stated underwriting guidelines. Financial institutions are scared due to the fact that if they have to buy back defaulted loans…it may put them out of business.
Why should the affected banks make any more loans if they might go out of business? Making loans under these circumstances is just a waste of time.
In terms of home prices, Zillow.com has reported that home prices will have dropped by about 7 percent in 2010. In 2011, Fitch Ratings has projected a further 10 percent decline in home prices.
The dynamics of the housing market, therefore, is that falling employment and incomes are still a problem in many sectors of the economy. Banks are not very willing to originate new home mortgages and have tightened requirements to obtain loans. Housing prices fall because the demand for homes has dropped and there is a large inventory of foreclosed properties on the market. This puts more homeowners “under water” with respect to the outstanding loan values they have. And the cycle continues…downward.
Given such a cycle, there is very little incentive for financial institutions to put home mortgages
on their balance sheets.
But, there is another possibility threatening the value of the home mortgages already on the balance sheets of commercial banks.
Fannie Mae and Freddie Mac are reported to be in discussions with people from the Obama administration seeking support for a program to write down loan balances on home mortgages where the borrowers mortgage is greater than the current market price of their homes.
Doing so would help these home owners by “forgiving” the amount of the loan that is underwater. This would reduce the probability of more foreclosures due to a mortgage being underwater and it would also have the effect of reducing loan payments. The “write down” would cost the American taxpayer as the government would have to pay for the amount written down.
Even more scary is the fact that if Fannie Mae and Freddie Mac start to reduce loan amounts to levels that are more consistent with current prices, what pressure would be put upon commercial banks to do exactly the same thing? And, this pressure would seemingly grow as the next Presidential election came nearer.
Commercial banks, both the largest 25 banks in the country and those smaller than these 25 banks, have slightly more than 14 percent of their assets in home mortgages. How much of a hit could these banks absorb and still remain solvent?
Even a little more “write down” in the face of all the other problems that reside on the balance sheets of the banking system would seem to be very troublesome. (See, for example, http://seekingalpha.com/article/241787-the-pending-2011-debt-refinancing-for-commercial-banks.)
The banking industry is fighting such a write down.
The problems existing banks are facing just seem to go on-and-on. Is it any wonder that the banking system, as a whole, is shrinking its loan portfolio? Is it any wonder that federal regulators are continuing to “prop up” the banking system so that these difficulties can be worked out as smoothly as possible? Is it any wonder that the banking system is not contributing to the economic recovery?
Even with some economic recovery taking place, there are still areas of the economy…housing and commercial real estate…that seem to be in on a cumulative downward cycle.
Answer: they really don’t want to add mortgages to their balance sheets.
The consequence is that very tight credit standards exist for mortgages at the present time, a time when credit standards have usually been increasing as the economy comes out of a recession. A Federal Reserve report covering the third quarter of 2010 showed that 13 percent of bank loan officers stated that they were working with tighter requirements. Only 4 percent stated that they were working with easier ones.
Banks, of course, are not issuing non-governmental mortgage-backed securities. In fact, the amount of mortgage-backed securities outstanding has plummeted beginning in 2008. Federal Reserve statistics indicate that privately issued pools of home mortgages fell by $310 billion in 2008, by almost $340 billion in 2009 and have fallen by about $230 billion in 2010.
Agency- and GSE-backed mortgage pools are increasing but at a rate way below previous levels.
In 2008, home mortgages totaled over $11.1 trillion; at the end of the third quarter of 2010, there was only about $10.6 trillion in home mortgages outstanding in the United States, a 4.5 percent drop.
It is apparent that financial institutions do not want to hold mortgages on their own balance sheets and if they cannot securitize them and sell them then they just don’t originate them.
There appears to be two reasons contributing to this behavior. First, delinquencies and foreclosures are still increasing at near record rates. Trying to work out loans that are delinquent and carrying out the process of foreclosure takes time and human resources, resources that could be used to originate mortgages. Second, home owners do not seem to be borrowing if they don’t have to. Mortgage applications have fallen by more than a third from the levels reached in late 2008 and show an almost continuous decline in 2010. Why should home people move if they don’t have to and home prices continue to decline?
Furthermore, Fannie Mae and Freddie Mac have gotten very aggressive demanding that commercial banks buy back defaulted loans if it can be shown that the mortgages Fannie and Freddie acquired were not originated under stated underwriting guidelines. Financial institutions are scared due to the fact that if they have to buy back defaulted loans…it may put them out of business.
Why should the affected banks make any more loans if they might go out of business? Making loans under these circumstances is just a waste of time.
In terms of home prices, Zillow.com has reported that home prices will have dropped by about 7 percent in 2010. In 2011, Fitch Ratings has projected a further 10 percent decline in home prices.
The dynamics of the housing market, therefore, is that falling employment and incomes are still a problem in many sectors of the economy. Banks are not very willing to originate new home mortgages and have tightened requirements to obtain loans. Housing prices fall because the demand for homes has dropped and there is a large inventory of foreclosed properties on the market. This puts more homeowners “under water” with respect to the outstanding loan values they have. And the cycle continues…downward.
Given such a cycle, there is very little incentive for financial institutions to put home mortgages
on their balance sheets.
But, there is another possibility threatening the value of the home mortgages already on the balance sheets of commercial banks.
Fannie Mae and Freddie Mac are reported to be in discussions with people from the Obama administration seeking support for a program to write down loan balances on home mortgages where the borrowers mortgage is greater than the current market price of their homes.
Doing so would help these home owners by “forgiving” the amount of the loan that is underwater. This would reduce the probability of more foreclosures due to a mortgage being underwater and it would also have the effect of reducing loan payments. The “write down” would cost the American taxpayer as the government would have to pay for the amount written down.
Even more scary is the fact that if Fannie Mae and Freddie Mac start to reduce loan amounts to levels that are more consistent with current prices, what pressure would be put upon commercial banks to do exactly the same thing? And, this pressure would seemingly grow as the next Presidential election came nearer.
Commercial banks, both the largest 25 banks in the country and those smaller than these 25 banks, have slightly more than 14 percent of their assets in home mortgages. How much of a hit could these banks absorb and still remain solvent?
Even a little more “write down” in the face of all the other problems that reside on the balance sheets of the banking system would seem to be very troublesome. (See, for example, http://seekingalpha.com/article/241787-the-pending-2011-debt-refinancing-for-commercial-banks.)
The banking industry is fighting such a write down.
The problems existing banks are facing just seem to go on-and-on. Is it any wonder that the banking system, as a whole, is shrinking its loan portfolio? Is it any wonder that federal regulators are continuing to “prop up” the banking system so that these difficulties can be worked out as smoothly as possible? Is it any wonder that the banking system is not contributing to the economic recovery?
Even with some economic recovery taking place, there are still areas of the economy…housing and commercial real estate…that seem to be in on a cumulative downward cycle.
Friday, October 22, 2010
Maybe Things Have Changed
During my professional career, three things have seemingly dominated the American culture. First, the labor unions; second, the manufacturing industries; and the third was home ownership.
I spent my formative years in Michigan and nothing dominated the newspapers more than the activity of labor unions and the car industry. That was just a part of the society there. Of course, there was the steel industry and in the case of unions there was the coal industry and so on. Nothing is more vivid to me than the role of manufacturing and labor unions in the culture of my youth.
If anything else came close it was the idea of home ownership and the suburban sprawl. It was especially important to put the returning soldiers into homes and to help them live the “true” American life.
These days are gone, but the role they played in this earlier existence still dominates our national life and our political philosophy. Maybe that needs to change. Maybe we need to re-direct our attention.
The manufacturing industries have become a smaller and smaller part of the United States economic machine…for better or worse. The economy has shifted toward information and “information goods”. An “information good” is broadly defined as anything that can be digitized. Besides the computer industry, three other major subcategories in this area are in financial services, higher education, and government. Finance, colleges and universities, and government deal, primarily, with information and “information goods”.
The “new” structure of commerce in the United States is tilted toward the more educated, the more mobile, and the modern urban community. The “old” structure relied more on physical effort, the stationary, and the suburban life.
That is, the driving forces in this new modern world are not cars, and steel, and manual labor.
The thrust of the labor unions has also changed and it seems as if unions have spread into the area of government as the presence of government has grown in the society over the last fifty years. Back in “the good old days”, unions were connected with industry and hard and dangerous jobs and “national” monopolies. International competition was not a threat at that time.
Today, the presence of unions has radically shifted. In the United States most union members are connected with government. This is also the case in the rest of the western, democratic nations. Labor unions are still important in the automobile industry, but the automobile industry is just not as important any more. I have seen figures that indicate that something like 60% of the membership in American labor unions these days is related to government. This move has completely changed not only the location of labor unions in the United States; it has also changed the focus.
The desire to get Americans into their own homes has been present in the country since the country was started. This was felt to be important not only for individuals themselves, but for the substantial positive externalities that were felt to accompany the growth of home ownership.
Today, we may find that renting may become more prevalent in the faster-moving, more educated, “urban” workforce of the 21st century. And, this mobility is becoming more global than just national.
The economic policies of the government have been built around the above factors which, I contend, are not as prevalent as they once were.
Monetary and fiscal stimulus were more effective in an age of “heavy manufacturing” because these industries relied upon fixed capital, huge plants and machinery, and a “local” labor force. When unemployment happened, labor stayed “at home”, both in terms of location, but also in terms of skills because the workers needed to know little else. Monetary and fiscal stimulus put these workers back to work in their old jobs as sales picked up. New investment also was created as the economy rebounded.
The same is not true in the Information Age. “Information” companies do not have huge plants and large machines to maintain. Downsizing and the shifting of the employees occurs incrementally and more rapidly than in the past. People move and re-train and change. Monetary and fiscal stimulus is not so effective because the companies and have “moved on” and do not re-hire people back into their old jobs as did the manufacturing firms. The employees have also “moved on”. Furthermore, these companies do not have large capital investments to undertake that help the economy to re-start.
The labor union issue is surfacing in another way. Labor unions connected with government workers have become very important in recent years and have been very successful in gaining large settlements related to health benefits and retirement. A recent edition of the Economist magazine has covered some of the issues here. The problem: “One California mayor estimates that the effective cost of employing each police officer and fireman is $180,000 a year. That sum is not their take-home pay. For police and firefighters, the big costs occur when they stop working—retirement at 50, combined with inflation-linking, health benefits and lump sums for unused sick leave…California is also shelling out fortunes to retired state and municipal managers; more than 9,000 have retirement incomes of over $100,000 a year.”
And, these pension promises have been subject to “Alice-in-Wonderland accounting.” The Economist presents figures that pension liabilities are estimated to be around $5.3 trillion, compared with $1.9 trillion of assets. “The total shortfall of $3.4 trillion is the equivalent of a quarter of all federal debt.”
So, when it comes to governmental employees, the fighting is not over peanuts. And, this is a worldwide issue as can be noted in the riots taking place in Greece, Italy, Portugal, Spain and France over their government’s retirement and pension payments. And, yesterday it was revealed that the new austerity budget of the British government contains a reduction of 500,000 public sector jobs. “Today, the fight begins,” states the general secretary of the largest government union in the UK.
The role of labor unions in the 21st century society seems to need to be re-addressed going
forward.
Finally, the pressure of the government to achieve high rates of home ownership must be re-visited. We, in the United States, have paid a major price for the emphasis placed on this goal and the resources that were allocated toward its achievement. Payment is still coming due in the area of foreclosures, commercial real estate bankruptcies, and the resolving of government support of Fannie Mae and Freddie Mac. It is very likely that we, the people of the United States, will be paying for this bailout for many years to come.
The whole point of this post is to argue for a change in some of the assumptions behind the economic policies of the leaders of the United States government. The world has changed. Maybe our leaders need to change their outlook as well.
Or, is that too much to ask?
I spent my formative years in Michigan and nothing dominated the newspapers more than the activity of labor unions and the car industry. That was just a part of the society there. Of course, there was the steel industry and in the case of unions there was the coal industry and so on. Nothing is more vivid to me than the role of manufacturing and labor unions in the culture of my youth.
If anything else came close it was the idea of home ownership and the suburban sprawl. It was especially important to put the returning soldiers into homes and to help them live the “true” American life.
These days are gone, but the role they played in this earlier existence still dominates our national life and our political philosophy. Maybe that needs to change. Maybe we need to re-direct our attention.
The manufacturing industries have become a smaller and smaller part of the United States economic machine…for better or worse. The economy has shifted toward information and “information goods”. An “information good” is broadly defined as anything that can be digitized. Besides the computer industry, three other major subcategories in this area are in financial services, higher education, and government. Finance, colleges and universities, and government deal, primarily, with information and “information goods”.
The “new” structure of commerce in the United States is tilted toward the more educated, the more mobile, and the modern urban community. The “old” structure relied more on physical effort, the stationary, and the suburban life.
That is, the driving forces in this new modern world are not cars, and steel, and manual labor.
The thrust of the labor unions has also changed and it seems as if unions have spread into the area of government as the presence of government has grown in the society over the last fifty years. Back in “the good old days”, unions were connected with industry and hard and dangerous jobs and “national” monopolies. International competition was not a threat at that time.
Today, the presence of unions has radically shifted. In the United States most union members are connected with government. This is also the case in the rest of the western, democratic nations. Labor unions are still important in the automobile industry, but the automobile industry is just not as important any more. I have seen figures that indicate that something like 60% of the membership in American labor unions these days is related to government. This move has completely changed not only the location of labor unions in the United States; it has also changed the focus.
The desire to get Americans into their own homes has been present in the country since the country was started. This was felt to be important not only for individuals themselves, but for the substantial positive externalities that were felt to accompany the growth of home ownership.
Today, we may find that renting may become more prevalent in the faster-moving, more educated, “urban” workforce of the 21st century. And, this mobility is becoming more global than just national.
The economic policies of the government have been built around the above factors which, I contend, are not as prevalent as they once were.
Monetary and fiscal stimulus were more effective in an age of “heavy manufacturing” because these industries relied upon fixed capital, huge plants and machinery, and a “local” labor force. When unemployment happened, labor stayed “at home”, both in terms of location, but also in terms of skills because the workers needed to know little else. Monetary and fiscal stimulus put these workers back to work in their old jobs as sales picked up. New investment also was created as the economy rebounded.
The same is not true in the Information Age. “Information” companies do not have huge plants and large machines to maintain. Downsizing and the shifting of the employees occurs incrementally and more rapidly than in the past. People move and re-train and change. Monetary and fiscal stimulus is not so effective because the companies and have “moved on” and do not re-hire people back into their old jobs as did the manufacturing firms. The employees have also “moved on”. Furthermore, these companies do not have large capital investments to undertake that help the economy to re-start.
The labor union issue is surfacing in another way. Labor unions connected with government workers have become very important in recent years and have been very successful in gaining large settlements related to health benefits and retirement. A recent edition of the Economist magazine has covered some of the issues here. The problem: “One California mayor estimates that the effective cost of employing each police officer and fireman is $180,000 a year. That sum is not their take-home pay. For police and firefighters, the big costs occur when they stop working—retirement at 50, combined with inflation-linking, health benefits and lump sums for unused sick leave…California is also shelling out fortunes to retired state and municipal managers; more than 9,000 have retirement incomes of over $100,000 a year.”
And, these pension promises have been subject to “Alice-in-Wonderland accounting.” The Economist presents figures that pension liabilities are estimated to be around $5.3 trillion, compared with $1.9 trillion of assets. “The total shortfall of $3.4 trillion is the equivalent of a quarter of all federal debt.”
So, when it comes to governmental employees, the fighting is not over peanuts. And, this is a worldwide issue as can be noted in the riots taking place in Greece, Italy, Portugal, Spain and France over their government’s retirement and pension payments. And, yesterday it was revealed that the new austerity budget of the British government contains a reduction of 500,000 public sector jobs. “Today, the fight begins,” states the general secretary of the largest government union in the UK.
The role of labor unions in the 21st century society seems to need to be re-addressed going
forward.
Finally, the pressure of the government to achieve high rates of home ownership must be re-visited. We, in the United States, have paid a major price for the emphasis placed on this goal and the resources that were allocated toward its achievement. Payment is still coming due in the area of foreclosures, commercial real estate bankruptcies, and the resolving of government support of Fannie Mae and Freddie Mac. It is very likely that we, the people of the United States, will be paying for this bailout for many years to come.
The whole point of this post is to argue for a change in some of the assumptions behind the economic policies of the leaders of the United States government. The world has changed. Maybe our leaders need to change their outlook as well.
Or, is that too much to ask?
Tuesday, August 17, 2010
Fannie Mae, Freddie Mac and the Future
Earlier this year a friend of mine and his wife got a mortgage on their new home. (As of today, they have only been married three hundred and fifty-three days.) Let me just say that the price of their home is well into the six figures. They borrowed twenty percent of the purchase price. Both of them have established, on their own, a credit rating of at least A and they pay off all of their revolving credit every month.
About two months after signing the mortgage my friend came to see me. He could not believe that his mortgage was now owned by Fannie Mae! Never in his lifetime did he expect to have a mortgage of his owned by this organization!
But, this is a part of modern America. It is a part of the whole effort by government for people to own “things.” Owning “things” in America is good! Monarchs and other royalty owned “things”. The evolution of the wealthy capitalist included owning “things.” It became the right of every American to own “things.”
And, this desire to own “things” played right into the hands of greedy politicians because politicians could promise to deliver “things” to the people that elected them and thereby get elected and re-elected. In the twentieth century, the “thing” of most importance was a home of one’s own. After all, the number one job of a politician is to stay in office! (http://seekingalpha.com/article/219804-wall-street-greed-vs-washington-greed)
Talk about financial innovations. The United States government is one of the most prolific financial innovators the world has ever seen. Just look at the last one hundred years: savings and loan associations, the Federal Home Loan Bank Board, the Federal Savings and Loan Insurance Corporation, the Office of Thrift Supervision, the Federal National Mortgage Association, the Federal Housing Authority, the Department of Housing and Urban Development, the Federal National Mortgage Association, the Government National Mortgage Association, the Mortgage-backed security, and so on and so on.
The surprise is that Fannie Mae and Freddie Mac don’t own more mortgages than they do!
Government programs based on achieving outcomes generally fail. There are two reasons why they fail. First, the goals and objectives of programs focused upon outcomes are generally not based on economics but are based upon achieving desired social consequences. Second, if a program seems to contribute in any way to politicians getting re-elected, more and more resources will be put into that program going forward.
“Popular” programs based on outcomes seem to grow exponentially as each party seeks to “out-do” the other in promising even more to more people. The underlying economics of the situation do not seem to play any role in the cumulative expansion of such programs.
How can people improve things when they tend to hold onto the “old” assumptions? This is a very difficult problem. We see the tip of the iceberg in the column by Andrew Ross Sorkin, “2 Zombies to Tolerate for a While,” in the New York Times (http://www.nytimes.com/2010/08/17/business/17sorkin.html?_r=1&ref=business) where Sorkin discusses what Congress should do about Fannie Mae and Freddie Mac with Congressman Barney Frank. To Frank, Congress has acted as it should have, well maybe a little later than it should have, but things are under control now. The point being: “money is not being lost by anything they (the agencies) are doing now.” The Congressional Budget Office says that taxpayers could absorb almost $400 billion in losses over the next decade, but, to Barney Frank, this is a result of what has happened in the past. Therefore, the agencies just need to be put on a working basis to go forward.
Yet, this doesn’t get at the fundamental issue which has to do with Americans owning “things”. As long as the focus of the government doesn’t change, the problems will not be resolved.
Again, Congress seems to be fighting the last war. As with the financial reform bill that has just been passed by the Congress (http://seekingalpha.com/article/213263-financial-reform-ho-hum), efforts to reform the housing agencies just aim at preventing what has happened over the past ten years or so. It does not deal with the fundamental issue of what it is trying to achieve (the goal itself) and whether or not this goal can be achieved.
However, the world has already changed and will continue to change.
For one, the world is changing at a much faster pace than it did a decade or two ago. Technology, for one, is changing at an ever increasing pace. People do not stay in the same place as long as they did in the past. Families are more divided geographically than ever before and one out of every two marriages ends up in divorce. Small- and mid-sized businesses rise and fall, grow and are sold, and expand and contract. Many people argue that owning “things”, especially “things” that cost a lot of money, will not be as attractive in the future as they have been in the past. The spending (leasing and renting) habits of Americans are changing.
In finance, the environment has also changed over the past fifty years. The whole idea behind the mortgage-backed security was to generate more cash going into the housing market by creating an instrument that pension funds and insurance companies would hold to match their liabilities thereby getting mortgages off the balance sheets of depository institutions, the originators of the mortgages. The idea was that these latter organizations could then create more mortgages.
This effort was based upon a “static” model of how financial intermediaries worked. With the inflation of the 1960s and 1970s, the model for financial intermediaries changed and became more “dynamic” in nature. By the second half of the 1980s, mortgage instruments became the largest component of the capital markets and the volume of trading in this sector was huge. Trading in mortgages became the most spectacular and volatile part of the capital markets.
With the growth in the number of other mortgage instruments, securitization, and derivative instruments, the mortgage finance industry became one of the hottest things around. This was not something the creators of mortgage-backed securities in the late 1960s expected. And, as with other areas experiencing financial innovation, new and more wonderful instruments can still be expected.
Congress continues to work with a “static” model of financial institutions and a perception that people will continue to focus on “things”. Both are wrong!
As a consequence, whatever Congress creates out of Fannie Mae and Freddie Mac, financial incentives will be set up so that people can “game” the system and take advantage of the efforts Congress makes to attain its social goals.
Maybe one day the government will own all the mortgages on all the homes in America. Some people may think that this would be a good thing. On the contrary, it would be just another story of the less well-to-do paying for the pleasures of the more well-to-do.
Who do you think is going to bear the burden of the almost $400 billion cost of Fannie Mae and Freddie Mac the Congressional Budget Office projects? Certainly not the wealthy. Why is it so hard for the people in government to see that the wealthy have enormous resources available to them to protect their incomes and wealth. The less-well-off do not have those resources. Consequently, over time, the burden falls upon the latter even on the programs designed to help them.
About two months after signing the mortgage my friend came to see me. He could not believe that his mortgage was now owned by Fannie Mae! Never in his lifetime did he expect to have a mortgage of his owned by this organization!
But, this is a part of modern America. It is a part of the whole effort by government for people to own “things.” Owning “things” in America is good! Monarchs and other royalty owned “things”. The evolution of the wealthy capitalist included owning “things.” It became the right of every American to own “things.”
And, this desire to own “things” played right into the hands of greedy politicians because politicians could promise to deliver “things” to the people that elected them and thereby get elected and re-elected. In the twentieth century, the “thing” of most importance was a home of one’s own. After all, the number one job of a politician is to stay in office! (http://seekingalpha.com/article/219804-wall-street-greed-vs-washington-greed)
Talk about financial innovations. The United States government is one of the most prolific financial innovators the world has ever seen. Just look at the last one hundred years: savings and loan associations, the Federal Home Loan Bank Board, the Federal Savings and Loan Insurance Corporation, the Office of Thrift Supervision, the Federal National Mortgage Association, the Federal Housing Authority, the Department of Housing and Urban Development, the Federal National Mortgage Association, the Government National Mortgage Association, the Mortgage-backed security, and so on and so on.
The surprise is that Fannie Mae and Freddie Mac don’t own more mortgages than they do!
Government programs based on achieving outcomes generally fail. There are two reasons why they fail. First, the goals and objectives of programs focused upon outcomes are generally not based on economics but are based upon achieving desired social consequences. Second, if a program seems to contribute in any way to politicians getting re-elected, more and more resources will be put into that program going forward.
“Popular” programs based on outcomes seem to grow exponentially as each party seeks to “out-do” the other in promising even more to more people. The underlying economics of the situation do not seem to play any role in the cumulative expansion of such programs.
How can people improve things when they tend to hold onto the “old” assumptions? This is a very difficult problem. We see the tip of the iceberg in the column by Andrew Ross Sorkin, “2 Zombies to Tolerate for a While,” in the New York Times (http://www.nytimes.com/2010/08/17/business/17sorkin.html?_r=1&ref=business) where Sorkin discusses what Congress should do about Fannie Mae and Freddie Mac with Congressman Barney Frank. To Frank, Congress has acted as it should have, well maybe a little later than it should have, but things are under control now. The point being: “money is not being lost by anything they (the agencies) are doing now.” The Congressional Budget Office says that taxpayers could absorb almost $400 billion in losses over the next decade, but, to Barney Frank, this is a result of what has happened in the past. Therefore, the agencies just need to be put on a working basis to go forward.
Yet, this doesn’t get at the fundamental issue which has to do with Americans owning “things”. As long as the focus of the government doesn’t change, the problems will not be resolved.
Again, Congress seems to be fighting the last war. As with the financial reform bill that has just been passed by the Congress (http://seekingalpha.com/article/213263-financial-reform-ho-hum), efforts to reform the housing agencies just aim at preventing what has happened over the past ten years or so. It does not deal with the fundamental issue of what it is trying to achieve (the goal itself) and whether or not this goal can be achieved.
However, the world has already changed and will continue to change.
For one, the world is changing at a much faster pace than it did a decade or two ago. Technology, for one, is changing at an ever increasing pace. People do not stay in the same place as long as they did in the past. Families are more divided geographically than ever before and one out of every two marriages ends up in divorce. Small- and mid-sized businesses rise and fall, grow and are sold, and expand and contract. Many people argue that owning “things”, especially “things” that cost a lot of money, will not be as attractive in the future as they have been in the past. The spending (leasing and renting) habits of Americans are changing.
In finance, the environment has also changed over the past fifty years. The whole idea behind the mortgage-backed security was to generate more cash going into the housing market by creating an instrument that pension funds and insurance companies would hold to match their liabilities thereby getting mortgages off the balance sheets of depository institutions, the originators of the mortgages. The idea was that these latter organizations could then create more mortgages.
This effort was based upon a “static” model of how financial intermediaries worked. With the inflation of the 1960s and 1970s, the model for financial intermediaries changed and became more “dynamic” in nature. By the second half of the 1980s, mortgage instruments became the largest component of the capital markets and the volume of trading in this sector was huge. Trading in mortgages became the most spectacular and volatile part of the capital markets.
With the growth in the number of other mortgage instruments, securitization, and derivative instruments, the mortgage finance industry became one of the hottest things around. This was not something the creators of mortgage-backed securities in the late 1960s expected. And, as with other areas experiencing financial innovation, new and more wonderful instruments can still be expected.
Congress continues to work with a “static” model of financial institutions and a perception that people will continue to focus on “things”. Both are wrong!
As a consequence, whatever Congress creates out of Fannie Mae and Freddie Mac, financial incentives will be set up so that people can “game” the system and take advantage of the efforts Congress makes to attain its social goals.
Maybe one day the government will own all the mortgages on all the homes in America. Some people may think that this would be a good thing. On the contrary, it would be just another story of the less well-to-do paying for the pleasures of the more well-to-do.
Who do you think is going to bear the burden of the almost $400 billion cost of Fannie Mae and Freddie Mac the Congressional Budget Office projects? Certainly not the wealthy. Why is it so hard for the people in government to see that the wealthy have enormous resources available to them to protect their incomes and wealth. The less-well-off do not have those resources. Consequently, over time, the burden falls upon the latter even on the programs designed to help them.
Tuesday, August 10, 2010
Those Greedy B*****ds in Washington
I have not heard one elected official or government bureaucrat in Washington, D. C. apologize to the American public for all the problems they have caused the American people over the past fifty years. All I have heard from this august bunch is “Get the Greedy Bastards from Wall Street”!
Yet, it is the “Greedy Bastards” from Washington, D. C. that put into place the incentives that everyone else in the country had to respond to and that created the environment that resulted in the mess the country has been going through over the last four years. These “Greedy Bastards from Washington” were greedy for power and for the benefits and rewards of being elected and re-elected over and over again. So they developed the incentives for the rest of the country that would allow them to get re-elected over and over again.
I could go into a long list of “incentives” that the White House and Congress created over the past fifty years, but I thought that today I would work from my list of personal experiences that, to me, show how Washington can impact the private sector and put in place “incentives” that end up causing more trouble for people than they do benefits, even though the programs are put into place to “make things better for people”…and to get elected people re-elected.
In the public sector I was a spectator to the build-up of the securitized mortgage. All this “stuff” we are hearing so much about really began in the late 1960s. Fannie Mae (FNMA) was split in two in 1968, the new wing became Ginnie Mae (GNMA), the Government National Mortgage Association. In 1968, GNMA guaranteed the first mortgage pass-through security. In 1970 FNMA was authorized to purchase private mortgages. Also in 1970, Freddie Mac was created to do the same thing as FNMA. I was able to see the early years of the operation of these institutions as a liaison between the Secretary of HUD and these agencies. I also experienced the effort to create more viable mortgage backed securities so that longer term funds from insurance companies and pension funds could flow into the housing market and provide more money to help “American citizens” own their own home. (By the time Michael Lewis wrote “Liar’s Poker” in the late 1980s, the market for mortgage backed securities was the largest part of the capital markets in the world! This is up from almost zero in the 1960s.)
From where I sat there was only one reason why so much effort was put into these “financial innovations” and that was to help the people in the White House and in Congress get re-elected. The stated goal of these programs was to put Americans their own homes. Okay!
The housing sector was “bankrolled” by the United States government, to get government officials re-elected. Both parties took advantage of this effort and both parties added to the incentives available to all those participating in the “give-away.” And, today we face the reality that over half the residential mortgages in this country are held by either Fannie Mae or Freddie Mac and that each of these institutions is losing so much money that it will eventually cost the taxpayer an estimated $350 billion. Little is being done about this, and, no one in Congress or the White House is apologizing for this loss. Shame on them!
Back in the private sector I joined the Senior Management of a mutual savings bank in late 1983 with assets of about $1.0 billion. In January 1984 I became the Chief Financial Officer of the organization. There were some pretty severe restrictions on the balance sheet of a savings bank at that time. Sixty percent of the assets of the bank, and no more, could be placed in residential mortgages. The other forty percent could be placed in a limited list of marketable securities, primarily Treasury securities. The organization I joined had about 60% of its assets in residential mortgages, 30% in longer-term U. S. Treasury securities, and 10% in very liquid assets.
The bank was in trouble! Not from the mortgages. The residential mortgages were performing well. The problem was in the portfolio of longer-term U. S. Treasury securities. They were deeply “underwater” and this threatened the life of the institution which had been in existence since the 1830s.
United States Treasury issues with a maturity of 10 years traded around 7.5% in 1975. In the 1983-1984 period these securities traded in the 11.5% to 12.5% range. Needless to say, the 30% of the assets the institution held was not in good shape.
Notice, however, this bank was not in trouble because of “bad” assets. The quality of the assets on the books of the bank was of the highest level. This was an institution that was very prudently managed.
The problem came from the inflationary expectations that were built into longer term interest rates, an inflation that came about due to the inflationary policies of the United States government in the 1960s and 1970s. Remember, a small amount of inflation was good at that time because it put people back to work and that was good for the politicians. The tradeoff between inflation and unemployment was called the “Phillips Curve.” Too bad about the highly restricted thrift industry!
Let me just mention two responses that were made to this situation. The first was to convert the mutual institution into a stock institution. This was done successfully and $42 million in new capital was injected into the bank. But, the nature of the bank had changed forever. We were in a new era where “maximizing shareholder returns” became the dominant goal of the organization.
Second, we examined a new financial innovation, a “risk controlled” interest rate arbitrage of $100 million, one-tenth in size of the whole organization, to “off-set” the low interest rates that were being earned on the Treasury portfolio. The justification for the arbitrage transaction was pages and pages of computer printouts that showed how the transaction would perform in dozens of interest rate environments similar to the ones that had existed in history…the last twenty years. Ah, the benefits of computer-based quantitative simulations. Financial innovation was grand!
What happened to the bank? Well, interest rates fell back into the 7.0% to 7.5% range in 1986 (thank you Paul Volcker) and the Treasuries were sold and the olvency problem was resolved. The bank is still in existence today.
The second turn-around I was involved in was a sleepy old savings and loan association that was run by the same old man and old board of directors that had been around for years. The portfolio was solid residential real estate mortgages. This institution did not have to convert and go public, but the environment was such that in 1986 they went public and raised $18 million dollars for an institution that had less than $300 million in assets. They didn’t know what to do with the money but now they had to maximize shareholder value. So they started up a commercial real estate development subsidiary and began to explore getting into more and more commercial activities and also acquisitions. This S&L was run by a “pillar” of the community who had done nothing more than make residential mortgages and manage a large number of women tellers for forty years or so. With the “new” money, the bank grew to about $1.0 billion with many problem areas because the “old guy” just didn’t get it! I was with this institution from 1987 through 1991.
The CEO was finally forced out of his position in 1991 along with many board members. This came about because the financial community substantially discounted the stock because of the “old guy” and the regulators finally forced some board members into doing something. The bank was finally sold to what is now one of the twenty-five largest banks in the country. A board member of the acquiring institution who I knew well told me later that this acquisition was so cheap it was the only acquisition he was familiar with that was accretive in the first year after the acquisition. The regulators did not know what to do with all the problem banks they had on their hands during this time period and so forced many “good” institutions into situations they were totally unprepared for.
I then moved into a commercial bank turnaround. This bank had been one of dozens of “startup” banks which took place in the late 1980s and early 1990s. When I was brought into the bank I was amazed that the bank had policies and procedures that were well suited for a multi-billion dollar bank, but not for a startup institution that never got above $100 million in assets. The management of the bank had grandiose ideas about what they could do and a board of directors that knew almost nothing about banking. But, Washington wanted more and more banks to keep money flowing into the community. The bank had severe problems but we succeeded to the extent that we were the only “boutique” bank in Philadelphia that was not either closed or forced to merge with another institution. So much for providing funds to the local community.
I have worked in both the public sector and the private sector in my career. I have seen how the incentives set up by government have distorted markets as the incentives played to the “greed” of many in the private sector. In the short run, these “incentives” seemed to work for the good of the society. In the longer run as people found out how to “play” the system, the greed of the private sector came to dominate the news angering the people from “Main Street” and making it easy for politicians to point their fingers at the “Greedy Bastards on Wall Street” and walk away as if they had nothing to do with all the problems that they had created. Those “Greedy Bastards from Washington”! Beware of what these “Greedy Bastards” do because they only have one incentive…to get re-elected.
Yet, it is the “Greedy Bastards” from Washington, D. C. that put into place the incentives that everyone else in the country had to respond to and that created the environment that resulted in the mess the country has been going through over the last four years. These “Greedy Bastards from Washington” were greedy for power and for the benefits and rewards of being elected and re-elected over and over again. So they developed the incentives for the rest of the country that would allow them to get re-elected over and over again.
I could go into a long list of “incentives” that the White House and Congress created over the past fifty years, but I thought that today I would work from my list of personal experiences that, to me, show how Washington can impact the private sector and put in place “incentives” that end up causing more trouble for people than they do benefits, even though the programs are put into place to “make things better for people”…and to get elected people re-elected.
In the public sector I was a spectator to the build-up of the securitized mortgage. All this “stuff” we are hearing so much about really began in the late 1960s. Fannie Mae (FNMA) was split in two in 1968, the new wing became Ginnie Mae (GNMA), the Government National Mortgage Association. In 1968, GNMA guaranteed the first mortgage pass-through security. In 1970 FNMA was authorized to purchase private mortgages. Also in 1970, Freddie Mac was created to do the same thing as FNMA. I was able to see the early years of the operation of these institutions as a liaison between the Secretary of HUD and these agencies. I also experienced the effort to create more viable mortgage backed securities so that longer term funds from insurance companies and pension funds could flow into the housing market and provide more money to help “American citizens” own their own home. (By the time Michael Lewis wrote “Liar’s Poker” in the late 1980s, the market for mortgage backed securities was the largest part of the capital markets in the world! This is up from almost zero in the 1960s.)
From where I sat there was only one reason why so much effort was put into these “financial innovations” and that was to help the people in the White House and in Congress get re-elected. The stated goal of these programs was to put Americans their own homes. Okay!
The housing sector was “bankrolled” by the United States government, to get government officials re-elected. Both parties took advantage of this effort and both parties added to the incentives available to all those participating in the “give-away.” And, today we face the reality that over half the residential mortgages in this country are held by either Fannie Mae or Freddie Mac and that each of these institutions is losing so much money that it will eventually cost the taxpayer an estimated $350 billion. Little is being done about this, and, no one in Congress or the White House is apologizing for this loss. Shame on them!
Back in the private sector I joined the Senior Management of a mutual savings bank in late 1983 with assets of about $1.0 billion. In January 1984 I became the Chief Financial Officer of the organization. There were some pretty severe restrictions on the balance sheet of a savings bank at that time. Sixty percent of the assets of the bank, and no more, could be placed in residential mortgages. The other forty percent could be placed in a limited list of marketable securities, primarily Treasury securities. The organization I joined had about 60% of its assets in residential mortgages, 30% in longer-term U. S. Treasury securities, and 10% in very liquid assets.
The bank was in trouble! Not from the mortgages. The residential mortgages were performing well. The problem was in the portfolio of longer-term U. S. Treasury securities. They were deeply “underwater” and this threatened the life of the institution which had been in existence since the 1830s.
United States Treasury issues with a maturity of 10 years traded around 7.5% in 1975. In the 1983-1984 period these securities traded in the 11.5% to 12.5% range. Needless to say, the 30% of the assets the institution held was not in good shape.
Notice, however, this bank was not in trouble because of “bad” assets. The quality of the assets on the books of the bank was of the highest level. This was an institution that was very prudently managed.
The problem came from the inflationary expectations that were built into longer term interest rates, an inflation that came about due to the inflationary policies of the United States government in the 1960s and 1970s. Remember, a small amount of inflation was good at that time because it put people back to work and that was good for the politicians. The tradeoff between inflation and unemployment was called the “Phillips Curve.” Too bad about the highly restricted thrift industry!
Let me just mention two responses that were made to this situation. The first was to convert the mutual institution into a stock institution. This was done successfully and $42 million in new capital was injected into the bank. But, the nature of the bank had changed forever. We were in a new era where “maximizing shareholder returns” became the dominant goal of the organization.
Second, we examined a new financial innovation, a “risk controlled” interest rate arbitrage of $100 million, one-tenth in size of the whole organization, to “off-set” the low interest rates that were being earned on the Treasury portfolio. The justification for the arbitrage transaction was pages and pages of computer printouts that showed how the transaction would perform in dozens of interest rate environments similar to the ones that had existed in history…the last twenty years. Ah, the benefits of computer-based quantitative simulations. Financial innovation was grand!
What happened to the bank? Well, interest rates fell back into the 7.0% to 7.5% range in 1986 (thank you Paul Volcker) and the Treasuries were sold and the olvency problem was resolved. The bank is still in existence today.
The second turn-around I was involved in was a sleepy old savings and loan association that was run by the same old man and old board of directors that had been around for years. The portfolio was solid residential real estate mortgages. This institution did not have to convert and go public, but the environment was such that in 1986 they went public and raised $18 million dollars for an institution that had less than $300 million in assets. They didn’t know what to do with the money but now they had to maximize shareholder value. So they started up a commercial real estate development subsidiary and began to explore getting into more and more commercial activities and also acquisitions. This S&L was run by a “pillar” of the community who had done nothing more than make residential mortgages and manage a large number of women tellers for forty years or so. With the “new” money, the bank grew to about $1.0 billion with many problem areas because the “old guy” just didn’t get it! I was with this institution from 1987 through 1991.
The CEO was finally forced out of his position in 1991 along with many board members. This came about because the financial community substantially discounted the stock because of the “old guy” and the regulators finally forced some board members into doing something. The bank was finally sold to what is now one of the twenty-five largest banks in the country. A board member of the acquiring institution who I knew well told me later that this acquisition was so cheap it was the only acquisition he was familiar with that was accretive in the first year after the acquisition. The regulators did not know what to do with all the problem banks they had on their hands during this time period and so forced many “good” institutions into situations they were totally unprepared for.
I then moved into a commercial bank turnaround. This bank had been one of dozens of “startup” banks which took place in the late 1980s and early 1990s. When I was brought into the bank I was amazed that the bank had policies and procedures that were well suited for a multi-billion dollar bank, but not for a startup institution that never got above $100 million in assets. The management of the bank had grandiose ideas about what they could do and a board of directors that knew almost nothing about banking. But, Washington wanted more and more banks to keep money flowing into the community. The bank had severe problems but we succeeded to the extent that we were the only “boutique” bank in Philadelphia that was not either closed or forced to merge with another institution. So much for providing funds to the local community.
I have worked in both the public sector and the private sector in my career. I have seen how the incentives set up by government have distorted markets as the incentives played to the “greed” of many in the private sector. In the short run, these “incentives” seemed to work for the good of the society. In the longer run as people found out how to “play” the system, the greed of the private sector came to dominate the news angering the people from “Main Street” and making it easy for politicians to point their fingers at the “Greedy Bastards on Wall Street” and walk away as if they had nothing to do with all the problems that they had created. Those “Greedy Bastards from Washington”! Beware of what these “Greedy Bastards” do because they only have one incentive…to get re-elected.
Tuesday, May 11, 2010
Goldman Had A Perfect Quarter
This may sound like a ridiculous headline, but it appeared in the Wall Street Journal today. (See http://online.wsj.com/article/SB20001424052748703880304575236132462861088.html#mod=todays_us_money_and_investing.)
The reason for the headline is that the Goldman Sachs traders made money every day the firm traded in the first quarter of 2010!
The article states: “Traders raked in more than $100 million daily for 35 days and made no less than $25 million daily during the rest of the three-month period, according to the regulatory filing on Monday. The streak was a first for the Wall Street firm, which typically loses funds on at least a handful of days in a given period.”
On that basis Morgan Stanley had a more typical quarter. Morgan Stanley lost as much as $30 million daily on four days during the quarter. The other days, well, they made money far in excess of the losses.
What the government takes away with one hand the government gives back with another.
While the government chastises Goldman and its management and sues it for securities-fraud, the Federal Reserve subsidizes Goldman with super-low interest rates.
During the first quarter of 2010, Goldman could borrow money for up to six months for 20 to 50 basis points. They could lend these funds out for almost 400 basis points, RISK FREE. And the Federal Reserve promised them that these spreads would continue to exist for an “extended period” of time!
Goldman Sachs should send Mr. Bernanke a big basket of fruit accompanying a big “THANK YOU, MR. BERNANKE” card.
Wish I could play this game!
And, now the European Central Bank seems to be getting wise to the game. And, our Federal Reserve system is going to support the ECB through currency swaps!
And, then the figures come in on Fannie and Freddie! And, with all the new spending programs coming from the Obama administration it is hard to take seriously the feeble coins that are tossed to the study of how to get the federal deficit under control. Official forecasts place the federal deficit under $10 trillion for the next ten years. I still believe that deficits will accumulate more toward the $15 trillion to $18trillion range.
The Fed is going to “tighten up” in the face of all this junk? Or, will they pull a “Trichet”. Or, has Jean-Claude Trichet, the Chairman of the ECB, pulled a “Bernanke”?
The problem, as I have written many times before, is that when a nation puts itself into a position like the United States (and many of the European nations and England) finds itself, there are really no good choices to left for it. However, the tendency is that once a nation finds itself in such a hole, they continue to dig deeper as the United States (and the European community) is now doing.
Peter Boone and Simon Johnson write in the Financial Times this morning about “How the euro-zone set off a race to the bottom.” (See http://www.ft.com/cms/s/0/5d666d5a-5c69-11df-93f6-00144feab49a.html.) The EU dug its own hole and now they continue to dig the hole deeper and deeper.
The Euro-zone system “encourages “a race to the bottom”—led by governments in smaller countries, which relax fiscal and credit standards to win re-election.”
I would add that this claim could be leveled against the United States and Great Britain just as well as they raced to provide more and more social services and housing to the electorate in order to get re-elected and justified borrowing massive amounts of money, both domestically and internationally, through Keynesian arguments that there was an infinite supply of funds available to governments.
The governmental emphasis on generating huge deficits, on financial innovation and creating massive incentives to inflate the amount of credit outstanding, changed the whole environment of finance. And, of course, the very people that created this environment, the various presidential administrations of the past fifty years and their co-conspirators in Congress, now condemn what they have created and sue it. Yet, they also continue to underwrite it through bailouts and subsidies like the monetary policy of the Federal Reserve called “Quantitative Easing.”
All I can say about the quantitative easing is that there must be a very large number of the remaining 8,000 “small” banks in the banking system that are in very serious financial difficulty for the Fed to continue to maintain this policy and subsidize the further growth of the “big” banks!
There are no good decisions left. And, I fear, that the ultimate resolution of this situation, as Boone and Johnson argue, is for these profligate nations to default, “either through repudiations or inflation.”
However, things don’t stop here. What this situation points to is the weakening of the influence of the Western nations, especially that of the United States. Given the current situation, why should China bow to any wishes made to it by the United States government except to those that are particularly in their interest? (See my post, “Why Should China Change?”: http://seekingalpha.com/article/193689-why-should-china-change.) The same applies to India (see a very interesting article in the Financial Times this morning, “India: The Loom of Youth”: http://www.ft.com/cms/s/0/8aefdf1e-5c68-11df-93f6-00144feab49a.html) and Brazil. The United States (and Western Europe) have made these countries relatively more powerful and independent. And, given the current position of the United States (and Western Europe) why should the countries be generous to the dominant power in the world?
The world has changed over the past fifty years and the United States has contributed significantly to its own relative decline. (Watch this played out in future meetings, like that of the G-20.)
And, it has contributed to Goldman being perfect!
The reason for the headline is that the Goldman Sachs traders made money every day the firm traded in the first quarter of 2010!
The article states: “Traders raked in more than $100 million daily for 35 days and made no less than $25 million daily during the rest of the three-month period, according to the regulatory filing on Monday. The streak was a first for the Wall Street firm, which typically loses funds on at least a handful of days in a given period.”
On that basis Morgan Stanley had a more typical quarter. Morgan Stanley lost as much as $30 million daily on four days during the quarter. The other days, well, they made money far in excess of the losses.
What the government takes away with one hand the government gives back with another.
While the government chastises Goldman and its management and sues it for securities-fraud, the Federal Reserve subsidizes Goldman with super-low interest rates.
During the first quarter of 2010, Goldman could borrow money for up to six months for 20 to 50 basis points. They could lend these funds out for almost 400 basis points, RISK FREE. And the Federal Reserve promised them that these spreads would continue to exist for an “extended period” of time!
Goldman Sachs should send Mr. Bernanke a big basket of fruit accompanying a big “THANK YOU, MR. BERNANKE” card.
Wish I could play this game!
And, now the European Central Bank seems to be getting wise to the game. And, our Federal Reserve system is going to support the ECB through currency swaps!
And, then the figures come in on Fannie and Freddie! And, with all the new spending programs coming from the Obama administration it is hard to take seriously the feeble coins that are tossed to the study of how to get the federal deficit under control. Official forecasts place the federal deficit under $10 trillion for the next ten years. I still believe that deficits will accumulate more toward the $15 trillion to $18trillion range.
The Fed is going to “tighten up” in the face of all this junk? Or, will they pull a “Trichet”. Or, has Jean-Claude Trichet, the Chairman of the ECB, pulled a “Bernanke”?
The problem, as I have written many times before, is that when a nation puts itself into a position like the United States (and many of the European nations and England) finds itself, there are really no good choices to left for it. However, the tendency is that once a nation finds itself in such a hole, they continue to dig deeper as the United States (and the European community) is now doing.
Peter Boone and Simon Johnson write in the Financial Times this morning about “How the euro-zone set off a race to the bottom.” (See http://www.ft.com/cms/s/0/5d666d5a-5c69-11df-93f6-00144feab49a.html.) The EU dug its own hole and now they continue to dig the hole deeper and deeper.
The Euro-zone system “encourages “a race to the bottom”—led by governments in smaller countries, which relax fiscal and credit standards to win re-election.”
I would add that this claim could be leveled against the United States and Great Britain just as well as they raced to provide more and more social services and housing to the electorate in order to get re-elected and justified borrowing massive amounts of money, both domestically and internationally, through Keynesian arguments that there was an infinite supply of funds available to governments.
The governmental emphasis on generating huge deficits, on financial innovation and creating massive incentives to inflate the amount of credit outstanding, changed the whole environment of finance. And, of course, the very people that created this environment, the various presidential administrations of the past fifty years and their co-conspirators in Congress, now condemn what they have created and sue it. Yet, they also continue to underwrite it through bailouts and subsidies like the monetary policy of the Federal Reserve called “Quantitative Easing.”
All I can say about the quantitative easing is that there must be a very large number of the remaining 8,000 “small” banks in the banking system that are in very serious financial difficulty for the Fed to continue to maintain this policy and subsidize the further growth of the “big” banks!
There are no good decisions left. And, I fear, that the ultimate resolution of this situation, as Boone and Johnson argue, is for these profligate nations to default, “either through repudiations or inflation.”
However, things don’t stop here. What this situation points to is the weakening of the influence of the Western nations, especially that of the United States. Given the current situation, why should China bow to any wishes made to it by the United States government except to those that are particularly in their interest? (See my post, “Why Should China Change?”: http://seekingalpha.com/article/193689-why-should-china-change.) The same applies to India (see a very interesting article in the Financial Times this morning, “India: The Loom of Youth”: http://www.ft.com/cms/s/0/8aefdf1e-5c68-11df-93f6-00144feab49a.html) and Brazil. The United States (and Western Europe) have made these countries relatively more powerful and independent. And, given the current position of the United States (and Western Europe) why should the countries be generous to the dominant power in the world?
The world has changed over the past fifty years and the United States has contributed significantly to its own relative decline. (Watch this played out in future meetings, like that of the G-20.)
And, it has contributed to Goldman being perfect!
Tuesday, January 26, 2010
Regulation and Information--Part C
The final point I would like to make in this series is that you cannot build and maintain a rigid financial regulatory system based on the achievement of specific outcomes if you insist on inflating the economy that includes this regulatory system and expect the regulated institutions to remain idle. This is the story of the last 50 years when the dollar lost 85% of its purchasing power. If the government creates an inflationary environment, financial institutions will not stand still, especially in this Age of Information.
Also, in my view, the United States government has injected large amounts of moral hazard into the economy and the financial markets over the past fifty years or so. And, the presence of this moral hazard has had a lot to do with the recent collapse of the financial markets and the economy.
Before going into this let me just say that I believe that almost everyone is greedy. I use the word greedy with all the bad things it conveys, because that is the word being tossed around so loosely these days. I do not believe, as the economist Joseph Stiglitz seems to, that the bankers of Wall Street are any more “morally bankrupt” than he is or any of the rest of us. We all are greedy and respond to the incentives that are placed before us. With that said, let’s now move on.
I want to concentrate on two specific areas in which the government has created moral hazard and helped to form the incentives that led to the bust of 2008. The first has to do with monetary policy and the second has to do with housing finance. Both have contributed to what I have called the credit inflation of the last 50 years.
A credit inflation occurs when the credit in an economy grows more rapidly than the economy itself or more rapidly than specific sectors in the economy. In the early part of the period under review, focus was primarily on consumer and wholesale price inflation. At this time, analysts were mainly concerned with money stock growth and the consumer price index or the GDP Deflator. Asset bubbles were not on the radar yet.
However, inflation creates the incentive to increase debt and as the amount of debt in the economy increases there is pressure on both financial and non-financial institutions to increase their financial leverage, to create a greater mismatch between the maturities of their assets and liabilities, and to take on riskier assets, to goose up returns. Credit creation thrives in an inflationary environment!
Inflation is good for credit and so the cumulative effect of a period of inflation is the creation of more debt! In the Age of Information, the incentive to create more debt is a license for financial innovation.
The dance began in the 1960s and, as former Citigroup CEO “Chuck” Prince so eloquently expressed it in the 2000s, if the music continues to play, you must continue to dance!
And, the enormous creation of credit spilled over into sectors other than consumer purchases creating a bubble here and a bubble there. The beauty about financial innovation in the Age of Information is that specific assets and specific asset markets don’t really matter because all that is being traded is information. The result: as “Chuck” Prince implied, the dance continued in the areas where the music was still playing. Credit flowed into the markets that had the most action so that you got one market “popping” at this time and another market “popping” at another time. And, innovations in new financial instruments and markets were created to help the music flow to all markets.
How does this scenario relate to monetary policy? Well, the monetary authorities acted in a very asymmetrical way. If markets seemed to be dropping, the Federal Reserve would come in and stop the fall. This was especially important if unemployment seemed to be impacted by the drop. The behavior became so predictable that it was given a name: the “Greenspan put.”
On the upside, the central bank attempted to maintain control of consumer price inflation, especially after the pain of the late 1970s and early 1980s, but believed that it could do nothing with respect to asset bubbles that inflated prices in various sub-markets, like housing.
The moral hazard that was created allowed prices to constantly rise for the Fed would always reflate the economy before there was any chance for prices to fall. And, consumers could only buy about 15 cents worth of goods and services in 2010 with what $1.00 could buy in January 1961. Also in asset markets like housing, prices rose and rose and rose during this period to the point where people were absolutely confident that housing prices could never fall. So, where are you going to place your bets after all this time which created the fundamental assumption that policymakers would continue the credit inflation indefinitely.
The other area where the government created moral hazard was in the housing market. To own your home is a big part of the “American Dream.” Owning your own home creates self-respect and stability. It is a great place to raise kids and it generates community. It produces good citizens.
So, anything that can be done to support home ownership in America is good!
The savings and loan industry was dedicated to financing homes. The Federal Housing Administration (FHA) was there to help people get mortgages for homes and played a huge role in home ownership for GIs returning home from World War II. But, Fannie Mae and Freddie Mac were created to help mortgage finance and to make sure money flowed into the industry. Then the Department of Housing and Urban Development was created and help flowed through a myriad of programs to assist low-income families to own their own homes. And, then the mortgage-backed security was created and so on and so forth.
Ultimately, we got a great information age idea, the sub-prime loan. This program combines the drive to get home ownership to more and more individuals and families, often without the needed financial wherewithal, and credit inflation, because if housing prices never go down they must be going up. And, this allows people who cannot afford the down-payment on a house to earn that down-payment through the inflation of the price of their home. Oh, by-the-way, you can originate the loans and then get them packaged and securitized to sell to financial institutions in China or Sweden.
Isn’t the Age of Information great! If the government has anything to say about it, “No downside risk!”
Well, Fannie Mae and Freddie Mac own most of the American mortgage market now and both are ‘bankrupt.’ The FHA is in deep, deep financial trouble. And, so are many banks and other financial institutions in the United States. And, the Treasury is going crazy trying to develop a program or programs that will help individuals and families stay out of foreclosure and lose their homes.
Bottom line: in the Age of Information, information spreads and spreads rapidly. Financial innovation will accelerate as we go forward for financial innovation will be applied to any area, regulated or not, that promises financial gain. Unfortunately, my guess is that the federal government and Congress will not have the discipline it needs to stop creating credit inflations and to keep from creating more and more moral hazard in the future. Consequently, the financial regulation that will be forthcoming will be backwards looking and, hence, will not prevent the next crisis.
Also, in my view, the United States government has injected large amounts of moral hazard into the economy and the financial markets over the past fifty years or so. And, the presence of this moral hazard has had a lot to do with the recent collapse of the financial markets and the economy.
Before going into this let me just say that I believe that almost everyone is greedy. I use the word greedy with all the bad things it conveys, because that is the word being tossed around so loosely these days. I do not believe, as the economist Joseph Stiglitz seems to, that the bankers of Wall Street are any more “morally bankrupt” than he is or any of the rest of us. We all are greedy and respond to the incentives that are placed before us. With that said, let’s now move on.
I want to concentrate on two specific areas in which the government has created moral hazard and helped to form the incentives that led to the bust of 2008. The first has to do with monetary policy and the second has to do with housing finance. Both have contributed to what I have called the credit inflation of the last 50 years.
A credit inflation occurs when the credit in an economy grows more rapidly than the economy itself or more rapidly than specific sectors in the economy. In the early part of the period under review, focus was primarily on consumer and wholesale price inflation. At this time, analysts were mainly concerned with money stock growth and the consumer price index or the GDP Deflator. Asset bubbles were not on the radar yet.
However, inflation creates the incentive to increase debt and as the amount of debt in the economy increases there is pressure on both financial and non-financial institutions to increase their financial leverage, to create a greater mismatch between the maturities of their assets and liabilities, and to take on riskier assets, to goose up returns. Credit creation thrives in an inflationary environment!
Inflation is good for credit and so the cumulative effect of a period of inflation is the creation of more debt! In the Age of Information, the incentive to create more debt is a license for financial innovation.
The dance began in the 1960s and, as former Citigroup CEO “Chuck” Prince so eloquently expressed it in the 2000s, if the music continues to play, you must continue to dance!
And, the enormous creation of credit spilled over into sectors other than consumer purchases creating a bubble here and a bubble there. The beauty about financial innovation in the Age of Information is that specific assets and specific asset markets don’t really matter because all that is being traded is information. The result: as “Chuck” Prince implied, the dance continued in the areas where the music was still playing. Credit flowed into the markets that had the most action so that you got one market “popping” at this time and another market “popping” at another time. And, innovations in new financial instruments and markets were created to help the music flow to all markets.
How does this scenario relate to monetary policy? Well, the monetary authorities acted in a very asymmetrical way. If markets seemed to be dropping, the Federal Reserve would come in and stop the fall. This was especially important if unemployment seemed to be impacted by the drop. The behavior became so predictable that it was given a name: the “Greenspan put.”
On the upside, the central bank attempted to maintain control of consumer price inflation, especially after the pain of the late 1970s and early 1980s, but believed that it could do nothing with respect to asset bubbles that inflated prices in various sub-markets, like housing.
The moral hazard that was created allowed prices to constantly rise for the Fed would always reflate the economy before there was any chance for prices to fall. And, consumers could only buy about 15 cents worth of goods and services in 2010 with what $1.00 could buy in January 1961. Also in asset markets like housing, prices rose and rose and rose during this period to the point where people were absolutely confident that housing prices could never fall. So, where are you going to place your bets after all this time which created the fundamental assumption that policymakers would continue the credit inflation indefinitely.
The other area where the government created moral hazard was in the housing market. To own your home is a big part of the “American Dream.” Owning your own home creates self-respect and stability. It is a great place to raise kids and it generates community. It produces good citizens.
So, anything that can be done to support home ownership in America is good!
The savings and loan industry was dedicated to financing homes. The Federal Housing Administration (FHA) was there to help people get mortgages for homes and played a huge role in home ownership for GIs returning home from World War II. But, Fannie Mae and Freddie Mac were created to help mortgage finance and to make sure money flowed into the industry. Then the Department of Housing and Urban Development was created and help flowed through a myriad of programs to assist low-income families to own their own homes. And, then the mortgage-backed security was created and so on and so forth.
Ultimately, we got a great information age idea, the sub-prime loan. This program combines the drive to get home ownership to more and more individuals and families, often without the needed financial wherewithal, and credit inflation, because if housing prices never go down they must be going up. And, this allows people who cannot afford the down-payment on a house to earn that down-payment through the inflation of the price of their home. Oh, by-the-way, you can originate the loans and then get them packaged and securitized to sell to financial institutions in China or Sweden.
Isn’t the Age of Information great! If the government has anything to say about it, “No downside risk!”
Well, Fannie Mae and Freddie Mac own most of the American mortgage market now and both are ‘bankrupt.’ The FHA is in deep, deep financial trouble. And, so are many banks and other financial institutions in the United States. And, the Treasury is going crazy trying to develop a program or programs that will help individuals and families stay out of foreclosure and lose their homes.
Bottom line: in the Age of Information, information spreads and spreads rapidly. Financial innovation will accelerate as we go forward for financial innovation will be applied to any area, regulated or not, that promises financial gain. Unfortunately, my guess is that the federal government and Congress will not have the discipline it needs to stop creating credit inflations and to keep from creating more and more moral hazard in the future. Consequently, the financial regulation that will be forthcoming will be backwards looking and, hence, will not prevent the next crisis.
Wednesday, November 11, 2009
Fannie, Freddie, and Feddie?
Will the Federal Reserve System join the ranks of other government public supported agencies like Fannie Mae and Freddie Mac?
One could argue that they are on the verge of such ignominy.
Never before has the Federal Reserve been under such attack and from all sides. The attacks have gotten so severe that the subject even made the front page of the New York Times today. (See “Under Attack, Fed Chief Studies Politics,” http://www.nytimes.com/2009/11/11/business/11fed.html?hp.) The legislative attack on the Fed continues with the new proposals on financial regulation coming from the Senate Banking Committee. (See “Senate Democrats Seek Sweeping Curbs on Fed,” http://online.wsj.com/article/SB125786789140341325.html?mod=WSJ_hps_LEFTWhatsNews.)
Certainly the leadership of the Federal Reserve seems to be deserving this scorn. Henry Kaufman states bluntly that “there is the Fed’s legacy of its inability to limit past financial excesses. By failing to be an effective guardian of our financial system, it has lost credibility.” (See, “The Real Threat to Fed Independence,” http://online.wsj.com/article/SB10001424052748703574604574501632123501814.html.)
Of course, Alan Greenspan gets his share of the blame for “keeping interest rates too low for too long in the early years of this decade”; for his failure to understand the changes in the financial markets coming from financial innovation; and for his role in the repeal of the Glass-Steagall Act.
But, Ben Benanke must also bear his share in the decline of Fed credibility. He was Greenspan’s co-conspirator, serving on the Board of Governors of the Federal Reserve System during the 2002 to 2005 period in which the Federal Funds Rate was kept below 2.00% from the time he joined the Board until November 2004. For much of the time this Fed Funds rate was around 1.00%. Bernanke was a strong defender of keeping the rates so low, both in terms of economic analysis and speeches.
After Bernanke assumed the position of Chairman he was slow responding to the possibility that the bubble was bursting in the subprime market. Then, Bernanke reacted very strongly to the financial collapse, possibly over-reacted, in the week of September 15, 2008. (See my post of November 16, 2008, “The Bailout Plan: Did Bernanke Panic?” http://seekingalpha.com/article/106186-the-bailout-plan-did-bernanke-panic.)
Congress certainly saw Bernanke in action that week. According to a Wall Street Journal article, which I quoted in the post, “(Hank) Paulson called the leadership in Congress and asked them to have a meeting with himself and Bernanke on Friday evening. The few members of Congress that talked with the press after that meeting said that Bernanke did most of the talking and ‘scared the daylights out of everyone.’ Bernanke got his wish in that Congress ultimately passed the TARP bill, although they did not pass the bill by the next Monday as Bernanke had originally pressed for.
I’m not completely convinced that Congress, deep down, has all that much confidence in a Ben Bernanke-led Federal Reserve System going forward even though President Obama seems to.
Then, the Federal Reserve, under Bernanke’s guidance, flooded the banking system with reserves, leading up the current time where excess reserves in the banking system total more than $1.0 trillion. His concern over this time period has been the liquidity of financial markets. (See my recent post, “Dear Fed: the Problem is Solvency, not Liquidity,” http://seekingalpha.com/article/171826-dear-fed-the-problem-is-solvency-not-liquidity.)
As Kaufman points out in his Wall Street Journal article, the Federal Reserve now has another major conundrum: “How will the Fed reduce its bloated balance sheet?” This is a real problem because the Federal Reserve has subsidized the financing of massive amounts of federal debt and has also provided massive support to the markets for mortgage-backed securities and federal agency issues. As of November 4, 2009, the Fed owned outright $777 billion in U. S. Treasury issues, $774 billion in mortgage-backed securities, and $147 billion in Federal agency debt securities, roughly $1.7 trillion.
In supporting these markets, the Federal Reserve has kept the interest rates on these securities below the level they would have attained without the support of the central bank. The first question is, what will happen to these rates once the Fed stops supporting these securities. Will their rates ratchet upwards?
And, then, what will happen once the Federal Reserve finally decides it needs to let interest rates move up as the economy gains strength? If the Federal Reserve pursues its exit policy of removing reserves from the banking system it will have to take a loss on these securities. No matter though, it will just reduce the amount of funds (its profits) it returns to the Treasury Department at the end of the year.
In a sense, this will make the Fed like Fannie and Freddie in that it can absorb losses deemed necessary by the government for good social reasons. However, the Fed will not have to go to the Treasury with its hand out, as Fannie and Freddie has to, in order to cover its losses because the Fed makes so much profits by being able to create money whenever it wants to.
But, there is another problem: how much upward pressure will the liquidation of the mortgage-backed securities put on interest rates. How much will Congress resist this upward movement in interest rates? What will the housing lobby do to counter-act this move in rates because such a move will certainly not be good for a recovering housing market.
There is another concern: billions and billions of dollars of government debt have been purchased at subsidized interest rates. Helping this along was the extremely low short-term rates resulting from the Fed’s “close to zero” interest rate policy. If I can borrow for six months at, say, 50 basis points or so, and lend these funds out at around 3.00% on 7-year Treasuries, with a “guarantee” from the Fed that the 50 basis points will remain for “an extended period” of time, I have a pretty nice deal.
And, making money in this way doesn’t even include the returns that are available on the “cover” trade.
But, what will happen to those that “underwrote” the placing of the federal debt when the Fed begins to let rates start to rise? How extensive and deep will be the capital losses? Not everyone can make it through the “exit door” at the same time. Will Congress hear about this?
There are additional regulatory issues relating to institutions that are “too big to fail”. These, too, get us into the political realm. Congress is going to want to get their hands into this “solution” as well.
Has the current leadership at the Fed (Republican appointed) brought us to the brink of the government making the Fed into another Fannie Mae or Freddie Mac? Printing money is sure an attractive way to try and achieve social goals. It is interesting that the political party (the Republicans) that was supposedly the strongest supporter of free-market capitalism has brought us to the edge of greater government control of industry (like autos and housing) and financial institutions (like large banks and the Fed).
One could argue that they are on the verge of such ignominy.
Never before has the Federal Reserve been under such attack and from all sides. The attacks have gotten so severe that the subject even made the front page of the New York Times today. (See “Under Attack, Fed Chief Studies Politics,” http://www.nytimes.com/2009/11/11/business/11fed.html?hp.) The legislative attack on the Fed continues with the new proposals on financial regulation coming from the Senate Banking Committee. (See “Senate Democrats Seek Sweeping Curbs on Fed,” http://online.wsj.com/article/SB125786789140341325.html?mod=WSJ_hps_LEFTWhatsNews.)
Certainly the leadership of the Federal Reserve seems to be deserving this scorn. Henry Kaufman states bluntly that “there is the Fed’s legacy of its inability to limit past financial excesses. By failing to be an effective guardian of our financial system, it has lost credibility.” (See, “The Real Threat to Fed Independence,” http://online.wsj.com/article/SB10001424052748703574604574501632123501814.html.)
Of course, Alan Greenspan gets his share of the blame for “keeping interest rates too low for too long in the early years of this decade”; for his failure to understand the changes in the financial markets coming from financial innovation; and for his role in the repeal of the Glass-Steagall Act.
But, Ben Benanke must also bear his share in the decline of Fed credibility. He was Greenspan’s co-conspirator, serving on the Board of Governors of the Federal Reserve System during the 2002 to 2005 period in which the Federal Funds Rate was kept below 2.00% from the time he joined the Board until November 2004. For much of the time this Fed Funds rate was around 1.00%. Bernanke was a strong defender of keeping the rates so low, both in terms of economic analysis and speeches.
After Bernanke assumed the position of Chairman he was slow responding to the possibility that the bubble was bursting in the subprime market. Then, Bernanke reacted very strongly to the financial collapse, possibly over-reacted, in the week of September 15, 2008. (See my post of November 16, 2008, “The Bailout Plan: Did Bernanke Panic?” http://seekingalpha.com/article/106186-the-bailout-plan-did-bernanke-panic.)
Congress certainly saw Bernanke in action that week. According to a Wall Street Journal article, which I quoted in the post, “(Hank) Paulson called the leadership in Congress and asked them to have a meeting with himself and Bernanke on Friday evening. The few members of Congress that talked with the press after that meeting said that Bernanke did most of the talking and ‘scared the daylights out of everyone.’ Bernanke got his wish in that Congress ultimately passed the TARP bill, although they did not pass the bill by the next Monday as Bernanke had originally pressed for.
I’m not completely convinced that Congress, deep down, has all that much confidence in a Ben Bernanke-led Federal Reserve System going forward even though President Obama seems to.
Then, the Federal Reserve, under Bernanke’s guidance, flooded the banking system with reserves, leading up the current time where excess reserves in the banking system total more than $1.0 trillion. His concern over this time period has been the liquidity of financial markets. (See my recent post, “Dear Fed: the Problem is Solvency, not Liquidity,” http://seekingalpha.com/article/171826-dear-fed-the-problem-is-solvency-not-liquidity.)
As Kaufman points out in his Wall Street Journal article, the Federal Reserve now has another major conundrum: “How will the Fed reduce its bloated balance sheet?” This is a real problem because the Federal Reserve has subsidized the financing of massive amounts of federal debt and has also provided massive support to the markets for mortgage-backed securities and federal agency issues. As of November 4, 2009, the Fed owned outright $777 billion in U. S. Treasury issues, $774 billion in mortgage-backed securities, and $147 billion in Federal agency debt securities, roughly $1.7 trillion.
In supporting these markets, the Federal Reserve has kept the interest rates on these securities below the level they would have attained without the support of the central bank. The first question is, what will happen to these rates once the Fed stops supporting these securities. Will their rates ratchet upwards?
And, then, what will happen once the Federal Reserve finally decides it needs to let interest rates move up as the economy gains strength? If the Federal Reserve pursues its exit policy of removing reserves from the banking system it will have to take a loss on these securities. No matter though, it will just reduce the amount of funds (its profits) it returns to the Treasury Department at the end of the year.
In a sense, this will make the Fed like Fannie and Freddie in that it can absorb losses deemed necessary by the government for good social reasons. However, the Fed will not have to go to the Treasury with its hand out, as Fannie and Freddie has to, in order to cover its losses because the Fed makes so much profits by being able to create money whenever it wants to.
But, there is another problem: how much upward pressure will the liquidation of the mortgage-backed securities put on interest rates. How much will Congress resist this upward movement in interest rates? What will the housing lobby do to counter-act this move in rates because such a move will certainly not be good for a recovering housing market.
There is another concern: billions and billions of dollars of government debt have been purchased at subsidized interest rates. Helping this along was the extremely low short-term rates resulting from the Fed’s “close to zero” interest rate policy. If I can borrow for six months at, say, 50 basis points or so, and lend these funds out at around 3.00% on 7-year Treasuries, with a “guarantee” from the Fed that the 50 basis points will remain for “an extended period” of time, I have a pretty nice deal.
And, making money in this way doesn’t even include the returns that are available on the “cover” trade.
But, what will happen to those that “underwrote” the placing of the federal debt when the Fed begins to let rates start to rise? How extensive and deep will be the capital losses? Not everyone can make it through the “exit door” at the same time. Will Congress hear about this?
There are additional regulatory issues relating to institutions that are “too big to fail”. These, too, get us into the political realm. Congress is going to want to get their hands into this “solution” as well.
Has the current leadership at the Fed (Republican appointed) brought us to the brink of the government making the Fed into another Fannie Mae or Freddie Mac? Printing money is sure an attractive way to try and achieve social goals. It is interesting that the political party (the Republicans) that was supposedly the strongest supporter of free-market capitalism has brought us to the edge of greater government control of industry (like autos and housing) and financial institutions (like large banks and the Fed).
Sunday, September 7, 2008
Coming Home to Roost
Try as hard as it might, Bush 43 could not postpone the consequences of its actions until it January 20, 2009. Bush 41 largely escaped. Son’s administration was not so lucky.
Yes, things started unraveling early in 2007 with the subprime market leading the way. But, the economy did not ‘tank’ and many, including McCain’s friend, advisor, and one time choice for Secretary of the Treasury in a McCain administration, kept telling us that ‘things weren’t so bad’ and that some people just suffered from mental depression and were just whiners.
After the initial liquidity scare, the unwinding of financial positions has been relatively smooth. Sure, Bear Stearns was bailed out, but Citigroup and Merrill have gotten capital infusions and are still standing. The housing industry has suffered tremendously, but there have been no major wipe-outs. There now have been 11 takeovers in the banking industry, but they have been relatively small banks…in general. Retail trades have only experienced a few bankruptcies. Food chains have been suffering, but no real biggies here. Manufacturing has been on hold but most large companies seem to be holding on with a fair amount of cash on hand. (Hold your breath General Motors…)
Now, however, some of the bigger paychecks are coming due. Fannie Mae and Freddie Mac have been taken over, their top executives relieved of their positions, and the United States Treasury Department has committed the American Government to “an open-ended guarantee to provide as much capital as they (Fannie and Freddie) need to stave off insolvency.”
What might this commitment amount to?
Well, Fannie and Freddie have accumulated more than $5 trillion in assets. Five trillion dollars includes a lot of zeros. There have been estimates that this commitment could cost around $20 to $30 billion, but I quoted a figure of $200 billion in a recent post. These are big numbers so we need to be careful in trying to comprehend their size. If there were a 20% write off of asset value, this would amount to $1 trillion; a 10% write off would amount to $500 billion, a 5% write off would amount to $250 billion, and a 1% write off would amount to $50 billion.
You pick a number. What will be the amount of the write down of these assets?
The important thing is that action has finally been taken. The administration finally reached the point where a takeover could not be postponed any longer. In fact, that has been the case for the last twelve months or so. The people in authority kept postponing and postponing action until they have no further choice.
The Bernanke Fed has gotten a lot of attention and praise/blame for the dramatic reduction in the target Fed Funds rate it uses to anchor monetary policy. But, if you remember the situation in the spring of 2007, Bernanke and the Fed kept putting off and putting off any reduction in its target rate of interest because they did not comprehend the need for such action. Then, when they did move they felt the drop needed to be one of the most precipitous declines on record.
The same thing is true of many of the other responses of Bush 43 in 2007 or 2008.
This is an administration that was pro-business and hands off in terms of rules and regulations. This administration did not want any economic dislocation coming on its watch. Now, it is having to act and the question is, how much more is it going to have to do before it gives up office?
The irony of the situation reminds me of that faced by the Nixon administration back in August of 1971. I joined the Nixon administration as a Special Assistant to George Romney (HUD) on August 1. Sunday evening, August 15, President Nixon went on national television and announced the freezing of wages and prices. I was fortunate (or not, depending on your philosophical leanings) to attend meetings of the Cost of Living Council and the Committee on Interest and Dividends. It was remarkable to sit in these meetings, day-after-day, and see individuals that abhorred controls of any kind, attempt to administer wage and price controls. Many of these people were violently opposed to wage and price controls or, at least, were indifferent to their application.
I perceive that many in the current administration are going through this soul-searching at the present time. And, they are faced with the prospect of other intrusions into the economic and financial system as they wind down their terms in office. How many of them wish that they had left the administration a year or so ago?
Fred Mishkin, who resigned from the Board of Governors of the Federal Reserve System in August…how lucky you are!!!
I really believe that these people want out. And, what is one of our presidential candidates shouting? “I think that we’ve got to keep people in their homes. There’s got to be restructuring, there’s got to be reorganization, and there’s got to be some confidence that we’ve stopped this downward spiral.” Senator McCain concluded, “It’s hard, its tough, but it’s also the classic example of why we need change in Washington.”
My question here is, who is Senator McCain, if he is elected President, going to use to clean up the financial and economic mess? My take is that the current people want out…they are receiving enough of the blame for the current administration. And, who might be brought in…Phil Gramm and Jack Kemp? The Republican pool is relatively dry…it has been picked over for the last eight years. Shall McCain reach across the aisle? If he is going to bring in a bunch of Democrats to clean up the mess…isn’t this a little bizarre?
There is a lot a new administration is going to have to do when it gets in office to get the economy and the financial system working smoothly again. Yes, economic growth is going to have to be renewed, but there is also the underlying inflation that will still be worrisome. Yes, the regulatory system needs to be revisited. Yes, the dollar needs to be attended to? Yes, foreign money is buying up American assets at a record pace. Yes, we need a real energy policy. Yes, the auto industry is in the tank. Yes, home owners are losing their homes. Yes, these are just a part of the agenda that will be facing a new administration come January 20, 2009.
This agenda is why I don’t believe any new President is going to have much room to introduce new items that are on their social or economic agenda. I think the campaign message should be…I would like to do thus and so…but, because of the current mess that I will inherit, there will be very little I can do in the next two to three years. I know you would like to hear something different, but, in all honesty, that is all I can promise you at the present time.
The problems created by Bush 43 are coming home and we must face them head on. The absence of an energy policy has put the United States in an embarrassing hole that it is finding difficult to climb out of. But, we need to stop digging the hole deeper. Our policy with respect to the dollar has been abysmal and it has put many United States assets on the block for foreign interests. Our fiscal policy has been totally out-of-control and has placed a large amount of the United States government debt in foreign coffers. Our monetary and banking policies have ignored the innovation taking place in the financial sector and, as a consequence, our authorities have lost control of sub sector inflations…inflations that have resulted in credit expansions pertaining to specific asset stocks and not to their sector cash flows.
We have a long way to go before we are out of this economic and financial morass. To me, risk is still being underestimated in the markets. The Fannie and Freddie experience is only another step along the bumpy road ahead of us.
Yes, things started unraveling early in 2007 with the subprime market leading the way. But, the economy did not ‘tank’ and many, including McCain’s friend, advisor, and one time choice for Secretary of the Treasury in a McCain administration, kept telling us that ‘things weren’t so bad’ and that some people just suffered from mental depression and were just whiners.
After the initial liquidity scare, the unwinding of financial positions has been relatively smooth. Sure, Bear Stearns was bailed out, but Citigroup and Merrill have gotten capital infusions and are still standing. The housing industry has suffered tremendously, but there have been no major wipe-outs. There now have been 11 takeovers in the banking industry, but they have been relatively small banks…in general. Retail trades have only experienced a few bankruptcies. Food chains have been suffering, but no real biggies here. Manufacturing has been on hold but most large companies seem to be holding on with a fair amount of cash on hand. (Hold your breath General Motors…)
Now, however, some of the bigger paychecks are coming due. Fannie Mae and Freddie Mac have been taken over, their top executives relieved of their positions, and the United States Treasury Department has committed the American Government to “an open-ended guarantee to provide as much capital as they (Fannie and Freddie) need to stave off insolvency.”
What might this commitment amount to?
Well, Fannie and Freddie have accumulated more than $5 trillion in assets. Five trillion dollars includes a lot of zeros. There have been estimates that this commitment could cost around $20 to $30 billion, but I quoted a figure of $200 billion in a recent post. These are big numbers so we need to be careful in trying to comprehend their size. If there were a 20% write off of asset value, this would amount to $1 trillion; a 10% write off would amount to $500 billion, a 5% write off would amount to $250 billion, and a 1% write off would amount to $50 billion.
You pick a number. What will be the amount of the write down of these assets?
The important thing is that action has finally been taken. The administration finally reached the point where a takeover could not be postponed any longer. In fact, that has been the case for the last twelve months or so. The people in authority kept postponing and postponing action until they have no further choice.
The Bernanke Fed has gotten a lot of attention and praise/blame for the dramatic reduction in the target Fed Funds rate it uses to anchor monetary policy. But, if you remember the situation in the spring of 2007, Bernanke and the Fed kept putting off and putting off any reduction in its target rate of interest because they did not comprehend the need for such action. Then, when they did move they felt the drop needed to be one of the most precipitous declines on record.
The same thing is true of many of the other responses of Bush 43 in 2007 or 2008.
This is an administration that was pro-business and hands off in terms of rules and regulations. This administration did not want any economic dislocation coming on its watch. Now, it is having to act and the question is, how much more is it going to have to do before it gives up office?
The irony of the situation reminds me of that faced by the Nixon administration back in August of 1971. I joined the Nixon administration as a Special Assistant to George Romney (HUD) on August 1. Sunday evening, August 15, President Nixon went on national television and announced the freezing of wages and prices. I was fortunate (or not, depending on your philosophical leanings) to attend meetings of the Cost of Living Council and the Committee on Interest and Dividends. It was remarkable to sit in these meetings, day-after-day, and see individuals that abhorred controls of any kind, attempt to administer wage and price controls. Many of these people were violently opposed to wage and price controls or, at least, were indifferent to their application.
I perceive that many in the current administration are going through this soul-searching at the present time. And, they are faced with the prospect of other intrusions into the economic and financial system as they wind down their terms in office. How many of them wish that they had left the administration a year or so ago?
Fred Mishkin, who resigned from the Board of Governors of the Federal Reserve System in August…how lucky you are!!!
I really believe that these people want out. And, what is one of our presidential candidates shouting? “I think that we’ve got to keep people in their homes. There’s got to be restructuring, there’s got to be reorganization, and there’s got to be some confidence that we’ve stopped this downward spiral.” Senator McCain concluded, “It’s hard, its tough, but it’s also the classic example of why we need change in Washington.”
My question here is, who is Senator McCain, if he is elected President, going to use to clean up the financial and economic mess? My take is that the current people want out…they are receiving enough of the blame for the current administration. And, who might be brought in…Phil Gramm and Jack Kemp? The Republican pool is relatively dry…it has been picked over for the last eight years. Shall McCain reach across the aisle? If he is going to bring in a bunch of Democrats to clean up the mess…isn’t this a little bizarre?
There is a lot a new administration is going to have to do when it gets in office to get the economy and the financial system working smoothly again. Yes, economic growth is going to have to be renewed, but there is also the underlying inflation that will still be worrisome. Yes, the regulatory system needs to be revisited. Yes, the dollar needs to be attended to? Yes, foreign money is buying up American assets at a record pace. Yes, we need a real energy policy. Yes, the auto industry is in the tank. Yes, home owners are losing their homes. Yes, these are just a part of the agenda that will be facing a new administration come January 20, 2009.
This agenda is why I don’t believe any new President is going to have much room to introduce new items that are on their social or economic agenda. I think the campaign message should be…I would like to do thus and so…but, because of the current mess that I will inherit, there will be very little I can do in the next two to three years. I know you would like to hear something different, but, in all honesty, that is all I can promise you at the present time.
The problems created by Bush 43 are coming home and we must face them head on. The absence of an energy policy has put the United States in an embarrassing hole that it is finding difficult to climb out of. But, we need to stop digging the hole deeper. Our policy with respect to the dollar has been abysmal and it has put many United States assets on the block for foreign interests. Our fiscal policy has been totally out-of-control and has placed a large amount of the United States government debt in foreign coffers. Our monetary and banking policies have ignored the innovation taking place in the financial sector and, as a consequence, our authorities have lost control of sub sector inflations…inflations that have resulted in credit expansions pertaining to specific asset stocks and not to their sector cash flows.
We have a long way to go before we are out of this economic and financial morass. To me, risk is still being underestimated in the markets. The Fannie and Freddie experience is only another step along the bumpy road ahead of us.
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