Its actually kind of ironic: Two Fed Governors warn Federal Reserve Chief Alan Greenspan about major problems — and are promptly ignored by the maestro. Ed Gramlich on subprime and predatory lending, and Bill Poole on Fannie and Freddie.
In the Sunday NYT, Poole argues that now Fannie and Freddie must be saved for systemic reasons — but then taken apart:
CRITICS of the Congressional housing package complain that we are now committing taxpayers to huge new outlays to rescue Fannie Mae and Freddie Mac. That view is wrong: Congressional inaction over the past 15 years had already committed taxpayers to the bailout.
Congress could and should have required Fannie and Freddie — which enjoy a peculiar and highly advantageous status as quasi-public agencies and quasi-private companies — to maintain more capital, but didn’t. Now the costs from Congressional inaction are becoming painfully apparent, and they cannot be avoided. To permit the two mortgage giants to default would set off a worldwide crisis. But we can decide what should become of Freddie and Fannie after this crisis. The best option is one getting little mention in Washington: get rid of them.
Because the government cannot permit Fannie and Freddie to default, their obligations are part and parcel of the full-faith-and-credit obligations of the United States. Thus, the national debt, usually viewed as the $5 trillion held by the public, is really $10 trillion once we add the Fannie and Freddie obligations and the mortgage-backed securities they guarantee.
For now, the Congressional Budget Office has entered a “place holder” of $25 billion to cover the bailout costs over the next two years but recognizes that this is a guess. The important issue is not the 2009 outlay, but the total that will be required eventually. Even if the two firms are technically insolvent, the market will continue to buy their obligations readily, for it understands that they are fully backed by the government.
Given this faith on the part of the marketplace, there will be no immediate catastrophe that would force the federal government to provide additional capital to Fannie and Freddie. The situation is similar to the one in the 1980s, when many savings and loans were technically insolvent yet had no difficulty attracting deposits, as they were covered by federal deposit insurance. So the federal government has the option of delaying any ultimate resolution of the Fannie-Freddie mess, as it did with the savings and loans 20 years ago, in hopes that the two giants can dig themselves out of the hole. Still, it seems more likely that — again, just as in the 1980s — the longer we delay, the higher the eventual taxpayer cost will be. (emphasis added)
Well stated . . .
Blaming Greenspan (June 2007)
Subprime Mortgages: America’s Latest Boom and Bust (May 2008)
Too Big to Fail, or to Survive
NYT: July 27, 2008
BR; when you say “well stated” are you saying Mr Poole presented his arguments well or you agree with all of them? Because if the latter you’re ignoring a fallacy at the center of his piece when he says the private sector will provide the finance to backstop the US mortgage market and quotes the fact that F/F share of the market declined to around 35% without mentioning that it has now bounced back up to around 90%. Why? BECAUSE the private sector is currently unwilling to provide the backstop finance. Imagine F/F didn’t exist who would now be providing the backstop? And what would the impact of the non existence of private sector financing be on US housing market.
Echoing the first comment, do you mean you think he’s stated his point clearly, or that his point is correct? If the latter I have to disagree, on two levels.
First of all, as with so many others, his ignoring the culpability of management is egregious. If indeed the US government’s goal was to create a private corporation where management was paid as though they were running their own business, but in fact were running a public sector service, one in which risks were irrelevent able to be taken on without consequences, then the US Government is effectively ‘throwing money down a hole’. There is no reason why ‘throwing money down a hole’ should be (or can be) sustained in perpetuity. The claim that because the US government created this fannie/freddy public/private set up in the 60’s in no way implies that we have to continue. Even more to the point this ‘rescue’ makes clear that the private/public structure, initiated under ‘free market principles’ was always a sham. Are we obliged to continue all cons that we create? It should be clear that the unwillingness, or inability, to ‘drop’ a con, is at the heart of getting busted.
Thus his statement is fundamentally disingenous. It is yet another voice trying to shift blame away from the falacious con game of ‘public/private’ enterprises that is at the core of the ‘free market’ revolution, and in addition, since he blatantly absolves the management of fannie and freddie from any responsibility of any kind, is nothing but another voice calling for socialism for the rich.
Lets quit pretending that we have anything other than an institutionalization of assymetric power — an aristocracy.
Most observers simply do not believe that using societal resources for the benefit of a few is a long term viable strategy for any society. This is why socialism for the rich has always been sold under an entirely fallacious name: ‘free markets’.
This statement you quote is nothing but another salvo in the ongoing effort to spin the crisis in this country as the fault of someone other than those who have the power and wealth to control the events that have occured. It is directly and clearly the fault of ‘free market capitalists’ and their lap dogs in DC.
Any ‘solution’ that fails to address the real causes (of any problem) is no solution at all.
these ‘solutions’ may be succesful in squeezing more real wealth out of the society for the benefit of a narrow few, like the people that ran fannie/freddie into the ground, but sooner or later ‘squeezing’ all you can is going to kill the patient. One suspects that most of the super-rich don’t much care if the US ceases to be a viable society either economically or socially. One suspects they don’t much care if we turn back into 1800’s England. But we do care, because we are not insulated from that society but rather a part of it. As such blatant lies designed to keep us from realizing that we are being squeezed by criminals are not particularly impressive.
This “worldwide crisis,” what does that mean exactly? I hear this and other ooga-booga phrases bandied about as if they are so patently awful that we need not bother describing who would be affected, how badly, and for how long.
What if we did nothing about the “crisis” and let the magic of the marketplace do its thing? Who would be the big losers? Certainly all the big financial companies and banks would be wiped out, along with the big hedge funds. Sovereign wealth funds would take a hit for all of their recent recapitalization bets. Boo-effen-hoo so far.
The home-equity-loan market would dry up almost completely. It’s on its last leg as it is already as banks struggle to preserve capital. The Home Depots of the world would take a hit to revenue, but after the abuse I have received in the big-box stores, I’m having a hard time summoning any sympathy there either.
What about the foreign central banks hold much of the mortgage-backed garbage? They would indeed take a major hit. Who knows? Maybe it would be enough for them to quit trying to prop-up the dollar against their currencies, the effect of which would be to level the trade deficit by boosting US exports and reducing foreign imports.
What about Joe Sixpack homeowner? No matter how many times I think about it, I come to the same answer: If they couldn’t afford the home when they bought it, they shouldn’t have taken out the loan. And besides, home prices are still way, way out of line with incomes. Until we return to traditional debt-to-income ratios, borrowers will be seduced into the risky financial arrangements (no-interest loans, teaser-rates, option-ARMs, etc) that got us into this mess in the first place.
I say let the invisible hand deal everyone the slap they have coming.
Not well said at all. The cost of Congessional inaction to require Fannie and Freddie to hold more capital is painfully evident? This mess was created by private securitization run amuck, while Fannie and Freddie stuck to conforming loans. The problem would be even worse had higher capital requirements made Fannie and Freddie less competitive. The national debt is now $10 trillion? Does the former Fed governor not know the difference between a debt and a contingent liability (which has been there all along)? The longer we delayed the resolution of the S&L crisis the higher the cost was? Does the governor have any idea how much money the private buyers of S&L assets made at the taxpayers expense as a result of the inept liquiditation fire sales sponsored by the government? The cost was multiples of what it should have been because there was political pressure to show the crisis was being dealt with. The bad assets created by private securitization have already been created; does anybody really think the cost of dealing with them will go down by getting rid of Fannie and Freddie?
“Maybe it would be enough for them to quit trying to prop-up the dollar against their currencies, the effect of which would be to level the trade deficit by boosting US exports and reducing foreign imports.”
And while this process of dollar collapse and readjustment takes place who is going to replace the roughly two billion a day that it takes to finance our current account and budget deficits. What would you like the dollar to be at? 2.25 to the Euro perhaps, or weaker still, and the Yen? Yep a real boon for our import bill. Then of course we’d lose our privileges as the world’s reserve currency of choice. The Brits can tell you what that means from their experiences from 1945 to 1965.
I’d like to ad:
I don’t disagree with Poole’s proposed policy action. It seems more than reasonable that one of two choices be made: dissolve frannie/freddie (somehow) or make them truly public sector entities, as they were intended to be. Indeed, it seems very reasonable to argue that the government has no business ‘promoting’ house ownership whatsoever.
But… that isn’t the real cause of the problem. The real cause of the problem is society wide shift away from the idea that government has an important role in regulating financial markets, and toward a belief in ‘self regulation’. I believe it was on Angry Bear recently (but could be wrong) if you tell your insurance company that you are going to self-regulate with regard to fire protection, but you still want their insurance, just exactly how much insurance are you going to get?
It is no surprise that a period of ‘letting the market regulate itself’ has ended in a financial crisis. NONE!
What is stunning is that most ‘solutions’ proposed attempt further deregulation. So fine we get ready of F/F, great. Are we going to regulate the mortgage market properly or are we going to continue to let it ‘run itself’. That of course is the real core idea behind the chnages institutionalized in the 30’s. Use regulation and federal power to ‘save capitalism from itself’.
If we do not AS A SOCIETY once again come to understand the wisdom in that stance, the phrase ‘our long national nightmare of peace and prosperity is over’, will cease being in anyway funny.
Blaming congress for deregulation, and proposing more deregulation as a solution is disingenous. Making changes to corporate strutures (private and public) completely misses the real issue — limits on the right of the powerful to steal from the weak, so that in fact, the powerful continue to have a host body to feed on.
Basically true. In the current situation where private sector backstop finance for the primary mortgage market is not available if F/F did not exist it would be necessary to invent them. In fact that is why they were invented. Poole very carefully doesn’t say they should be allowed to fail which if he really believed in the sanctity of moral hazard he would. Whether we like it or not F/F are an inescapable part of the mixed private/public system of housing finance in the US. F/F are NEVER going to be liquidated. (NOTE;there was literal error in my piece F/F share quoted by Poole was 15% not 35%)
Poole is a conservative idealogue whose analysis does not comport with the reality of a mixed economic system.
F&F are hybrids bridging the span between public purpose and private profit. They could have been regulated better. They could have kept higher capital ratios. These things can and will be fixed.
But we cannot afford to get rid of them as they serve a vital public interest. We also cannot afford to nationalize them as private capital is cheaper than public capital. And privitizing them completely will only make matters worse as we would lose their public purpose to buy mortgages thereby freeing up capital for increased economic activity.
Paulson has it exactly right: keep them in the current form but with increased oversight of both managerial and operational matters. Make the implicit Treasury guarantees explicit. And, if needed, infuse some public capital along with the private capital that will be raised.
“And while this process of dollar collapse and readjustment takes place who is going to replace the roughly two billion a day that it takes to finance our current account and budget deficits.”
US treasuries are still backed by the full faith and credit. The bet with CDOs was that the risk was similar to treasuries while yielding a much higher return. That was a bad bet that deserves no extra protection.
As for the dollar’s collapse, and reserve currency status, I don’t see how letting the chips fall where they may is any worse than firing up the printing presses to cover the added obligation of the bailout. Respectfully, I think that fears that the world will defect from the dollar en masse are overwrought.
Chris: If F/F reneged on their mortgage backed bonds it would be tantamount to a US default because everyone knows the govt backed them. US credit would probably not totally collapse although short term disruption is likely but the cost of our borrowing would have gone through the roof. Even Argentina was able to borrow after their default but at a premium. This is one of the two reasons Paulson, who after all is a rock solid Republican, was literally desperate to rescue F/F. The other reason is that housing finance would have dried up overnight because no one else at this time is willing to provide it which is the flaw at the center of Poole’s argument and why BR is wrong on this one. Poole is a right wing idealogue and he’s being totally disingenuous on several fronts.
One major problem with Poole that deserves closer examination is his plans effect on the cost of new capital for these firms.
If investors believe that at some point in time the government is going to walk away from these companies it is unlikely they will be able to raise new capital at any price.
If they abandon their congressional charter and start anew as recapitalized investment banks then who needs them and why would investors take a chance with such seemingly troubled companies?
Pooles solution does not make any practical sense. It is nothing but idealogy.
If these companies are going to raise private capital, which is the preferred option over public capital, they will do so only with the understanding that the government will continue to guarantee these companies long term survival.
You put it perfectly. It’s quite impossible to eliminate public involvement in the housing finance market. As I said, if F/F did not exist it would be necessary to invent them. Yes, they should not have been allowed to overleverage, but then neither should Citi or Bear Stearns. What’s the difference. It’s a failure of regulation not an argument that F/F don’t satisfy a need. Paulson, who is a conservative but very sensible man knows that even if a bunch of doctrinaire conservatives don’t. The essential falseness of their position is that none of them(other than the total fruitcakes like Bunning) actually want to allow a F/F failure despite their obeisance to the sanctity of moral hazard.
This statement odes two very bad things:
“Because the government cannot permit Fannie and Freddie to default, their obligations are part and parcel of the full-faith-and-credit obligations of the United States.”
It is not a logical statement, it is presumption. Not basis for further argument from this statement.
Second, there is a thing in the law and supported by concrete logic that you cannot do anything ex post facto (an old Roman theory), including appropriate funds in 2008 for insuirance underwriting “expenses” in 2006.
Those of us who have worried about “anti-deficiency” now see there was never a concern.
The productive side of the economy is bankrupted by the paper passing side????
One last point: I understand that the bank who “buys” a failed bank from the FDIC gets to decide to honor or not the terms and conditions of its CD’s and so forth.
Is that true?
You are right about Paulson. But then he came from Goldman Sacs and knows wherefore he speaks.
I am really impressed by his grasp of the situation and his proposed solution. What worries me is that people with less knowledge but bigger mouths will be able to turn a win into a loss for investors and taxpayers alike just for the sake of idealogy. It makes me sick.
You must save the village to destroy it.
I don’t think that’s going to happen because when the chips are down the Republicans, at least the sane ones, even Poole, are rolling on this because the alternative is too awful to contemplate. It’s no exaggeration to say that at the moment the agenda for Bush’s final days is being set by Paulson at home and Gates abroad. If Paulson hadn’t got 100% support on this hovering in the background is that he could have resigned and not being a straw man, like say Powell, would. In the longer term that depends on November but the climate has changed. As for F/F there is not the least chance they are ever going to privatized which is one of the reasons the right is apoplectic because they know this crisis has actually made them stronger with for example the US govt guarantee moving from the implicit to explicit. What I find odd is that BR buys Poole’s line since it is totally flawed. Maybe he’s just trying to stir us up.
Thank you, fellows, for this most educational discussion. I appreciate, especially, the separation of the intent of the establishment of F/F from their lack of regulation and their mismanagement.
The various financial blogs are frequently dominated by the Ron Paul types, whose anger may be legit but whose knowledge is generally quite weak, and it’s great to hear more informed voices.
>> And while this process of dollar collapse and readjustment takes place who is going to replace the roughly two billion a day that it takes to finance our current account and budget deficits.
I’d like to point out the following:
As our currency depreciates, it takes less foreign currency to buy our debt.
Therefore, I don’t think currency depreciation is as bad to funding our debts as people think. It’s only bad at the point when people think we’re about to depreciate. After that, we’re ok. And, therefore:
– In the event we reject FF debt, we should not fear an absence of buyers of our debt.
– In the event we bail out FF debt, we should fear an absence of buyers of our debt, because other CBs will know we’re going to choose to inflate our way out of debt.
So, while we’re on the same side, I think your policy prescription will yield the opposite of the effect you seek.
And who would you rather lend money to:
(a) someone with currently small debts or
(b) someone with currently large debts
Who’s a bigger credit risk and who will you demand more interest from??
Defaulting on our debts. Allowing the dollar to tank. This make foreigners actually more willing to take our debt and not to demand a substantially higher rent for their money to cover both dollar devaluation and elevated risk? An interesting perspective.
Bill Clinton!!!! Blame that motha phucka
“Therefore, I don’t think currency depreciation is as bad to funding our debts as people think. It’s only bad at the point when people think we’re about to depreciate. After that, we’re ok.”
Seriously. Read that one again:
“Therefore, I don’t think currency depreciation is as bad to funding our debts as people think. It’s only bad at the point when people think we’re about to depreciate. After that, we’re ok.”
Your statement is like selling no-doc loans for suites on the port side of the Titanic, 10 minutes after it hit the ice burg.
Keep rearranging those deck chairs…
I think Wunsacon has it generally right, but it’s important to remember that current marginal buyers of US debt aren’t necessarily profit-seeking private buyers. They’re governments required to buy US debt to implement export-dependent domestic industrial policy.
A F/F failure would certainly stress and possibly fracture the debt-for-exports models in these countries, and shut down those flows. Eventually, as Wunsacon notes, the US economy would slow as savings rates rise, and devaluation and inflation risks would drop to the point where private flows would stabilize debt markets. The road from here to there would be a rough one though.
Joshua’s deck chairs analogy works, but maybe not for the reason he suggests. As these debt-for-exports flows grow, the risks associated with the resulting imbalances also grows. China, for example, is having growing trouble with hot money inflows anticipating an upward revaluation. Whether that particular iceberg has gone through the hull remains to be seen, but as the speed of the ship picks up, it follows that one eventually will and the faster the ship is going, the worse the hole will be.
John – “if F/F did not exist it would be necessary to invent them”
Does Canada have a nationalized mortgage pooling entity? Does Britain? What is it about the US that suggests it couldn’t possibly pool mortages the same way others do?
Why is the US housing and mortgage market unique in needing nationalization (ahead of say, food or healthcare)?
I’ve read somewhere that F&F were semi-privatized in the late 60’s as a way to cook the books about the deficits related to the Vietnam War. Is this the case? If so, why couldn’t they be deprivatized?
It looks like they performed well for over 30 years as semi-private entities. We really should find out (but probably won’t) how they went off the tracks after decades of competent management.
Which is why my analogy follows 10 minutes after that ice berg has hit…
My problem with Wunsacon’s theory was that it was based upon other countries picking up our debt, as if that was a good thing.
When other countries are picking up our debt, are we really looking at a good and healthy thing in relation the the dollar?
I would say that it isn’t until we are in navigate able waters, where the value of the dollar is able to rise (and its pricing in commodities brings them back down). At this time, no aspect of cheap debt prostrated to the world is going to be in any ones’ interest except the insiders making money on the speculation.
Sure, the latest or so issue of the Economist is going to keep repeating the the “hot money” meme. But, having lived there in China, I can see where the money is going. Infrastructure, power generation, and transportation are being put in at an unheard of scale. And this because the Chinese are taking the long term on this this and looking past their US Dollar currency reserves and planning ahead. Not at the increasingly devalued 1’s and 0’s that they currently have in US notes. When this “hot money” dries up, the infrastructure to manufacture and produce will have been developed. Much more than can be said for the “developmental funds” earmarked for EU countries like Romania and Poland.
Our Chinese friends are holding onto US TBills because it is convenient for them now. Holding 1/5 of someones external debt gives them leverage over a lad.
We can get into and entire “They need us more that we need them” type of tryst, but let’s go back to the premise of my initial point (which I never really articulated in my response to Wunsacon’s idea).
When your gov’t debases the currency by selling even more debt to try to make up for its inability to pay for its current debt, to the extent that its valuation can only implicitly go down, year over year, then you have a problem. This problem may be able to be incurred if there was full credit and faith behind the currency, but I would argue that we have a credit system in limbo and a faith that is more emotional than technical based.
“This mess was created by private securitization run amuck, while Fannie and Freddie stuck to conforming loans.”
No. Government lending is always and everywhere a tool for driving up prices and subsidizing unworthy borrowers. Housing, college education, you name it: it always ends with prices tripling, and good people chained to excessive debt.
And if you think conforming paper near the bubble peak did not include lots of horrifically underwritten loans, you are in for quite a surprise.
“The problem would be even worse had higher capital requirements made Fannie and Freddie less competitive.”
No. If the GSEs had not been writing exploding paper, they would now be able to put a rational floor under the crashing markets, instead of standing by while a cascading fire sale drives prices below their fundamental value. They would now be able to issue securities that were nearly as good as money, helping keep the securitization engine running, and thereby mitigating the leverage draw down that is sending our fractional-reserve system (leverage = money supply) into a deflationary spiral. They would now be able to use the years of locked-in profits from their non-bubble assets to subsidize recovery of the crashing markets.
Poole is a conservative idealogue
Neither “Ken” nor “John” can even spell ideologue correctly.While you are at it go ahead and call Poole a counter-revolutionary, capitalist-roader, running-dog lackey of the imperialists etc……..
GSEs are as hybrid as a mule. The product of their mixed DNA, government and private enterprise, is sterility (non productive).
How about a 95% net-worth tax on all the officers and board members of these firms getting bailouts – and it should include a 10-year reach-back to recover any assets given way to friends, or family or disposed of by any method – just like states do to nursing home patients who require public funds to cover their care expenses. And just as with indigent nursing home residents we can allow these malefactors of great wealth a $50 a month “crazy money” stipend for denture adhesive and hearing aid batteries.
Sounds like a plan, hjmler!
Let’s write our Congressmen…
>> When your gov’t debases the currency by selling even more debt to try to make up for its inability to pay for its current debt, to the extent that its valuation can only implicitly go down, year over year, then you have a problem.
We shouldn’t “sell more debt” to back it. I believe we must issue the credits without debt. And, I believe it’s possible our creditors will embrace the idea, because, for instance, the Chinese government probably prefers to keep its citizens employed/engaged (making goods partly for export and partly for domestic consumption) rather than suddenly having no export customers and not enough domestic demand to replace it.
The issuance of “debt-free money” will be printed at a rate that will be measured — and embraced by the rest of the world. (This is a time for multilateralism.)
>> My problem with Wunsacon’s theory was that it was based upon other countries picking up our debt, as if that was a good thing.
I’m suggesting debasing our existing debt via monetization. So, other countries aren’t picking up an increase in “real debt” from us.
I don’t think our existing debts are serviceable — especially not with a decreasing GDP. (Unless you want to pay much higher taxes.) So, I’m thinking “monetization” is our least painful exit strategy.
To repeat what I’ve said elsewhere on this blog, I was against bailouts early on, because I considered the amounts unserviceable. Since our financial leaders have maneuvered us into this position, I think we must continue with the Bernanke plan. (Come what may.)
If I’ve missed your point(s), please advise.