Willem Buiter has a characteristically colorful post, “Time for comrade Paulson to pull the plug on the Fannie and Freddie charade” on the prospect of a Fannie and Freddie rescue. Why is it the British can fulminate better than we Americans do?
But Buiter’s beef isn’t the operation of the GSEs but the philosophy behind them, the hydra-headed and not fully visible ways the US has socialized real estate (did you know about the Farm Credit Banks, for instance?). He provided a good summary of the history and dramatis personae.
The whole post makes for great reading. Let me give some key extracts, which I wish I had written:
Are Fannie Mae and Freddie Mac adequately capitalised, as asserted recently by US Treasury Secretary Hank Paulson, Federal Reserve Board Chairman Ben Bernanke and their regulator Office of Federal Housing Enterprise Oversight Director James B. Lockhart III? The answer is: obviously not, if these two government-sponsored enterprises of the US federal government had to make a living on normal private commercial terms. Obviously not if they were subject to the market discipline preached by Paulson and Bernanke, but not practiced when it comes to large financial institutions perceived as systemically important (too large or too interconnected to fail) or too politically sensitive to fail…..
There are many forms of socialism. The version practiced in the US is the most deceitful one I know. An honest, courageous socialist government would say: this is a worthwhile social purpose (financing home ownership, helping my friends on Wall Street); therefore I am going to subsidize it; and here are the additional taxes (or cuts in other public spending) to finance it.
Instead the dishonest, spineless socialist policy makers in successive Democratic and Republican admininstrations have systematically tried to hide both the subsidies and size and distribution of the incremental fiscal burden associated with the provision of these subsidies, behind an endless array of opaque arrangements and institutions. Off-balance-sheet vehicles and off-budget financing were the bread and butter of the US federal government long before they became popular in Wall Street and the City of London.
The abuse of the Fed as a quasi-fiscal agent of the federal government in the rescue of Bear Stearns is without precedent, and quite possibly without legal justification. The creation of the Delaware SPV that houses $30 billion worth of the most toxic waste from the Bear Stearns balance sheet (with only $1 billion of JP Morgan money standing between the tax payer and the likely losses on the $29 billion committed by the Fed to fund the SPV on a non-recourse basis) is the clearest example of quasi-fiscal obfuscation I have come across in an advanced industrial country. The decision by the Fed to ‘invite’ the primary dealers and their clearers to collude in the (over) pricing of illiquid collateral offered by the primary dealers to the Fed at the newly created TSLF and PDCF (by the Fed accepting the pricing/valuation by the clearers of the illiquid collateral) is another example of the abuse of the Fed as a vehicle for channeling taxpayer-financed subsidies to the primary dealers. This form of socialism for the rich is therefore well-established.
The chair of the Senate Banking Committee, Chris Dodd, has said the Fed and the Treasury were considering opening the Fed’s discount window to Fannie and Freddie. I am afraid he may be right. After all, an injection of the liquidity by the Fed is so much more politically expedient than an explicit fiscal subsidy, even though their economic effect is identical. This would not be a liquidity enhancement operation by the Fed, which would be a legitimate operation for the central bank to engage in. It would be a quasi-fiscal recapitalisation of two insolvent institutions, which is not part of the mandate of the Fed.
The financial assistance offered to US homeowners through the spagetti of federal financial inducements (ranging from the tax deductability of nominal interest payments to the subsidisation of mortgage financing provided by the FHA and the GSEs) is not primarily socialism for the rich. It is socialism for the electorally sensitive, rather like the agricultural welfare state that exists in the US.
So let’s call a spade a bloody shovel: nationalise Freddie Mac and Fannie Mae. They should never have been privatised in the first place. Cost the exercise. Increase taxes or cut other public spending to finance the exercise. But stop pretending. Stop lying about the financial viability of institutions designed to hand out subsidies to favoured constituencies. These GSEs were designed to make losses. They are expected to make losses. If they don’t make losses they are not serving their political purpose.
So I call on Secretary Paulson, Chairman Bernanke and Director Lockhart to drop the market-friendly fig-leaf. Be a socialist and proud of it. Come out of the red closet. The Soviet Union may have collapsed, but the cause of socialism is alive and well in the USA. Granted, the US version of socialism is imperfect thus far. The federal authorities have mainly intervened to socialise the losses in the financial sector while allowing the profits to continue to be drained off into selected private pockets. But that is bound to be an oversight. It surely cannot be the intention of such committed Marxists to target taxpayer-funded largesse solely at the very rich and at a few favoured, electorally sensitive constituencies. Fannie and Freddie are, or will be, safe in the hands of comrades Paulson, Bernanke and Lockhart.
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The privately owned and operated Federal Reserve is the problem. From negative real interest rates, to failure to advocate or regulate best practice, to opaque interventions, to the idea they really didn’t know what a bubble might look like, the Federal Reserve was in lock step to disaster every inch of the way.
The privately owned and operated Federal Reserve should be replaced with a public institution that produces money without debt. Leveraged debt is the problem of the private bank’s monopoly on money creation. This leveraged debt is now imploding sucking down the economy like a black hole.
With a public central bank that produces money and credit without debt the government , we the people garner the profit from creating money, not the banks. With a public central bank credit can be allocated through interest rate differentials to sustainable uses rather than auctioned for consumption. With a public central bank interest rates can float rather than be manipulated for political or profit motives. We even have names for the Fed’s negative real interest rate benevolence to the markets, the Greenspan put and now Helicopter Ben.
Our right to create money, granted by the Constitution has been usurped by the banks for printing their own interest bearing money that they lend at leverage. The prerogative and benefit of money creation is the property of the government and its citizens.
The private Bankers have been in charge and their record is clear, episodes of greed and pillage followed by the inevitable economic fallout with tax payer bailouts.
Why is it the British can fulminate better than we Americans do?
Because we are not obsessed with being “cool” and it is a myth to imagine our “sang” is always “froid.”
Bloody marvelous piece of writing. If more people pay attention we may eventually achieve sound money and transparency.
On another note, Yves, an emergency rate hike of minuscule proportions would have enormous psychological impact on the stability of markets here. For those who think this is crazy, the Treasury market already tightened by ~15bps while everyone was watching the Fannying around yesterday. As usual, the Fed is being led by the markets, not the other way around.
Who owns the most GSE paper, as a percentage of total assets? And who stands to benefit most from an explicit guarantee? Inquiring minds need to know.
“The Federal Reserve has not had any discussions with Fannie Mae and Freddie Mac about access to direct loans from the central bank, Fed spokeswoman Michelle Smith said. “
http://www.bloomberg.com/apps/news?pid=20601087&sid=a79GKfbIbW10&refer=home
We’ll see…
“After all, an injection of the liquidity by the Fed is so much more politically expedient than an explicit fiscal subsidy, even though their economic effect is identical. This would not be a liquidity enhancement operation by the Fed, which would be a legitimate operation for the central bank to engage in. It would be a quasi-fiscal recapitalisation of two insolvent institutions, which is not part of the mandate of the Fed.”
This is frothing at the mouth in an otherwise decent article. Let’s be accurate. Secured lending, whatever the risk of the security, is not the same as capitalization. The Fed’s role, in the case of both Bear Stearns and this hypothetical, is a stop gap measure, joint with re-capitalization, not instead of it. It’s a secured liquidity measure, just as it would be in the case of a large commercial bank in trouble in a more conventional sense. The fact that those qualifying for support have been extended to investment banks and now potentially GSEs is obviously a huge issue. Attack if you must, but attack accurately. This is not capitalization.
Foreign central banks have huge holdings in FRE and FNM securities. They will take huge losses if FRE and FNM securities were written down to FMV. Of course, if the US government guaranties agency securities, the foreign central banks will take losses on their holdings in US Treasuries. It seems as if the foreign central banks think a guarantee is better for themselves overall.
Pimco and other private institutions also have large holdings in FRE and FNM securities. But no one’s holdings match China’s, Japan’s, and the middle east’s.
From Kotok:
1. Under present rules the Fed is already specifically authorized to purchase F&F debt for its own account. No change in rule or law is needed. As of the most recent Fed Reserve report (Thursday, July 10) the Fed’s holdings were zero.
2. The Fed already accepts F&F as collateral for Discount Window lending and TAF lending. The same is true for all the debt of any of the Government Sponsored Enterprises (GSE).
3. The Fed does not lend directly to F&F at the present time. F&F are not primary dealers. For a list of the primary dealers, look at the NY Fed website. You will not see F&F.
4. The Fed could make F&F a primary dealer at any time. It can invoke the same emergency power that it used in the Bear Stearns transaction and in the subsequent authorization of direct lending to the remaining primary dealers. At the moment the Fed has no reason to do this. F&F are not important agents for the Fed when it engages in open-market operations.
“did you know about the Farm Credit Banks, for instance?”
Yes, and there is much more beyond that… OPIC, Title XI, and more…
Our government has a ton of lending programs… oh, and don’t forget all the credit tenant leases. No debt, they rent from the private sector at costs higher thean that of borrow/buy.
Yves darling, please note that the Farm Credit Bank system actually paid back the entire $4 billion in assistance it received.
“Yves darling, please note that the Farm Credit Bank system actually paid back the entire $4 billion in assistance it received.”
Now if we could only cut all of the other grotesque farm subsidies, especially the ethanol program that is causing hunger around the world.
Q. How do you starve a farmer?
A. Weld his mailbox shut.
Just short Bucky, she’s going for a ride.
JKH,
The Fed’s role in the case of Bear Stearns was as secured lender? I beg to differ.
The Fed has no recourse to JP Morgan – aside from a token $1BN. Sure, technically there are assets pledged for the Fed’s financing (assets which have already been written down) – but let’s get real. If I lend an insolvent company $30BN secured by a bag of pucks, is that “secured” lending?
In reality the Fed offered a subsidy to make the acquisition of Bear Stearns acceptable to JP Morgan. The beneficiaries of the subsidy were Bear shareholders and creditors and JP Morgan. Plain and simple, no?
Why is it the British can fulminate better than we Americans do?
They may or may not, but Willem Buiter is Dutch.
Love those Brits fulminating! A spade is a spade – a spade is a shovel! No this spade is that gnormous shovel that uncovers coal seams in the open pits out west!
The West Is Red!
Dead Enders
WMD
Candy and Flowers
Bring It On
Mission Accomplished
Yahoo!
http://www.fhlb-of.com/issuance/debt_outstanding.html
Add another 1.3 trillion in debt to the tab…
from across the curve on FHLB..excellent writeup on how oit was a shadow central bank in the early innings…this was used as a credit line for countrywide. This is what passes for being creative on Wall Street. I belive it was GS that advised countrywide. Shocking
Speaking of socialism, am I the only one who believes that barring prepayment penalties on existing mortgages is no different from Argentina converting dollar accounts into peso ones? Is the following even legal?
———————-
http://www.bloomberg.com/apps/news?pid=20601087&sid=axD1nVft5dN0&refer=home
Fed to Bar Loan Penalties That Deter Refinancing, Person Says
By Alison Vekshin
July 12 (Bloomberg) — The Federal Reserve, in a bid to end abusive lending practices, will ban penalties on some high-cost mortgages that make it harder for people to refinance, a person familiar with the decision said.
The prohibition on prepayment penalties, part of a broader Fed response to the collapse of the subprime mortgage market, targets high-cost loans with interest rates that reset in the first four years, the person said. Rules also would limit charges when borrowers seek to pay off mortgages in the first two years on other types of high-priced loans, the person said.
————————–
BTW 10 to 100 bps move is quite susbstantial and would result in sizable markes for the trading portfolio of all the majore banks/brokers.
For example JPM trading account $30B of GSE debt (10Q), BAC has $194B of trading account assets of which (“Includes $26.4 billion and $21.5 billion at March 31, 2008, and December 31, 2007 of government-sponsored enterprise obligations that are not backed by the full faith and credit of the U.S. Government”)
insurance guy –
Not so fast.
A loan secured by hockey pucks is not capital.
jdk,
A loan made without the intention of repayment and secured by collateral that is likely to be worth less than the value of the loan is precisely an injection of capital.
This is Buiter’s point. The deal was structured in a way that allows policy makers to claim a free market solution – when actually we’re talking about a subsidy. Worse, we’re talking about a capital contribution with no possibility of any upside – just downside for the Fed as the collateral deteriorates in value.
The US is really deeply and profoundly socialist, but the key difference is that it is selectively only for the benefit of big corporations and the rich. Now wait a minute…that was the case in Soviet socialism too, the ones in power and their buddies reaped the main benefits. So the only real difference then is tha the US flavour of socialism is geared at keeping the poor poor. So much for the American drea…an empire in final decline.
Buiter may be Dutch by descent, but his style is pure Oxbridge.
insurance guy,
Buiter is wrong. A secured loan is not capital. Calling it capital doesn’t make it so. Nor does a proprietary forecast of collateral value make such value factual.
A credible indictment of the Fed should not require such truthiness.
jkh,
We’ll have to agree to disagree.
JP Morgan obviously didn’t like the deal with those $30BN in assets involved. The Fed took on the risk of those assets and injected cash into Bear in exchange. There is no repayment coming for that “loan”. Hard to argue the Fed is a “secured lender” when there is no borrower to repay the loan! In effect, to my mind anyway, that’s a capital injection.
I see nothing wrong with Buiter’s characterization.
Doesn’t the question of providing liquidity vs. capital come down to whether the Fed is accepting assets at an inflated mark? It seems clear that the Fed stepped in to take on eventual write-downs in the BSC portfolio that JPM was unwilling to fund. If the Fed is also going to provide fictional valuation for GSEs assets by holding them and not marking them for the term of the loan, that would be a capital subsidy to the extent of the avoided mark-down. Since the Fed is accepting the debtors’ marks for TSLF and PDCF, why not include the GSEs in the land of make-believe? Maybe because people can go to jail for this in the private sector?
The chickens are coming home to roost, one by one, and all that stands between us and national insolvency is the productive powers of American workers. As long as the latter does not fade, all will, eventually, be well. Bailouts are troublesome indeed for purists but why kid ourselves: America is not nor has it ever been a “pure” capitalist society. If that is true (and it is) why expect pure capitalist outcomes? The solution: be a capitalist, get back to work, spend less than you make, abd pay the bills.
Did you cats see this??
FASB Bombshell: FAS 140 to Eliminate QSPEs
http://bigpicture.typepad.com/co…- bombshell.html
This is hyper-technical accounting stuff, but it has enormous potential impact on markets. There may be trillions of dollars worth of derivatives buried on banks’ QSPEs.
To grossly oversimplify, Banks have been using QSPEs to effectively boost their leverage and hence, their return on capital. Without the balance sheet constraints of the old days, banks were encouraged to create assets — by making lots of loans they shouldn’t have — that could, in theory, be sold off later. It hasn’t quite worked out that way.
QSPEs can have legitimate purposes — but they also can obfuscate the true financial condition of a bank or broker.
>> Which links to this:
US banks fear being forced to take $5,000bn back on balance sheets
Accounting changes could force US banks to take thousands of billions of dollars back on to their balance sheets in the coming months in a move that is likely to curb further their lending and could push them into new capital raisings, analysts have warned.
Analysts at Citigroup said a planned tightening of the rules regarding off-balance sheet vehicles would force banks to reconsider arrangements and could result in up to $5,000bn of assets coming back on to the books.
The off-balance sheet vehicles have been used by financial institutions to keep some assets off their balance sheets, thereby avoiding the need to hold regulatory capital against them.
Birgit Specht, head of securitisation analysis at Citigroup, said: “We think it is very likely that these vehicles will come back on balance sheet.
“This will not affect liquidity because [they] are funded, but it will affect debt-to-equity ratios [at banks] and so significantly impact banks’ ability to lend.”
I am an commodities trader who has worked for investment bank. I say this because the following statements could be construed as being communist or anarchist.
Congress wants money and re-election, preferably the latter. They will pimp themselves to any donations which get them back into power. They are self-serving power whores who should be rounded up and shot.
The Fed is a bizarre, probably unconstitutional institution which has been serving banks, wealthy individuals, and Wall Street since it’s inception. Greenspan and Bernanke would be charged under the Patriot Act except that they are really doing the job Congress, Wall Street and the White House wanted them to do.
Wall Street is composed on immoral, greedy, sleezy thieves. They will do anything for a buck. They have been stealing money from the world forever, principally through connivance with government inflation. They continue to pour money into campaigns and write the legislation they need to get richer than ever.
The American Consumer is not even “the American People” or “American citizen” anymore. He never understood the system or was kept happy with plasma tvs and Hummers. For this last round of debauchery, he was told the Bad Guys were coming for his freedom so he better borrow and spend. He got “rich” in a massive bubble. Now he still blames everyone but Congress, the Fed, and Wall Street, or for that matter, himself.
The system is designed to make Wall Street rich so that everyone can feel good about America. Whatever measures are required to bail out Fannie, Freddie, JP Morgan, Citi, etc. are needed will be taken. Government bailouts, buyouts, cash injections, mergers, 100 years TSLF windows. Whatever it takes.
There will be no pain for the ruling elite whose accumulation of wealth over the past decade surpassed even Imelda Marco’s greed. A few thousand sacrificial analysts will be tossed out of Wall Street banks, but the top dogs will be paid off for their “hard work” and contribution to American capitalism.
Go figure… A government that helps its citizens house themselves and feed themselves … attacked by a mouthpiece for the backers of Fascism. You may call U.S. arrangements “socialism” all you like, Mr. Buiter, but if you read our Constitution’s Preamble, you will discover why things are the way they are here. And they wouldn’t be so awfully bad, either, had your deranged aristocracy not tempted the dumber among our nation’s financiers with your nation’s offshore financial havens. Oh, and by the way. Paulson will fail in his attempt to light the fires of war among those sovereign nations who hold GSE paper, much as your City’s creeps quite evidently are scheming to effect. Won’t everyone in the Commonfilth be surprised when the U.S. reconstitutes the Bank of the United States and enters into fair trade agreements with France, Germany, Russia, India, China, Japan, etc. We might consider including Great Britain, too. However, you all seem so busy with that “monster” Mugabe and your colonial schemes to reclaim South Africa’s natural resources. You people really are a joke…
Now, this is capital:
“US TREASURY secretary Hank Paulson is working on plans to inject up to $15 billion (£7.5 billion) of capital into Fannie Mae and Freddie Mac to stem the crisis at America’s biggest mortgage firms … Under the terms of the proposed move, the US government would receive a new class of shares in exchange for the capital, which would be hugely dilutive to shareholders.”
Risk Averse,
Your ability to read and reason seems badly impaired. You have made the first mention of Mugabe that has ever occurred on this blog. Buiter does not object to socialism as long as it is honestly presented as such. What we have in the US is not an effort to house people, but socialism for the middle class and rich that may well sink the financial system. Having lots of houses sit vacant because the old owners were evicted and no one else wants to buy them says to me that oversubsidization of housing is not a good idea.
Similarly, last I checked, Paulson has nothing to do with the Department of State or Defense, and has not engaged in any war-mongering. There are plenty of others in the Administration on that beat.
And by virtue of being covert and serving multiple interests, particularly those of promoters of various sorts, it has not served the objectives you incorrectly attribute to it, namely “house themselves.” People do not need to own housing to be “housed”. Rentals work as well.
40% of the homes built in the recent boom were second homes, hardly suitable vehicles for public assistance. Over half the subprime loans were cash-out refinances, which means they were not used to buy housing, but to extract equity from houses already owned.
I suggest you try anchoring your broadsides in a few facts if you want to get a receptive hearing.
Yves:
Do you take the Preamble to the U.S. Constitution as an honest presentation of a socialistic idea?
You see, I do. However, this does not subject me to being tarred a “socialist.” Rather, I am an American. And I take offense to those who like to throw around the word “socialist” as though the pursuit of the common good projects something sinister, something evil. This essentially is the essence of my broadside on Mr. Buiter.
So, per reasonable institutional support the U.S. historically has provided to ensure the widest possible availability of such basics as housing and food, I take no offense to whatever shades of “socialism” these might represent.
That said, though, I agree with your commentary on circumstances precipitated by the present arrangement. However, you argue “effect” without much to say about “cause.” This, of course, is the massive leveraging of physical assets (however unproductive these assets might be deemed in the grand scheme of “economy”) for the benefit of a few and the increasing detriment of many. To opine the defense of GSEs is about promoting some socialist agenda rather than simply maintaining the viability of a massive mountain of private-sector-created leverage is in my opinion the better demonstration of badly impaired reason. Sure, the misuse of the GSE’s implied guarantee was all well and good while the leverage could be expanded. And the effect was just as you put forward. However, it was not this effect that was driving the expansion of GSE balance sheets. Nor was this done for the sake of some altruistic intention. Anyone with half a brain cell functioning knew the very circumstance we are seeing would be the outcome. And what of this is harmonious with the idea of socialism? None. For me to believe the intention behind the astronomical expansion of GSE balance sheets was to do with some misplaced socialist mindset in the U.S. is similarly to believe we are in Iraq for the sake of spreading democracy throughout the Middle East.
Which dovetails nicely with my next comment…
Last I checked Paulson is working for the Bush administration, notorious for its capacity at creating controlled chaos. Fomenting financial tension is a great way to precipitate all-out war. What better way for a bankrupt aristocracy to maintain their power than the destructive distraction of a manufactured conflict? But then again, I probably am going off the deep end here because, after all, we are living in a time when it is possible for a bunch of cave dwelling, monkey bar climbing, dog gassing fleas to bring a nation that spends hundreds of billions of dollars each year on its defense and intelligence to its knees.
And speaking of distractions, it’s just a damn shame such a resource rich nation like Zimbabwe has to be ruled by someone who would dare defend his nation’s sovereignty at a time when the value of paper assets are crumbling, particularly when so many of these are tied to the UK’s unregulated, offshore financial centers.
Mr. Buiter would do better expending his intellectual capacity on such matters as directly affect his nation. We here in the States will do our level best to fulminate about the matter of Mr. Paulson’s performance. Surely, the U.S. Constitution provides ample capacity to resolve our present financial quandary. Those who do not understand this are either ignorant, and so unqualified for the job of Treasury Secretary, or they are acting contrary to the idea they are sworn to defend.
Like many here, I’ve become very cynical about politics. The crazy thing is how dead-on Ron Paul is about all things financial, and how acceptable it has been in the mainstream to label him as “crazy” when he is the ONLY one to talk about anything close to real positive difference. Eliminate the fed, balance the budget, shrink government programs.