At a time when the credit/money bubble financial institutions are in crises the Economist chooses to lead with a story on Mr Cameron – the leader of the British Conservative party. I can not claim to have read the story as I do not find Mr Cameron very interesting – at least compared to other matters. And, as I am British and have been an active member of the Conservative party since the end of the 1970’s, if he was of such great interest to anyone (other than his family and friends) it would be surely be me.
In case anyone makes the defence that the financial crises was not known at the time when the Economist went to press…
Well the absurd government created Freddie Mac and Fannie Mae had not lost 50% of their stock market value when the Economist went to press – but their problems were obvious, as were the problems of the compassionate lender to the poor (always run a mile from a company that says it is in business to help the poor) Indybank of California, the run on that enterprise was well under way.
The people at the Economist could have made some reasonable predictions about the general financial situation, but they did not – or at least did not lead with them. I will make the prediction now that the the gutless Bush Administration will not order the arrest of the corrupt Mr Johnson (the ex head of Fannie Mae and leading Democrat) as this would upset his friends, such as Senators Obama and Durbin and Congressman Barney Frank – and we must not upset these upstanding individuals…
…Any more than we must upset Speaker Nancy Pelosi by having a Presidential press conference asking people to telephone her to ask why she will not allow a vote in Congress on whether or not to allow more drilling for oil at a time of record fuel prices – although it is fine for Speaker Pelosi to have a press conference telling everyone to telephone the President Bush to blame him for high fuel prices.
Of course the Economist did have other stuff in it:
A brief look, thanks to the library, showed an article sneering at Governor Bobby Jindal (the upcoming Republican and someone the Economist shows signs of fearing) and another puff piece about the all wise Senator Obama – this one claiming that his cynical habit of saying anything to get elected (even, supposedly, reversing positions he has held all his life – well reversing them till after the election) is a good thing, and pointing to his economic advisers as the height of “sensibleness”.
No doubt they will prove about as sensible as the fanatical collectivist Paul Krugman – a man the Economist long favoured.
I could go on, for example examining their obituary of the late Senator Richard Helms and showing how the obituary shows the Economist writers do not understand the nature or effects of the 1964 Civil Rights Act, but I will stop here.
Anyone who is still buying the Economist is beyond rational argument.
Who’s this Richard Helms guy? I heard when Jesse Helms (R-NC) died, did I miss one?
Richard Helms was head of the CIA or FBI or some such big deal agency a decade or so back. The writer just confused Richard for Jesse.
IMO letting Fannie Mae and Freddie Mac collapse would be the first sign of sanity since this crisis began.
In such a crisis the prospect of a government bailout makes matters worse. It gives insolvent lenders an incentive to stall, mislead, and obscure in hopes the Feds will save their butt sooner or later.
Then the most reckless will get rewarded while more responsible lenders get nothing.
The best policy is to accelerate bankruptcy proceedings. If you fail your assets get sold in 60 days, your creditors get paid first, your stockholders last, your doors close, your employees go home, your stock options vanish, and your pension plan is on its own.
The solvent survivors will get tremendous bargains when buying up the assets of the failures. Let them. Nothing wrong with profit.
The Bush administration has taken an even worse course than a total bail out. They chose a partial bailout. Zig zag, this way and that. One firm saved, another not, and who the devil knows what tomorrow day will bring?
“IMO letting Fannie Mae and Freddie Mac collapse would be the first sign of sanity since this crisis began.”
Agreed. Let ’em burn. Once the smoke clears, we should get a nice rally before the Obamassiah is elected and issues in the next crash.
Shame about the Economist. Used to be a good read.
I would go 90 days. And if the pension plan is on its own, then the plan’s administrators, if they have not permitted the pension owners to freely operate their own plan, have to be held accountable for its failure. Including criminally if appropriate.
Good catch on the Richard/Jesse. I vaguely remember reading a book either by or about Richard Helms 25 or 30 years ago. It was The Man who Kept the Secrets or something like that. I think. It’s one of my in-a-box-somewhere books.
It’s worth sneering at Jindal, since he seems to be quite happy to support creationist-friendly legislation with regard to education in Louisiana.
It’s just surprising that this little blot on his scutcheon didn’t actually make it into the article.
Sorry, I know it’s not very libertarian-sounding of me to say this, but letting Fannie/Freddie collapse is simply not an option. Ordinarily I would agree with you on letting failing companies take their lumps, but this is not just a couple of local manufacturing plants we’re talking about, or even a Bear Stearns. Collectively these two entities guarantee $5 trillion of mortgage-backed paper. That number is so big it is essentially incomprehensible. If they were to fail it would bring down the entire western financial system. Their current problem isn’t a simple liquidity crunch, which is generally the cause of a bankruptcy; it is a market perception (probably accurate) that their capital base (large as it is) isn’t adequate to support the contingent (not current or even actual) liabilities implicit in those loan guarantees in light of the current level of mortgage delinquencies and the state of the US real estate market.
Furthermore, there is no way their assets could be liquidated in 90 days. Most of those assets are mortgage-backed securities, and if you tried to dump a few trillion dollars of them all at once the market would simply collapse, and take down every other financial institution (since they all own those same securities). The world-wide financial carnage would be unimaginable.
That’s not to deny that something needs to be done, and that the shareholders should pay the price. But an ordinary insolvency isn’t the answer. It’s a very complicated and important problem. I have my own ideas on what should be done (as does everybody else with any knowledge of the system), but this isn’t the place for that discussion. The Economist would logically be one such place, but evidently they aren’t too interested. Curious, isn’t it?
Laird, maybe you can write a post about it, and ask Perry to post it?
Laird,
Incomprehensible in the same way as $s T-bills outstanding? What are they at now, somewhere around 9 or 10 trillion?
If the gov bails Fannie and Freddie, they only way they will be able to do it is by monitizing however much they need. Monitizing is by its structure a tax only on people who hold rather than owe $s (debt). It will devalue the dollar and cause T-bill holders to see the light and start dumping (faster).
Even if Funny and Freaky are only holding 20% wastepaper, and I think the good debt has gone elsewhere and they are holding a disproportionate amount of dubious debt, that is still an overnight jump of 10% in US Debt/$ supply.
You want to see something that “would bring down the entire western financial system”, trying scaring away investors (especially SWFs) from holding dollars as a reserve.
You are going to be dumping them no matter how you do it. Bad debt must be marked to market. The question is where the missing $s are come from. Taking it from the $ holders and (if things last that long) the tax payers by converting it into T-bills is just not a rational option. I think bundling into mixed packages and auctioning the debt, not auctioning T-bills, is the least harmful way to go.
Both methods will be excruciatingly painful, no doubt. But one of them will dramatically inflate the dollar and certainly accelerate, perhaps complete, the end of the dollar as a reserve currency. The other way will not inflate the dollar at all and will actually soak up a lot of inflated dollars from the market.
One is a finite pain for a permanent fix, the other is euthanasia for the $ economy.
Seriously, Laird, printing money to in effect make the missing mortgage payments (which is how it would look to the economy as a whole) is suicide. It is pretending that those missing payments are coming out of the economy/money supply. Except they aren’t. It is pure inflation to the tune of however much the default is.
Laird: I sense that you advocate letting the experts continue using their expert methods.
Actually it is not methods but method. There has been only one expert method used by our government for decades: borrow money and spend it; repeat.
How has that been working lately?
I’m glad I saw Midwesterner’s reply before I posted. His suggestion about auctioning is essentially what I intended to post.
“You are going to be dumping them no matter how you do it. Bad debt must be marked to market. The question is where the missing $s are come from. Taking it from the $ holders and (if things last that long) the tax payers by converting it into T-bills is just not a rational option. I think bundling into mixed packages and auctioning the debt, not auctioning T-bills, is the least harmful way to go.”
In fact, I think Midwesterner has the rest of his comment right too.
Of course bad debt must be marked to market; it is. But we not talking about “bad debt.” You’re confusing the performance of the underlying loans with the performance of the bonds which were issued to investors (insurance companies, banks, etc.) The bonds are not “bad debt.” They are performing, so when they are “marked to market” it reflects two factors: the relationship of their interest rate to the current market rate on similar securities, and the market’s faith that the bonds will ultimately be paid off as promised. That latter part is reflected in the credit grade, so if a group of bonds is downgraded from, say, Aaa to Aa, it has a negative effect on the price of the bonds because with the higher perceived risk they should bear a higher interest rate. (Interest rate and price are inversely proportional.) Dumping a few trillion of bonds onto the market isn’t a financial “mark-to-market” issue; it’s a supply and demand issue, and would have severe ripple effects on every financial institution in the world.
Fannie and Freddie guaranty the payment on the bonds. Most of the cash to make bond payments comes from the mortgage loans against which the bonds were issued. A certain delinquency and default rate is assumed when the bonds were issued, which provides a “cushion” of excess cash flow. Only if the delinquency rate substantially exceeds the expected levels would it be necessary for the Agencies to come out of pocket to make up the shortfall to bondholders. We aren’t there yet, but given delinquency trends there is a fear that we might someday be. This is the reason for concern over the Agencies: if delinquencies get really high it is feared that they might not have enough cash to cover it.
Even if an individual loan goes bad, Fan/Fred only has to advance the monthly payments due, and even then only until the loan can be foreclosed upon and the collateral property sold. That generally results in a loss, but it is nowhere near the entire amount of the loan. Declining real estate values in much of the country increase these losses (and also tend to increase delinquency rates, as people “walk away” from homes with negative equity). So when we talk about the Agencies having inadequate capital, we’re talking about capital to cover its guaranty on forecasted losses. At this point this is all speculation and educated guesses; they are (today) not real losses or costs.
To the extent that the government steps in to cover any of this, until the Agencies’ entire capital base is wiped out it would only be a guaranty, not an actual payment. The full faith and credit of the United States government would now be standing behind the bonds, so investors wouldn’t be concerned about their collectibility and wouldn’t be driving the price down. With luck this would stabilize the market and the guaranty would never be drawn, and nothing would be “monetized.” Even if that fails, and some of the guaranty has to be used, you are correct that it would be monetized and add to inflation. But the amount, and the destructive consequences, would be far less than letting them default. Also, please note that this has absolutely nothing to do with helping individual borrowers with their mortgage payments (although that is also something the government is talking about).
I wouldn’t advocate any sort of governmental assistance unless the shareholders were first wiped out. And I would make several structural changes in the Agencies (which probably won’t happen, but now is clearly the perfect time to “rein them in”). But letting the entire financial system collapse would severly harm everybody, and it simply isn’t necessary (or wise). I don’t mean to be disrespectful, Mid (I often agree with you), but your suggestion of “bundling into mixed packages and auctioning the debt” just shows me that you don’t understand these markets, or the magnitude of the problem.
Well, the question is now moot. The Fed and Treasury just announced they will back Freddie and Fannie all the way. And Congress will also be asked to let the government buy the stocks.
In accompaniment, predictable and nonsensical bleats about regulating better and being tough also spewed from the Potomac madhouse.
A second story says no other lenders can expect any such help. More total BS. Like this latest rescue the next bailout will also depend upon who you are.
I’m not sure where Libertarians stand on Fannie and Freddie. Anyone wish to enlighten me? These government sponsored enterprises are archetypal fascist economy, third way, constructs. While private individuals own equity they were founded by government, ‘privatised’ by government and are ultimately controlled by government. My gut feeling is that it’s better for Fannie and Freddie to be government owned than government controlled with private equity holders who don’t, de facto, have the same rights.
I wish to agree with Laird on the matter of what the US should do now. This isn’t a catastrophic problem. $5tn of, generally, very good quality asset backed liabilities wouldn’t be troublesome for the US long-term (even $5tn of pure debt wouldn’t make it more of a basket case than Italy or Japan).
I don’t usually take much notice of Jim Cramer but he called the demise of Fannie and Freddie last autumn. He now says nationalisation and $100bn of initial capital will see the US taxpayer making huge profits in 3 years. Of course the assets should be drawn down, it would open up a very large new market for private companies.
PS. when does The Economist go to press? The problems with Fannie and Freddie were exacerbated on Thursday with comments from the ex-chair of the St. Louis Fed. With the NYT making making these GSEs front page news it was obvious the story would be humongous prior to London opening Friday. It completely overshadowed decent numbers from GE and reasonable economic numbers.
The Economist has been living on its reputation for a long, long time. Classic case of the leftists moving in and hollowing out a structure built by better men.
Now that The Economist has missed the boat on a story of this magnitude in what is supposed to be its area of expertise, there must be a number of subscribers asking themselves why they still bother to read it?
I’m a little confused here. My understanding is that their duration gap is growing substantially. But if F&F are not in default yet, then there is no reason to intervene. And when they do default, how does the government ‘guaranty’ the bonds without any cash out?
Three years ago, David Bernstein noted that 61% of all new California mortgages were “interest only, no money down.” While Cal, Az, and (quite) a few others were extreme cases, a lot of old mortgages were being rolled into new ones, not to mention credit card debt, so I wonder what percentage of total mortgages approximate this description. I suspect a bond compromisingly high share of F&Fs mortgages may be bad. Interest only/no down is in walk away territory.
I think normal math for reselling foreclosed property is out the window. There are too many properties. They were too high above present market value. The number of defaulted properties concentrated together, as they often are, exacerbates the devaluation. The more of them for sale, the less the reselling mechanisms can handle the load. The longer they sit empty the less they are worth. (This process accelerates exponentially, not linearly. They are quite soon are worth less than empty lots.) Conventional foreclosure math may assume a devaluation, but I bet it still assumes a lot more equity than will almost certainly be the case. F&F are no doubt talking a huge hit on their overall obligations to equities ratio.
You say, “Dumping a few trillion of bonds onto the market isn’t a financial “mark-to-market” issue; it’s a supply and demand issue, and would have severe ripple effects on every financial institution in the world.” Actually it is a mark-to-market issue in its purist sense. And the alternative shower of new dollars will be slower (T-bills will not fall find their true market value as quickly as F&F bonds I expect), but the consequences are greater. A prolonged monitization of government obligations, substantually boosted with this new addition, is going to escalate the speed and the volume of revolving bubbles. I suspect oil is in a bubble right now because it has substantially out-inflated the still substantial inflation of things it usually more or less tracks.
I believe that if F&F fail, cannot meet their obligations, the best thing to do is to clear them quickly. Get all of their mortgages onto the open market ASAP. Get empty properties in default cleared and resold ASAP before they become so many bulldozer targets. F&F will not and can not do that. Buyers of the bundled mortgages will clear that bad dept quickly and mop up a lot of inflation $ in the process.
It sounds like it is too late and the politicians will tell the central bankers to do what politicians have always told central bankers to do. “Print money, this is an election year.” It is time to start guessing the order in which the various oncoming bubbles will occur. Oil now, then what? Grains? But as each cash target becomes smaller and the cash pool gets larger, the bubbles will be faster, more volatile and the consequences of the bursts will be harder to predict.
I used to subscribe to The Economist for almost 20 years – until about a year ago. I then finally cancelled the subscription in disgust over their constant spruiking of the deep green/AGW mantra and pushing the case for carbon taxes.
It used to be a great magazine, but no longer. Nowadays I don’t read even their online free content.
Yes I did type “Richard” rather than Jesse – why I did that I do not know. Although it reminds me that there was a time when the Agency actually tried to do stuff – rather than just organize disinformation campaigns against the Bush Administration (which proves its gutlessness by letting them get away with it) and Republicans generally. There was a time when physical courage was more needed by C.I.A. people than the telephone numbers of contacts with the New York Times and so on.
As for Senator Helms – I never met him. However, I found it interesting that the Economist assumed that running election ads against job quotas and being against the Civil Rights Act of 1964 meant that one MUST be a bigot.
I wonder they think of Thomas Sowell – long a critic of the background and consequences of the 1964 Act.
Freddie Mac and Fannie Mae.
There are no good options – as the Irish side of my family would say “I would not start from here”. These entities should never have been created.
Government ownership would solve nothing – they are already run by poltical types. By the way my prediction proved correct – the gutless Bush Administration has not moved to arrest Mr Johnson (the corrupt former head of Fannie Mae and leading Democrat).
Economic harm can not be avoided – but at least it could be pinned on the Democrats. Or it could be if the Bush Administration was not made up of people without courage – starting with George Walker Bush himself.
“If we let them go bust the economy is …..”
The economy is …… whatever is done or not done.
There is a vast credit/money bubble, these malinvestments must be liquidated.
The only question is the following:
Will the government allow prices and wages (and the economy generally) to adust to liquidations – fast and totally?
If “yes” then things will go like 1921 – recovery starting about six months after the crash.
If “no” (with Herbert “The Forgotten Progressive” Hoover in charge) then prices and wages (and the economy generally) will not be allowed to adust fast and totally – and the situation will be more like post 1929.
Jindal soft on the Creationists?
That would seem to help Pawlenty (or someone else) on to the ticket.
McCain does not like Creationists – to put it mildly.
That is one of the real reasons that John McCain and (for example) Ann Coulter are not on friendly terms.
Paul: Thanks for the Irish saying ‘I would not start from here.’
I doubt any one who posted on this topic would disagree, or could sum up the situation better.
Besides the usual GOP laxity in regulatory oversight a big problem is that Bush is now a lame duck. Most of his appointees lose their job next Jan. and they are looking for work. I don’t think we can expect much zeal from the ranks.
The brightest appointees have already left. That is pretty typical in the last year of a Presidency.
I don’t think Bush lacks political or personal courage. But he and his father seem to have a blindness to domestic concerns. In some strange way they simply cannot see them.
Show them a world crisis and they are immediately activated – for better or worse.
I think Laird has it right. The sheer scale of the loans involved would make the failure of these agencies a catastrophic event. They issue vast amounts of mortgage-backed securities. The default of these bonds would be like the equivalent of a medium-sized European nation state defaulting on its debt. We are not talking about some flaky Latin American country defaulting, but a G7 nation.
I agree that we are starting from a bad place. The Freddie Mac et all disaster also demonstrates the absurdity of the idea, as championed by such journalists as Will Hutton in the Observer, that state-backed mortgage lending is a good idea. Wrong. The mortgage market has not been a proper example of laissez faire for years, and all the worse for it.
These agencies have enabled long-term fixed mortgages, but come at a price of seriously underpricing borrowing risk and added to the vulnerability of the US economy to the mortgage and property market. I hope these agencies are gradually wound up and their better assets protected.
Yet another example of how so many bad things were set up in the 1930s.
Johnathan,
I don’t think many (any?) of us challenge that statement. It is a question of which remediation will stand the best chance of recovering a free market. If you believe destroying the value of the dollar will serve the cause of personal liberty (and many people reasonably hold that view) then opening the window and giving F&F a virtual blank check, which is what has happened, is desirable. The underlying plan that appears to be driving this approach is that, unlike private lenders (ie Indybank) these two will be treated as extensions of the Fed and used to throttle, rev and brake, the economy. At least that is sure where this looks like this is going.
But there is no way that this can be seen as anything other than the government assuming yet another massive debt and then monitizing it. When the dollar ceases to be the (or even a) major reserve currency, redistribution government is dead. At that point it must either die quietly or become openly totalitarian. Being a rather cautious sort sometimes, I would prefer the pain of a F&F collapse and the selling of their mortgages (~50% of the total market?) to the other more private and more accountable mortgage holders. It would be painful but a step in the right direction and make the odds of a total collapse of the US gov much less likely. Not to mention the civil violence that would come with a collapse.
I don’t think I am exaggerating the consequences of the collapse of the dollar as a currency. Redistributionism would collapse. Violently I believe. It is like falling and making the quick choice to whether to risk your neck to save your leg or protect your leg by risking your neck.
Since this is the area you work in, I very much would like hearing your discussion of the forces and consequences at work here. Do you think that the dollar can survive a perhaps 25% jump in the government debt, therefor in T-bills, therefor a smaller %age but still very large jump in M3, ie serious inflation, ergo a sustained loss by T-bill holders with no end in sight, therefor an escalating spiral of interest rates enforcing the monetary inflation?
At this point (but I’m eager to reasonably contradicted), it looks to me like the path chosen is ultimately more dangerous. I all ears to hear your’s, Laird’s or any other reasoning on this.
Nuts. I just heard seconds ago Bernanke say “If you’ve got a better idea, I’d like to hear it.” We are so screwed.
Excellent article by Megan McArdle here. She does say that any attempt to mark them to market would make them technically insolvent.
If the amounts weren’t so huge, and the stakes so large, Mid, I would be agreeing with you that a bankruptcy and orderly liquidation would be the right approach. But this is different. You’re worried about what are basically long-term (or at least medium-term) effects of inflation and dollar devaluation. I’m worried about the immediate collapse of every financial institution in the west.
If F&F were to dump $5Tr of mortgage-backed securities onto the market all at once, who do you think would step up and buy them? Yes, the market would ultimately clear (it always does), but at what price? Such a huge flood of supply would force down the price drastically, in a manner wholly unrelated to the underlying value of the bonds. Every financial institution in the western world owns these bonds, many in amounts well in excess of their total capitalization. They would all be forced to mark them to the (new) market price, wiping out their capital overnight over what is really nothing more than a accounting convention. The result would to total financial melt-down, right now.
Dollar devaluation is a serious problem, but it’s a long-term one. Your proposal would create disaster today. We’re falling off a cliff. I want to at least flap our arms; we might yet be able to negotiate a softer landing. You want to just nose straight into the ground. No, thanks.
Actually I have thought about that and it is the major reason I, at present anyway, hold the opinion I do. There is still a lot of money seeking something that is not a bubble. I think investing (through experience mortgage handlers) in this F&F mixed bag is in fact not a bubble and one of the best possible ways we could both reduce the bubble and not spin up the $ presses even faster.
It would need to be orderly and measured. I do not know the bond repayment schedule but I think that they need only auction as fast as the bonds come due. It is even possible that the portfolio could regain solvency during that process I would hope they would finish anyway.
We are in uncharted territory here so some oddball suggestions are worthy of consideration. What about using the net value of the mortgages/net obligations to declare F&F insolvent and take over careful deconstruction. – I POSITIVELY do not trust F&F to touch anything. They need to sit in the lobby while Feds clean out their desks and return to them any personal property. I worked for a company that did that on occasion. This is one of those occasion it needs to be done. At that point divide mortgages into bundles of estimated equal value and then auction those bundles only as fast as needed to service the bonds.
But my idea doesn’t specifically address getting the ’empty house’ loans recycled before those properties become bulldozer targets. That is a huge huge matter and if this goes as it looks like it will, I expect the worst possible outcome. A $250,000 house this year is a $40,000 empty lot with a $25,000 municipal demolition tax lien on it by this time next year. Time is, as they say, of the essence.
Perhaps the Feds could auction only the default properties quickly before the need to be razed. That would make tempting targets for investors and still be far better than the outcome above.
Would that not both reassure investors, get the
crookser political managers out, help rather than harm the inflation picture, and delay the need for any outlay of printed money. I think that their losses could be as low as .5 and as high as 2 trillion but that number is just a guess based on bits and pieces of news not any estimate. BTW, do you have any idea of the bond repayment schedule. How much how fast are we talking about here?A couple of points for reference in future discussion, I think the dollar problem is at the most optimistic a medium term problem. I am afraid with the ‘right’ trigger it could be a short term or even now problem. As an economist said tonight, all of the arrows in the Fed’s quiver have been used. Hence the Bernanke quote above. When this ‘managed’ system loses the tools to influence in one direction, any strong tilt cannot be reacted to. A similar situation arose in Japan when they couldn’t go negative with their interest rate. But our problem is the other side. Our only recourse is to print. And that is a (not always) slow acting suicide pill. The reason I am so jumpy about the dollar is that it is so heavily owned by SWFs. If they dump, dollar he dead. Immediately.
Great article here. I see he puts the possible value of loans in default at $1.4 trillion. If they move really fast, maybe my .5 figure is possible. If they move fast they should at least be able to keep it under $1.
BTW, here’s for your ‘WTF!’ file:
That’s right. They were not only bundling and selling high risk bonds, they were buying them as well.
I think Iowahawk has about the right spin on this:
It’s useful to think of our current economic situation as a spirited game of nude Twister, with Fannie Mae as an extremely fat drunk chick. One unanticipated “Left Foot Blue” spin could mean a trip to the emergency room for all of us, not to mention uncomfortable explanations for our various wives. It is critical that Congress makes sure that Fannie Mae gets the additional “do over” spins necessary to keep her from crushing us on the vinyl.
More seriously, the article by Lawrence Kudlow is a good one. He does a good job of explaining the “moral hazards” implicit in a federal bailout. But note that he agrees with me: “So the bailout was wise, at least in the short run.”
You’re right, empty houses have to be liquidated as promptly as possible, but (a) that is being done already, and (b) it has nothing (directly) to do with this crisis. F&F don’t service loans themselves; that’s done by third parties (typically the bank which originated the loan), and they do try to do it quickly. The problem is that they are under pressure from the federal government to work with borrowers to avoid foreclosure altogether, and the foreclosure timeline is being extended by activist (and/or populist) judges, local governments, and elected officials, who (either out of a misguided belief that they are helping borrowers or from raw political calculation) are slowing down the process. You can’t sell a house until you own it, and you don’t own it until after the foreclosure is complete. Once it’s owned, the servicers are selling as fast as they can (real estate auctions are at an all-time high).
On another of your points, these bonds don’t “mature” in the same way as do ordinary corporate or government bonds. They are tied to the mortgage payments; all cash flows are passed through to the bondholders once received. Yes, the principal component of mortgage payments can be allocated in ways which accellerate the payment of some bond “tranches” and delay others (which is one of the benefits of securitization), but there is no specific maturity date; they pay off when enough principal has come in from the borrowers to do so.
But you are absolutely correct that F&F have turned them selves into huge hedge funds. They have learned that they can issue unsecured notes at rates almost as low as the US Treasury (far better rates than any other company could get, because investors believed [correctly, as it turns out] that the government would back them up) and use that money to buy their own mortgage-backed securities. They make massive profits on the “spread” between those two rates, and this is a large part of the reason they are so big. They have turned into a huge arbitrage play. Also, what you may not know is that Fannie Mae is the biggest lender in the country for multi-family housing. That has nothing to do with fostering home ownership, but everything to do with profits for them and the major property developers (and, of course, campaign contributions to all the politicians they have in their pockets).
We’re now getting away from the “disaster prevention” discussion and into “what to do next” mode, but in my opinion F&F should be prohibited from engaging in either of these activities. My recommendation is that F&F be divided (like Gaul) into three parts: its “core” function of providing liquidity to the mortgage market (which I would bring back into the fold and make it an explicit government agency again, as it originally was); a liquidating trust to allow the portfolio of MBS’s to run off naturally; and a spin-off of the multi-family housing business along with a few other activities which aren’t a part of its core function. That last piece I would sell off, and use the proceeds to bolster the capital needed for the core business, but if necessary it could simply be spun off to the shareholders as a separate company.
Maybe someday we will come to understand that the government no longer really needs to provide liquidity for the mortgage market, but we’re not there yet. My plan at least shrinks the beast and starts us down the right path. Which is why it will never happen; too many politicians have a vested interest in the status quo, and as long as we can get past the immediate crisis nothing meaningful will be done.
Mid, I think Holman Jenkins of the Wall Street Journal agrees with you.
Laird,
Thank you for that. Well, not for the ‘fat nude twister’ image. I think I’ll skip lunch now, thank you very much.
I’m working on a comment that I may or may not post for you to fillet and sauté for me. I’ll be back later and if what I wrote still makes sense to me, I’ll post it. Watch this spot 🙂
Your comments in this thread are as usual informative and influence my thoughts and understanding of interesting things. You may yet change my mind but Holman Jenkins sums up my present opinions exactly. I think this is an opportunity not to be missed. Maybe more on that later unless I return, reread it, and then do a forehead slap/’D’oh!’ and scrap it.
“At this poin [the collapse of the Dollar] the redistributionist state must either collapse or become openly totalitarian”.
Midwesterner, assuming the above to be true.
As you know…..
Speaker Pelosi, Majority Whip Dubin and President? Obama would not consider totalitarianism to be a bad thing.
Paul,
They are all totalitarians. They are only varying in nationalism v internationalism, and competence. I hope we do not have sympathetic totalitarians in charge when it happens. To their credit, Obama and Pelosi have shown an impressive capacity for offensiveness and will be the most likely to inspire the necessary backlash.
I believe that the biggest threat for successful implementation of totalitarianism is with McCain. He is too trusted.
Laird: Thanks for outlining your plan. It would be far better than nothing.
As you probably noticed I am firmly in the raze, burn, and throw rascals off cliffs, camp. Not only about F&F but about financial malfeasance in general.
Now this particular F&F crisis has been settled, we know what will be done.
The reason I oppose saving these institutions is that that every one is said to be “too important to fail” or “special cases.” Both terms are simply a resort to the mystical, appeals to let the priests run matters.
In solemn tones, spoken by honorable men, we are told reforms will follow, must follow, just not quite yet.
And if misbehavior is clearly seen the experts are astonished, somehow these things just happen, no one and no policy led to them.
Promptly the bailout is made. Somewhere in the administration and in Congress interest in reform expires. Which is about what you say in your final paragraph. I almost expect to hear “can’t we just move on.”
K, I’m all for throwing rascals off cliffs; I just don’t want to be dragged off with them! My bank stock portfolio is already in the toilet, thank you very much; I don’t want it flushed, too.
Mid, I eagerly anticipate your next post. Sorry your stomach is so weak. One sidebar question: how did you get that little doohickey over the “e” in “sauté?” Things like that are so cool. I’d love to be able to be able to properly post the word “resume,” for example, or use an umlaut in “schadenfreude”, or put the proper double-dots over the “i” in “naif.” My ignorance of html is pitiful.
Laird,
Yes he (Holman Jenkins) does. He says what I have only been attempting to say.
If you have a lick of sanity, you will take one skim of this comment and ignore it. The F&F sharks were trying to hide what they are doing and the did a pretty good job until the waterline hit the weather deck. Now we are looking at the funnel. I am trying exclusively to look at money supply as I think that is by far the most crucial, and every bit as immediate, problem facing us. I am not the only one who thinks the Fed is fighting the wrong fire. Megan McArdle thinks so too(Link). I know, I know. I’ve quoted her twice in one thread. But she’s not only smart and wise, she’s hot. 🙂
I think in shapes and three dimensional images, and more strangeness to the way I think than I can describe. But what I am seeing (I think) and trying to convert into demonstration numbers, is huge disparity in the money supply consequences depending on what choices are made now.
It helps to remember that the size of M3 is greatly influenced by lending. Far more greatly than just the T-bills would ever directly account for. By ‘un-lending’ money, by auctioning for cash rather than underwriting the reissue of the mortgages, the money supply shrinks by much more than the actual transaction would make it appear. I’ll give an example. I’ll try to make it an oversimplified ‘pure’ case to show basic principles, things are complicated enough already. I ignore interest since it does not change money supply. The bolded numbers are before and after money supply specific to each transaction.
A loan is originated for $100,000. The money is paid to a developer in exchange for a house. The developer’s money then enters the economy. Because of fractional reserve, only a fraction of this amount is removed from circulation to fund the loan. So (using a 20% reserve) the money supply has increased from $20,000 to $120,000.
Ordinarily at the origination of the loan:
Depositor’s $20,000
——————————————
+ bank holds reserve $20,000
+ borrower received $100,000
= $120,000
20K->120K=500% inflation on this trans
And at repayment:
Depositor’s $20,000
——————————————
+ bank holds reserve $20,000
+ borrower received $100,000
– borrower repays $100,000
– bank releases reserve $20,000
= $20,000
20K->20K=0% inflation at end of trans
But the borrower defaults. Fed covers full debt. Money supply is now increased to from $20,000 to $220,000.
Depositor’s $20,000
——————————————
+ bank holds reserve $20,000
+ borrower received $100,000
– borrower repays
$100,000defaulted+ Fed replaces $100,000 for another loan
= $220,000
20K->220K=1000% inflation on this trans
But let’s say instead, a cash flush investor buys a 100,000 mortgage note for 75,000 (his estimate of the property’s worth). Somebody loses 25%. I don’t know who, but if it is covered by FDIC (or anyone else) then it needs to be added to the inflation side. Who loses the money? If it is F&F hedge funds, its the stockholders, right? If so, screw ’em. They’re running the company, they deserve it. (Oops. Just read your comment. Is you them?) If it’s the bond holders, are they the guarantor or is it still F&F (stock holders)? I’m hoping you can tell me. What are the economic consequences of this transaction? The $100,000 given to the developer is still in circulation. But the Fed does not need to print $100,000 to repay the loan adding that amount to (rather than removing it from as would happen if the loan was repaid properly) the money supply. Instead, the $75,000 that purchased the devalued mortgage is transfered to the original investor, and $75,000 of new investor’s is removed from the money supply and either $25,000 is removed from the money supply by the guarantor’s loss or $25,000 FDIC is created and added to the money supply.
Depositor’s $20,000
——————————————
+ bank holds reserve $20,000
+ borrower receives $100,000
– borrower repays
$100,000defaulted– investor contributes $75,000
– guarantor loses $25,000
– bank releases reserve $20,000
= $20,000 total in existence.
20K->20K=0% inflation on this trans
or with FDIC payment
Depositor’s $20,000
——————————————
+ bank holds reserve $20,000
+ borrower receives $100,000
– borrower repays
$100,000defaulted– investor contributes $75,000
+ FDIC contributes $25,000
– bank releases reserve $20,000
= $70,000 total in existence.
20K->70K=250% inflation on this trans
In a nutshell, the previous tech bubble was outside of the central banker’s direct reach. It could not be used to resolve and restore any soundness to the dollar. The luck of the draw here is that F&F actually (by virtue of their structure and defacto support) ARE able to be eliminated and a huge hunk of the inflated currency will come off of the inflated side of the balance sheet. And it can do it while reenergizing the housing market and at the same time de-inflating it. But in a controlled descent. People who might otherwise lose everything, can still have a pre-bubble value to their investments.
Pluses, shrinks money supply dramatically by converting loans to owned outright. Instead of paying back over a long period of time, or even indefinitely on interest only loans, these resolve immediately. This reduces money supply. Also, it reduces the flood of money chasing safe harbor by 75% of foreclosed loans (the amount investors are diverting to buying up defaults).
Minuses, If FDIC is paid, it does not reduce inflation on each loan to zero as full repayment or sale would. It turns people who should never have attempted to buy big houses back into either renters of big houses or buyers of small houses. It turns buyers of small houses who shouldn’t have into renters again. It (depending on where the guaranty lies) punishes the stock holders of spectacularly mismanaged companies. Some may think that is a good thing. It makes the Fed’s tampering tools functional again. Some may consider that a good thing.
Ah, you were smart and skipped down to the bottom. Well, I enjoyed the exercise, but will happily have my mistakes corrected. Laird only knows, I caught enough of them myself that there must be a ton more. Possibly including some fundamental errors of reason.
On your last questions re: résumé, naïf (or naïve) and sauté, I did it the same way you did sauté. By cutting and pasting. 🙂 I wasn’t sure what code was being used by what other browsers internationally so I cheat. I cut and paste it from Wikipedia. It seemed like the safest guess. But when I don’t care what character set it is in, I just go to start -> all programs -> accessories -> system tools -> character map and use my default. I keep meaning to look up what Wikipedia is using but haven’t bothered to yet. There are keyboard shortcuts I presume, but I haven’t bothered to track them down either. And stuff that will work on your own computer will fail on computers in other countries using different character sets. So Wiki to the rescue again.
BTW, are you sure that “schadenfreude” has an umlaut?
Now, I shall go to bed and wake up to reenact an Emily Litella moment. “Oh? . . . Never mind.”
BTW, I don’t think I need to point it out to you but if any other masochists are reading the thread, I should.
When I say ‘inflation’, I am specifically referring to the quantity of dollars in whatever category I’m talking about. When I mean ‘consumer prices’, I’ll try to remember to say it that way. Consumer prices (other than the mark down of the over valued mortgage) does not enter into this comment.
Good point on the distinction between inflation and consumer prices, Mid. They are far from the same thing, but most people don’t understand the difference.
As to the rest of your long post — gaaa! I think you’re trying to win this argument by sucking all the bandwidth out of this site! I’ve delayed responding because I don’t know where to start. (Also I’m not sure I totally understand the post, anyway; have to read it a few more times. Would beer help?)
Anyway, this is not the place to get into a discussion on the relative merits of the fractional reserve banking system. Pending more thought (and drink), and reserving the right to respond more fully if the spirit moves me, can I just leave it that I am not disagreeing with you on the inflationary risks of a governmental bailout of the GSEs, merely opining that it was the least bad alternative available?
(Oh, and you are correct about the lack of an umlaut in schadenfreude. Mea culpa!)
I specifically tried to avoid discussing the merits (or lack there of) of the fractional reserve system and to stick exclusively with a good faith effort to keep the present ship sailing.
I encourage you to read the comment thread in this Megan McArdle post (linked earlier). The commenters are all over the spectrum but they give a very good reference picture. I recall Brian Macker, Ten and some others having pretty cogent arguments. Ten | July 16, 2008 8:05 PM is sadly correct.
Again at this point, I am stating a good faith observation with the idea of preserving the present government/currency. I personally would not mind seeing the currency collapse so terribly much, but I would like a government that at least pays lip service to our constitution on stable feet. It might not survive a dollar collapse at this point. But again, it might be a good thing to wean it, I just don’t want to take the chance.
Take all the time you want with it. Amazingly, I reread it a couple of times this morning and it still made sense. Of course I saw some errors of terminology, etc, but I think the underlying claims are sound as far as they go.
Do you happen to know who the legal guarantor is of the bad loans? I know it has by the Feds intervention been assigned to all holders of US dollars, but who was assigned it on the record?
With respect to your question at the end, there is no “guarantor” of bad loans other than the borrowers themselves. The GSE guarantees the payment stream to the securitization trust, and thus indirectly to the bondholders. In the event of a mortgage delinquency the actual loan payment amount is generally advanced by the servicer (usually the bank which originated the loan), and those advances are recouped out of monies later received with respect to that specific loan (i.e., when the borrower makes a payment, or the loan is paid off, or it goes through foreclosure and the property is sold). A foreclosure sale doesn’t usually generate enough cash to pay all of the principal, accrued interest and foreclosure expenses, so the servicer reimburses itself for any out-of-pocket expeneses, recoups its “delinquency advances”, and sends whatever is left to the trust. From the bondholders’ perspective this is exactly the same as a prepayment; the full amount of principal outstanding on the loan must be paid to them. The shortfall comes out of cash which would otherwise have gone to the holders of subordinated interests in the trust (lower-grade uninsured bonds or “residual” interests which occupy the “first-loss” position, which can be the GSE itself). Only if that is also insufficient does the bond guarantor (here, the GSE; in other deals, a private bond insurer) have to cough up actual cash out of its own funds.
All this is why it is difficult to determine how much capital the GSEs really need to support their activities. It’s a forecasting exercise: you have to project how many loans will become delinquent; how many of those will ultimately default and go into foreclosure (lots of delinquent borrowers reinstate their loans short of foreclosure); what the net losses will be on those foreclosures (you rarely lose 100% of the loan amount); and the timing of all this. It’s done using historical averages and educated guesswork.
Does any of this help?
BTW, per your instructions I worked through the comment thread on the Megan McArdle post. (I read her actual post yesterday; it’s OK). Frankly, I wasn’t overly impressed. Your buddy Ten didn’t have much useful to say (I don’t buy the old fractional-reserve-derived money velocity argument he trots out, although he might be right about the smart money being on eventual insolvency); ratewatcher is an arrogant idiot with delusions of financial sophistication (my bet is that he’s a New Yorker); and most of the other posts are simply uninspired. To me, the only resonably intelligent and interesting posts were the predictions made by ras (5:36PM) and the observations by Cure (9:26PM).
Aargh! Smited! Honestly, I’m innocent! If you’re all lucky my pearls of wisdom will be paroled shortly.
Its getting late and my mind may be thick. I am a little confused on how a borrower can guarantee his own loan so maybe I am not understanding your first paragraph correctly. I’ll have another go at it tomorrow. Your second paragraph made good sense. I have a gut instinct from lots of different reading that the non-performance on the loans will be somewhere between .5 and 2 trillion. Sorry I can’t narrow it down any more than that. 🙂 Assuming that is a valid range, I really don’t think that amount is worth the consequences of the choice they’ve made, but I guess we’ll find out.
If by that you mean arithmetic, it could explain our disagreement. It is the inflation that directly traces to the fractional reserve multiplier that makes up the bulk of M3 expansion and contraction. And unlike T-bills directly, it is very difficult to control, they have to do it by interest etc manipulations. My choice if I were managing for a sound dollar instead of maximum government skimming, I would slowly raise the reserve requirement until eventually all lending returned to contract lending. That still causes inflation but runs on banks, for just one example, are impossible. The closest popular equivalent we have now is CDs I guess.
ratewatcher was one of the people I hoped you would spot. I don’t like or agree with him at all, I think you described him pretty well. My point is that there are a lot like him out there who intended from the start to walk away and don’t care if (as I think he expected) his credit rating tanks for ten years. I think there are a lot of people that never intended to tough it out.
ras was right but was being very cynical, I assume you picked up on that too.
I thought cure didn’t have much of anything to contribute. He mostly just defends the Fed. And not very well. The US gov in general has been going to twisteresque contortions to try to hide consumer price increases. cure says: “But the fact that it is *difficult* does not mean that the Fed just ignores food and energy inflation! Not a meeting went by that we didn’t look at overall inflation and its components. The people at the Fed aren’t idiots.” Well, a cynical person could believe that they don’t ignore inflation, they try to hide it, that not a meeting went by that they didn’t spend some time trying to figure out how, and to those who say that the people at the Fed are either dishonest or incompetent, well, he has an answer for them too.
No, what I liked that thread for was the cross section of the players it provided. Everybody from a Fed economist like cure to a gambler like ratewatcher. While I naturally sided with some of them, I found the characters and beliefs of the players themselves to be telling. That is what I meant by ‘reference picture’. Human nature is going to drive a lot of what happens and that was a typical (I suspect) sample of the humans involved.
Sorry I was unclear at the beginning. I simply meant that there is no true “guarantor” of the individual loans in the sense I believe you meant; only the borrower is resposible for payment, and the house is the only collateral securing the debt. What the GSE guarantees is that the senior bondholders will be paid; there is enough “cushion” built into the trust to permit a reasonable (anticipated) level of defaults. It’s when defaults (and losses) materially exceed the forecasted levels that there is a risk that the guaranty will be called upon.
Midwesterner:
I am as careful using the term “totalitarian” as you are when talking about the money supply.
A totalitarian believes in total control of education and the media in order to dominate the opinions of most people (even most totalitarians do not hold that they can have a vast influence influence over the thinking of everyone – but they do not need to).
The whole point is to make a “backlash” impossible – because the mental universe of most people will not include other views of the world (as their access to these views will be, as far as possible, cut off) and their minds will be influenced by the process of education and by the media (including entertainment – music, film, books and so on).
The fact that you talk of a backlash, and the fact that you call John McCain a totalitarian “they are all totalitarians” shows that you do not know what you are talking about.
Paul,
Whether a totalitarian would “use the force for good” like a Luke Skywalker does not change one iota the fact that they would “use the force”.
Like you, I use the word ‘totalitarian’ as a specific description of political philosophy, not a pejorative. John may be a good guy. He may want to do good things. But he wants to use brute force to do those good things. And to do that requires government powers that are accurately described as totalitarian.
Do I prefer the things McCain wants to use government power to achieve over the things Obama wants to use government power to achieve? Of course. But I don’t want government to have the power it would take. I want maximum contention and strife among the power brokers. And I absolutely assure you that the levels of strife under Obama will make McCain look like a choir director. The Democrats I know have been railroaded and they know it. They are spluttering furious at the merest mention of Obama. They show exactly the same symptoms to Obama that they do to ‘W’ Bush.
I am assuming that had the gov not intervened, the pecking order for losses would have started with stock holders and ended with highest category of bonds. Is that correct? How far up that list would it have gotten if, say, 1/5 was the full non-performance level (by which I mean the portfolio was overvalued by 1/5)? You don’t need to validate it, we are all guessing the level of default but what does your gut tell you? It sounds like you think the default would reach far into the bond holders?
You’re really pushing me, aren’t you? This is difficult stuff. OK, here’s my best shot. (Most of these numbers are as of 3/31/08, which to my knowledge are the latest public numbers available.)
The two GSEs together have core capital of about $81B (Fannie $42.7B, Freddie $38.3B), and their total of guarantees and owned loans is just under $5.2T (Fannie $3.01T, Freddie $2.15T).
Goldman Sachs recently did an analysis in which they calculated that the total amount of embedded losses in the GSEs is $53B (Fannie $32B, Freddie $21B). This is only about 1.03% of portfolios, and less than their total capital. If that’s right there is no loss to either the bondholders or the government, and the Treasury’s “guaranty” is just eyewash to stabilize nervous markets. I have no idea how accurate that forecast is, but I’m willing to stipulate that it was arrived at by some very bright people, drilling deep into the numbers, and without any particular reason to low-ball the result. That’s the good news.
But let’s be pessimistic. Seriously delinquent loans (90+ days past due) are currently running at 1.15% of the total, which by historical standards is extraordinarily high for this quality paper. That’s a static number (it’s a snapshot as of a particular moment in time), so even if every one of those loans does go into foreclosure more will crop up later (out of the group which is not presently seriously DQ, or not even DQ at all). For this type of analysis you also have to view the overall pool itself as static, which means that it’s a fixed universe of loans which shrinks over time as loans pay off. Typically one would assume that the aggregate lifetime default segment in a pool is about 2.5 or 3 times the static number (over the life of a pool the default percentage is a curve, which rises for a while as the pool matures, peaks, then drops down to a sort of “steady-state” tail). But since we’re being conservative, let’s triple that norm to 7.5 times the static number, which works out to around 8.63% of the total pool. To review, what we’re assuming is that this amount of the loans, sooner or later over the lifetime of the pool, will go into foreclosure.
Then you have to calculate the actual losses realized on foreclosure sales. Mortgage insurance is required on any loan with a loan-to-value ratio of greater than 80%, which limits the losses. Also, keep in mind that people don’t generally default on loans where they have significant equity in the property, so we can assume that when foreclosures do occur the property value has declined fairly substantially from the original appraised value (the appraisal was probably inflated to begin with). So let’s assume that, on average, foreclosure properties have market values of 10% to 15% less than the loan amount (or 30% to 35% lower than the original appraised value). Even in hard-hit areas like Florida and Arizona that seems about right. Add in legal expenses and realtor commissions on the sale, and probably some delinquent property taxes, and the average net loss is perhaps 25% of the loan balance. Applying that to the 8.63% lifetime default rate and you get aggregate losses in the range of about $111B, or $30B more than total capital. That shortfall would come out of the hides of either the subordinate bondholders or the taxpayers. $30B is not an inconsequential number, to be sure, but in the grand scheme of things it is not extreme. Also, it would not hit all at once, but would occur over time.
None of this takes into consideration the possibility of the GSEs raising more equity capital (both of them are talking about it right now), or factors in any income they generate from operations in the interim. So even if you were to make still more conservative assumptions as to foreclosure rates and losses, it seems highly unlikely that any charge to the US Treasury would be horrendous. And with any luck, and the real estate market stabilizes, the losses could be much smaller and within the range of what the GSEs’ capital could absorb.
That’s the best I can do.
Midwesterner:
I have never said that John McCain is a “good guy”, I have never met the man – and, indeed, heard reports that he is a hard man to work with.
Senator McCain being a “good guy” is not relevant to totalitarianism.
And neither is your claim that he wants to “use force to do good things” – I do not see how this fits with deregulating the health market, ending earmarks, and going for entitlement program reform, but even if it did…..
Totalitarianism is NOT “using force to do good things” or bad things.
Totalitarianism is supporting total control of the education of the young and of the media and culture.
It is such things as wanting to end home schooling (by such tactics as demanding that parents have teaching qualifications in every subject – as the Californian “progressive” court has tried to do) and (de facto) closing down alternative sources of media – such as Fox News and the conservative part of Talk Radio.
The left (or rather the hard left – the left in the Marxist tradition) demands control over the whole culture – from books and films, to schools and broadcasting.
This desire is partly power for its own sake – but mostly so that most people (they do not need everyone) will be influenced to such an extent that the losing power in the future becomes very unlikely. For example any economic decline will be blamed on greedy corporations or just on “the rich” and many rich people will rush out to AGREE (partly out of fear – but mostly because their own minds are influenced by the leftist stragglehold on the culture).
The Marxist tradition (in its mutated Gramsci style form – with imput from Saul Alinsky and others) is the tradition that Senator Obama comes from.
And it has nothing to do with John McCain.
Laird,
Thank you very much for your comment at July 19, 2008 05:50 AM. It is going into my bookmarks on economics institution solvency (well the thread is) under the title ‘F&F comment at at July 19, 2008 05:50 AM’. That is my method when I want to use something for reference. By laying it out like you did, it gives me a clear picture of things to watch and what to look for.
Thanks. BTW, I still think you are missing my point on money supply. Turning bad loans into paid up properties vs printing and loaning more cash. One other comment, if the numbers are as small as you show, then it seems to me to be utterly silly that any bailout is necessary at all. Are you sure there is nothing more to it?
No I am not certain that there isn’t more to it; there may be wheels within wheels of which I am totally unaware. However, both F&F and the Fed have been consistently saying that the GSEs are adequately capitalized, and that it is only a market perception (but not reality) that they are in trouble. Maybe that’s true; such perceptions can become self-fulfilling prophesies. The market is a strange place, and for all their outward sophistication investors can at times be irrational, panicky animals.
If the government’s announcement last week got everyone to stop hyperventilating and shouting that the sky is falling, maybe that is all it will take to get everything back onto a relatively even keel and allow the mortgage market will stabilize. This could be a turning point for the economy, and it might cost the government nothing (except for having to acknowledge that it will in fact backstop the Agencies, something which it has steadfastly denied for years). I hope that’s the case. The GSEs are still politically wounded now, though, which makes this the ideal time to rein them in. I certainly hope we do. We probably won’t ever get a better chance.
It is well to start with the basics.
Borrowing (whether to buy a house, or for any other purpose) must be financed from real savings – i.e. from income that someone else has chosen not to spend.
It must not be “based on” real savings – it must be from real savings, period.
For example, if I want to borrow X Dollars to buy a house, someone else is going to have to consume X Dollars less – not X minus something. And we both can not have the same money at the same time – if a person lends me money (either directly or through a bank) THEY DO NOT HAVE THE MONEY ANY MORE – and they do not have the money till WHEN AND IF I pay them back.
Any effort to “expand credit” by breaking the above rule ends in tears – a boom/bust.
As for Fannie and Freddie – even the Economist admits (a week late) that the scale of the problem is vast.
Details on the matter can be got from the Ludwig Von Mises Institute (yes I know they are Rothbardian headbangers – but on financial matters they are sound).
Of course consumption (whether to buy food or to buy houses) must be supported by production.
Contrary to what some people say, a large country can not be “based on” financial services.
People must produce before they consume. Some people must work and save – before others can borrow.
Indeed one would hope that quite a lot of the borrowing was for productive investment (for example building factories that will produce goods people want to buy) – rather than to just finance consumption.
For, if it is not, how are the debts going to be repaid?
Or are the words “repaying debts” naughty ones?