BREAK OUT THE POPCORN AND WATCH THIS MOVIE by John McLeod
Debt In The Afternoon (2005)
starring GSE guru Peter Wallison as THE MATADOR
costarring S&P bond analyst Mike DeStefano as THE BULL
with special guest Bert Ely as THE PICADOR
Kidding aside, the 2 hour 8 minute long February 3, 2005 panel discussion with real title Receivership Powers: What Are They and Should Fannie and Freddie’s Regulator Have Them? remained for several weeks after the event the American Enterprise Institute’s most popular video download. It featured an all-star cast of academics and financial policy analysts. Considering the venue, keep in mind the possibility of a right wing slant. The panelists were aware of a huge concentration of US mortgage risk in the two biggest US housing GSEs, Fannie Mae and Freddie Mac. They exchanged views on how these monster enterprises might be wound up should they ever fail. Several explored prospects for the US Government evading the implicit guarantee that the two companies will always be bailed out by Congress, especially with regard to their senior agency debt.
The bursting housing bubble is threatening to send a wave of defaults toward the mortgage finance system. This video gives us an inside look at how some of the best experts in the field were preparing for the impact a year and a half ago.
SOME CORRECTIONS TO THE TRANSCRIPT
Before we begin, there are a few errors and omissions to point out in the transcript. First we should deal with these two potentially confusing typos.
“Class 1 is what we call–I call–solvent [should be "sovereign"] equivalents and that’s to say … that is to say solvent [again should be "sovereign"] equivalent.
…
… all three of the GSEs do not have timely financial statements. The Federal Home Loan Bank–is Alex Pollack [ph] [should be AEI GSE project member Alex Pollock] in the room here?” (always my emphasis in the quotations)Mike DeStefano 1:09:00-1:10:02, 1:17:31-1:17:42
The name after a quotation refers to the speaker, and any numbers refer to times on the video.
The questioner misidentified as “Burt” is independent banking analyst Bert Ely. “Dawn with Dow Jones” is business reporter Dawn Kopecki, presently covering mortgage finance and national security for BusinessWeek. A Google cached profile of questioner Josh Rosner, a mortgage finance analyst, can be found here.
An unusual intervention took place before the presentations got under way when John Berthoud, president of a lobby group called the National Taxpayers Union, presented a letter (supported by a number of other lobby groups) calling for the privatization of Fannie and Freddie. This incident seemed meant as a show of support from other groups for AEI’s approach to GSE policy.
MODERATOR AND FIRST PANELIST
The panel’s moderator, Peter Wallison, was Counsel to (and biographer of) President Ronald Reagan. He heads up AEI’s Housing GSE Project and has written or co-written (often with Bert Ely) numerous books and papers on the subject. He is a great believer in privatization of GSEs.
The first presenter, Richard Carnell, is a Fordham University Law Professor. He mostly discusses a paper (available on the event page in long and short forms) where he lays out the advantages of receivership over conservatorship for GSEs. Here, from the transcript, are some of his more memorable passages.
“Investors and other financial market participants believe that the government implicitly backs Fannie Mae and Freddie Mac in the sense that the government would make sure that Fannie and Freddie’s creditors got paid.
…
Consider the case of a GSE that has suffered a series of major accounting scandals. I am, of course, referring only to a hypothetical GSE.
…
… by the time a GSE gets to [the point where it isn't paying its debts], it’s going to be pretty far gone. And it would be better to key receivership to a specified level of capital, so you can intervene at a time when you may not need to do creditor haircuts or where the haircuts can be small.
…
I think Mike just said something very significant about creditor perceptions. And remember what we’re talking about here in terms of perceived government backing of–people say perceived implicit guarantee, and I ridicule that term in my paper. Don’t miss it. It’s about page two. I liken it to a mental will, in which the person who has just died has stated where they want their property to go. It’s not going to be effective, is it? Or an oral traveler’s check. Again, not very effective. … An implicit government–and implicit financial guarantee it’s really a contradiction in terms.
…
Now, in fact, if creditors would associate perceived government backing of GSEs with the words national integrity on the Alexander Hamilton statue in front of the Treasury, which means we pay our bills; if that association is there, then these things, this–then that should be on budget. It should be reflected in the credit–the subsidized credit should be reflected–I see the OMB people are smiling–should be reflected in government spending and it should be voted by Congress, and that would certainly be a different world for GSEs.”Rick Carnell 0:16:47-0:17:01, 0:27:17-0:27:27, 0:37:24-0:37:44, 1:47:39-1:48:17, 1:48:30-1:49:06
ENTER THE FED: THE SECOND PANELIST
Next up was Robert Eisenbeis, Executive Vice President and Director of Research at the Federal Reserve Bank of Atlanta. He summarized the findings of a paper (available on the event site) he co-wrote with two other Atlanta Fed researchers. It compared the situation of a GSE failing with that of bank insolvency. Central bankers are notoriously obscure, but a couple of his statements were illuminating.
“The knee-jerk reaction, the tendency, has tended to be to engage in some sort of [forbearance] rather than attempting to deal with [a problem in a major financial institution] promptly..
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… these institutions may [not be] too big to fail, but they clearly are probably too big to liquidate in any sort of way that avoids the kind of disruptions to other holders of their liabilities in the markets in which they serve.”Bob Eisenbeis 0:42:18-0:42:30, 0:48:12-0:48:30
Because the Fed deals in magic and words of power, statements like these must be treated with high paranoia. A famous story relating a joke told by a former Chairman reveals their attitude. It was retold by David R. Francis in a December 19, 2005 Christian Science Monitor commentary.
“Eons ago, in the pre-Alan Greenspan era, Paul Volcker (Mr. Greenspan’s predecessor as chairman of the Federal Reserve System) was touring the Museum of Anthropology at the University of British Columbia. He pointed to an especially fierce native American mask.‘That must have been for their central banker,’ Mr. Volcker joked for the benefit of the journalists tagging along.”
“Forbearance” is a code word. It suggests a fear that bureaucratic inertia would prevent a regulator from acting until things got really, really bad. Prevailing opinion seems to be (and reality at least partly supports) that forbearance is a genuine problem. Perhaps this opinion could be summed up in these jocular …
Three Laws of Regulation
Eisenbeis’ second quote should be taken in the context of an obscure November 27, 2004 speech by St. Louis Fed President Bill Poole. Poole suggested a possible new “too big to liquidate quickly” policy for GSEs to replace the present “too big to fail”. Eisenbeis’ echoing of Poole might be taken to be mildly ominous.
A BOND RATER ENTERS THE RING
A highlight of the event was the presence of senior Standard & Poor’s bond rater Michael DeStefano. He is one of the elite Wall Street figures responsible for the continued AAA rating on Fannie’s senior debt. He has been studying this situation for a long time, as evidenced by the pre-9/11 article “Cracks in the Fannie-Freddie foundation: Critics charge Fannie Mae, Freddie Mac pose risk to economy”, Washington Business Journal – April 13, 2001, by Eric Winig, where he is cited on a new class of Fannie’s subordinated debt. His willingness to take on all comers in the present discussion helped make this event a significant source of understanding for the present situation in US mortgage finance. Here are some of his stand-alone comments.
“… the notion that a GSE would be liquidated by anybody, under any circumstance, would be so remote that I think it would be hard for us or capital markets participants to take that seriously as a real option …
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as long as … Alexander Hamilton’s statue is in front of the Treasury Department, the government is going to pay.
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… [without the implicit guarantee] our financial assessment for Fannie Mae is still double-A minus and it’s on credit watch. Negative under review.”Mike Defestano 1:14:41-1:14:59, 1:45:52-1:45:59, 1:58:49-1:58:57
This indicates the supreme importance of the implicit guarantee. It’s safe to say that if Fannie’s senior debt suddenly went to double-A minus, it would turn much of the financial world upside down.
Perhaps the heaviest engagement occurred in the time-frame 1:15:57-1:19:32 when Mike and Peter went at it hammer and tongs. The following sequence might have been the high point of this important exchange.
“MR. WALLISON: Okay. Now here’s a company–again, perfectly hypothetical company with two and half percent capital; issues no financial statements; has no financial statements right now, and then there is a receiver appointed to this company that has no financial statements, and you’re going to say–and you do financial analysis–
MR. DESTEFANO: Right.
MR. WALLISON: Of some kind. You’re going to say that a company like that should still be triple-A. And if you say that, how is Class-3 different from Class-1?
MR. DESTEFANO: You’re saying under Class3, what is the basis of our financial analysis?
MR. WALLISON: Well, I mean if you’re doing financial analysis of a company that doesn’t have any financial statements.
MR. DESTEFANO: This temporary hiatus in having a financial statement. Actually, as a matter of fact, all three of the GSEs do not have timely financial statements. The Federal Home Loan Bank–is [Alex Pollock] in the room here? The Federal Home Loan Bank has been having problems with getting theirs up so it’s holding up the whole system.”
1:16:43-1:17:42
THE REGULATOR BATS CLEANUP
Last up was Patrick Lawler, Chief Economist of OFHEO, Fannie’s and Freddie’s regulator. His remarks included the following two points.
“Under our conservatorship authority, there’s nothing we could do to cancel or kill off that subordinated debt. And, in fact, in five years we could stop payments–if you got a conservatorship going for five years, which would not be a good thing. After five years that those payments would be due and would be–this would be an issue–the existing of the sub-debt which is designed to help protect the government, protect senior creditors, in fact, would inhibit the ability of the regulator to actually do a constructive resolution. With receivership authority, you could reduce or cancel those claims and solve the issue as well as potentially some of the claims of senior creditors.
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… the perceived implicit guarantee is really the heart of the issue to the extent that it doesn’t have almost universal support.”Pat Lawler 1:23:58-1:24:54, 1:26:28-1:26:37
The subordinated debt raised in the first quote was the issue DeStefano spoke to in the 2001 paper mentioned above. It is important because sub debt might be the first thing that goes in the event of a GSE meltdown.
A CLASSIC FROM THE QUESTION PERIOD
After Pat’s speech, the conversation became general. Of special note is the confrontation between Mike and Bert Ely that occurred 1:41:46-1:47:30. Bert and Mike dealt with quite a few substantive issues, but I’m including this short tactical exchange just because it was so much fun.
“MR. DESTEFANO: … And I think most people would say, if you proposed bankruptcy, yeah, but it’s never going to be involved. You know, when the time came for it, everybody would draw back and say that the best way to resolve the problem is on the policy level, which means that, you know, in our view, there would be role, an important role for Congress. And I think this is the expectation.
MR. ELY: Isn’t that same thing true of receivership then?
MR. DESTEFANO: Yes.
MR. ELY: If bankruptcy would never be invoked–
MR. DESTEFANO: Yes, that’s what I in effect said.
MR. ELY: Then receivership will never be invoked.
MR. DESTEFANO: Yes.
MR. ELY: So isn’t this kind of a pointless discussion in some ways today?
MR. DESTEFANO: No, it isn’t a pointless discussion if you want to have it.
[Laughter.]“
1:44:30-1:45:19
Score one for the bull!
CONCLUSION
I hope you enjoyed the show. These analysts are very smart people with widely divergent opinions. They all knew eighteen months ago there was a real possibility that the mortgage industry might generate a large crop of losses. This seminar was an important step in setting up a configuration to determine who was going to get hurt if the housing bubble burst, investors or taxpayers. The venue for this discussion has mostly moved to Congress, and now that the housing bubble is showing real signs of popping, this policy debate must take on added urgency. Indeed, events may well be overtaking the policy makers. Soon the arcane jargon and arguments of this seminar could become all too familiar on the Five O’ Clock News.
Northern Virginia Housing Bubble Fallout
UK House Bubble
Bubble Meter
Ohio Fraudclosure
Mish's Global Economic Analysis
Breaking News Relevant Articles© Copyright 2012 Housing Doom | Copyright© 2011, AuthentiCraft, Inc.
John-
Thanks for a great post. Too many people ignore the problems with Fannie and Freddie- assuming wrongly that as long as they aren’t in their portfolio, they don’t have a problem.
When Japan’s housing bubble popped though, it caused a banking crisis.“As U.S. home prices shoot to unprecedented highs in many regions, the notorious property bubble in Japan presents a scary scenario.”"Japanese land prices soared in the late 1980s. Around 1991, when they peaked, the land under Tokyo’s Imperial Palace was valued at more than all the land in Florida.”
“Now, more than a decade later, average Japanese land prices are still falling and banks are only just pulling out of a land-related bad-loans crisis.”
http://www.mailtribune.com/archive/2005/0711/biz/stories/02biz.htm
A headline in yesterday’s Pittsburgh Tribune-Review proclaimed “Media Falls Flat on Fannie”
“When most people hear the word ‘Enron,’ they mentally complete the phrase by adding the word ‘scandal.’ As reporter Lester Holt of NBC’s ‘Today’ put it in a Jan. 1 story, ‘Enron has been the poster child, if you will, of corporate scandals.”
“It isn’t the only one, though. There’s a $40 billion scandal with most of the same elements — even connection to prominent politicians.”
“Just don’t expect to see much about it on TV. After all, the top people involved are Democrats.”
“Welcome to Fannie Mae, the government-sponsored mortgage giant. As part of a scandal that’s been running nearly two years, Fannie Mae has ‘misstated earnings’ to the tune of $10.8 billion.”
http://www.pittsburghlive.com/x/pittsburghtrib/opinion/columnists/guests/s_463854.html
Rapid house appreciation has functioned as a “high tide” if you will, covering the rocky problems of bad debt in this country. As prices go down, the toxic loans began to be exposed. The problem won’t just affect the stock holders of GSEs- it will affect all Americans, and by extension, the global economy.
Thanks again for shining light on a problem the main stream media is passing by.
Â
Debi -
I noted the Tribune-Review story on Doom’s articles list earlier today and decided to start working on that theme for episode IV. Dan Gainor (note misspelling at the start of today’s article) is Director of the Business & Media Institute. The BMI is characterized in its Wikipedia article as being a conservative organization with an interest in exposing liberal media bias.
I had previously noted with interest Gainor’s April 6, 2005 piece in Human Events titled “Networks Ignoring the Coming Fannie Mae $11-Billion Bailout”, that covered much the same ground.
The lack of major network television coverage of the GSE scandals is puzzling, and party-political considerations may be a factor. However, there are plenty of resources in the print and specialist media. Many of these are freely available online, and I hope to list some of these next week.