Bill has graciously let us re-post his latest article [1] on the timely topic of GSEs versus OFHEO and the Bush Administration. So, Doomers, you can all just hop on board. We hope you enjoy the ride.
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Mr President, Get on the Bus!!
by Bill Maloni
What’s a President to do when the markets are reeling from “credit concerns?”
Well, the first thing is not to say and do dumb things and the next is to get out of the Fed’s way!
Can his mind even encompass what the Fed and Treasury might have to do if Wells, Citi, or one of the investment banks couldn’t meet their commitments because of real estate losses?? (May it never happen!!!)
Shouldn’t Paulson be “schooling” W?
The action you will see in the next few days from the Fed is a reflection of the line that we used to throw around to each other when I worked there in the early 1980’s, to the effect that the central bank is “more powerful than the White House, except we don’t have the nukes!”
Expect the Fed to move into the market, providing reserves, and pushing levers here and there to assuage frightened market participants, who now appear to be in every nation and selling on every exchange.
President Bush doesn’t seem to have the political currency (pun intended), confidence or even warmth to give comfort to the markets, nor the understanding to assure the world that he will do “whatever it takes” to keep domestic U.S. financial ills from adding to his current foreign policy shortcomings.
Wouldn’t a combination of the Fed ”priming” and Fannie and Freddie providing billions in liquidity look pretty good right now?
A good politician and leader would have jumped all over the Fannie Mae request for portfolio investment relief and turned it into a gain for his agenda, not repeat some tired old right wing rhetoric. Someone please tell him, “In helping them, George, they are helping you!”
(The following was written about 10 PM on Thursday evening and still is relevant, but is far less acerbic than it should be, given the Administration’s behavior this week.
I like Washington DC in August, despite the brutal heat and humidity, because a whole slug of DC area residents leave, making it easier to get around, shop, bike ride, go to restaurants, etc.
With the Congress “home” for summer recess in August–and Congress is the straw that stirs the Capital of the nation’s drink –you often don’t get any political “action,” in the year’s eighth month, but that hasn’t been the case this past August week!!
With the great uncertainty in the credit markets, problems popping up all over the mortgage market, huge jumps and drops in the stock market, the GSEs find themselves in the middle of some very compelling political and industry drama. Unfortunately, the Bush Administration once again is showing its hind parts to the world and making bad matters worse with very questionable decisions.
To wit, on Monday, August 8, I blogged that the White House and Congress collaborate and remove the portfolio investment caps, which had been placed on Fannie Mae and Freddie Mac over a year ago, by their safety and soundness regulator, OFHEO, and its Director James Lockhart.
I argued that if the WH took that easy regulatory step now, it could have a major calming benefit; show leadership and market savvy; was a low risk move in a high stakes game; and be welcomed by the lenders and investors who’s bad case of nerves were making the mortgage markets unstable and potentially super risky.
At the time I made the suggestion (the blog was completed on Saturday, but I waited until Monday to do a fact check and then publish), I did not know that Fannie Mae was preparing–indeed that very day–to formally ask OFHEO for the relief I was suggesting.
On Tuesday, Senators Chris Dodd (D-Ct), Chairman of the Senate Banking Committee and Chuck Schumer (D-NY), Chairman of its Housing Subcommittee, endorsed removing the GSE investment caps. Later, Senator Hillary Clinton, in a housing position paper released that day, also called on the Administration to creatively employ Fannie and Freddie to work on subprime mortgage and credit problems (a truly ailing segment of the market, which I have noted, ad naseum, can be blamed on Wall Street and a hired corps of mortgage brokers, fueling the hedge fund high return investment mania).
The next day, House Financial Services Committee Chairman Barney Frank (D-Ct) added his voice to the Senate legion, giving the Administration the perfect political cover to initiate this simple action, which never was sold as a total panacea, but as a smart substantive gesture that would be viewed quite favorably by all concerned, especially the very nervous lending, banker, investor contingent.
But the problem that many of us noted at the time (none more accurately than Steve Pearlstein, the Washington Post’s fine financial services columnist, in his Tuesday column) was that the Bush Administration had so demonized the GSEs that it might not be able to back away from its campaign and bring itself to realize the benefits that “removing the handcuffs from Fannie and Freddie” (my blog description) could bring to the markets and to the Administration’s own credibility.
Through two presidential news conferences this week, that position seemed to prevail as President Bush was twice asked about removing the GSE investment caps. (HUD Secretary Alphonso Jackson, separately, was asked at his own press event the same question.) Bush was adamant in his rejection of the suggestion, throwing out some puff answer about the need to “reform the companies first” and then look at other ideas, as if he had any congressional clout or leverage to get that done.
Great observation “Nero,” but isn’t that smoke over there?
Secretary Jackson, obviously not yet on the White House song sheet, seemed more open to the proposition, but since his response was sandwiched, in time, between the Prez’ answers, don’t look for anything but AJ getting quickly into line.
In a brief contemplative mood this morning, I observed to a friend that Fannie and Freddie were like fine, super efficient interstate buses, which have been carrying families back and forth across the nation’s highways for years, providing great service at low cost and earning user satisfaction. The problem is that ideologically, the Bushies have been criticizing, maligning, and degrading these “buses” for years.
Facing shaky credit and mortgage markets and with no abundance of flexible solutions it controls, the Bush Administration needs, figuratively, to get, quickly, from “Bad Nervousland” to “Good Promisedland” and its transit choices are to walk or use the GSEs.
Be smart, Mr. President. Get on that bus, now!
The world does not want to hear another Katrina-like boast, “Great job, Lockie! Um, Lockie? Lockie?”
(Speaking of OFHEO’s Jim Lockhart, please see Jim Cramer’s latest video “take” on “Two Gun” at TheStreet.com and then think about the game “Whack-a-Mole.)
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Notes and References
[1]: "Mr President, Get on the Bus!!", by Bill Maloni, Bill Maloni’s GSE Blog, August 10, 2007.
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No offense to Mr. Maloney, but it seems to me that over the past several years Fannie and Freddie should have invested more effort in ensuring their balance sheets were correct and less efforts on lobbying.
We are in the middle of a housing price correction. By the end of this correction, the current conforming limit may seem laughably high.
The effects of of rasing the conforming limit are:
1)Put the taxpayer on the hook for mortgage losses that we already know are coming (more losses than they already have on their books).
2)Lets the risk-takers off the hook.
Also this does nothing to resolve the cause of the recent credit market melt-down, nor will it support plunging housing prices.
I am going to point out that the government should not be interfering in the market on the way down any more than it did on the way up. Stand aside and let market prices fall, just as it did when they rose.
ooops. The mis-spelling of Mr. Maloni’s last name was *not* intentional. My apologies.
With total offense to Mr. Maloney, you sound more like a lobbyist for Freddie and Fannie than you do a purveyor of sound economic practices.
Fannie Mae hasn’t filed an earnings statement since 2004 and was found to be manipulating earnings so their heads could make millions more in bonuses. This is your efficient bus example?
Actually your bus example is a good one. Because, more than likely we’ll find that theses “buses” have been losing money and are on the verge of losing alot more when the housing downturn accelerates. And what happens when a government sponsored bus system loses money? The government throws more money at it to prop it up. Essentially what you are advocating is the government stepping in and supporting borrowers who should have never gotten on the bus in the first place or should have had more money to pay for their ticket before they got on the bus to pay the real fare.
Subsidizing the housing market has all sorts of problems. While it creates a short term panacea, it doesn’t fix the longer term underlying problem called “reversion to mean”. Instead of a big blow out where prices drop quickly over a year or two, you create a slow leak where prices drop back to the same nominal level but over a 5-10 year period. Now, instead of a few million people buying overpriced houses, you effectively spread the pain over a much larger segment of the population. Thus, a wider swath of the population gets punished by the gambling habits of a few. This is immoral at best.
When the panic in the bond markets subside, there will be alot less mortgage backed securities to package and alot less bankers making multi-million dollar salaries. There will also be alot less people making double digit returns on bonds as returns on bonds will go back to their mid single digit historical averages (possible after a fall during reversion).
What will be left? The normal market for risking capital without a guaranteed rate of return. If you are not familiar with it, it’s called the STOCK MARKET. It’s where people put money down to own a piece of a private company with their money 100% at risk. As is today, when the bond market starts to lever itself such that it tries to act like the stock market but with a bond with a guaranteed rate of return, is it no wonder that it ends up with a period repricing where the truly unsustainable ideas fall in value, just like a stock?
We are not even 1/2 way through the housing meltdown, so lets save the government interventions for when they need to hold up our failing banks. It’s not a problem now, because the problem is largely subprime and alt-a. But wait until all those OPTION ARMS start to reset and 80%-90% of those people just “walk away” from their house. Option Arms are not subprime losses of $20k-$40k on a low end house. Option Arms are $200k-$400k losses on high end houses. That party doesn’t even get started until late 2008.
Spud (comment #1) -
Thanks for helping me to put down Hormats and now I urgently require that you find the obvious flaw in the following. I don’t like where it’s leading.
Your comment provided a key piece of the puzzle, and now at least part of the situation is crystal clear. This may not rank up there with the discovery that gravity acts as a repulsive force in the Rings of Saturn, but it would seem that a similarly counter-intuitive and obvious fact will help us adumbrate the shape of the shock-wave that’s nearly upon us. Conforming mortgages are too safe.
Think of a river flooding. Sally Submariner’s house lies low by the water’s edge, Allen Altman’s is only slightly higher, while Peter Primus’ is a fair bit up the bank. Pete’s in a less risky position, but should the river ever get up to his level, he’ll go to the emergency shelter only to find that Al & Sal have taken all the available beds.
Or think about the three little pigs. If, heaven forfend, the Wolf were ever to put a dent in the Third Pig’s house, he’d apply to Hillary’s fund only to find the money long gone on sticks and straw.
Now Fannie Mae’s $700-odd billion retained portfolio features a witch’s brew of leverage and risk management, the latter having turned to custard as evidenced by some Quant noting last week that his sector has become correlated since about the first of this month. What Fannie did to leverage their portfolio during the Tim Howard era was they sold nearly all of it to counterparties in such a way that Fannie retained much of those mortgages’ profits (so it’s still there in a real sense), but it’s no longer on the balance sheet, so Fannie has to keep way less capital around in case of trouble. Tanta sketched out how these deals work in a post one week ago titled “SFAS 140: Like A Bridge Over Troubled Bong Water”.
It’s leverage because the decreased capital effect (fewer mouths to feed) is more significant for Fannie’s shareholders than what they give up to the portfolio’s buyers for taking on the risk. That is, if there’s a loss in the portfolio, it’s covered by the counter-parties’ capital. But with less risk, there are many fewer stockholders to share out modestly less income, so it’s a big win for them.
Now for the risk management to work, Fannie’s managers will seek contractual assurances that their counter-parties are themselves excellent risk managers with uncorrelated, diversified portfolios — hello, hedgies. And the portfolio is really good stuff, so Fannie has likely diversified themselves by selling these great assets to just about everyone.
But subprime and Alt-A have swelled up in importance since this financial engineering plan was first put in place. And with the help of the raters, this stuff got sausaged into high rated tranches, CDOs, CLOs and on and on that also got sold all over the place.
Tom Zimmerman, Russ Winter, Aaron Krowne and the ABX exchange have taught us that the various qualities of mortgage paper are exquisitely correlated, and should there be a problem with the AAA and AA tranches, that event is likely to be preceded by more severe problems in the lower tranches.
Now the subprime crisis itself has caused a mild but noticeably world-wide financial event to this point. Starting with Bear, we learned that many hedge funds themselves were so leveraged that only a few reverses in some of their riskiest bets would cause them to exhaust up to all of their capital on only a few days or weeks. It’s hard to see how Fannie’s mortgages, being relatively safe, could lose value fast enough that the counterparties holding the risk wouldn’t have some other more risky bet going down first. Think what it would mean if Sowood had had to sell some Fannie mortgages (not a clue if they had any, but they did sell good stuff to raise funds) at less than par.
In other words, we can guesstimate up to 100 percent counterparty risk for Fannie’s QSPE’s, and Bob might as well start thinking about welcoming a large proportion of that $700 billion back onto his balance sheet.
I expect a few of the folks at both Fannie and OFHEO calculated this in broad outline over morning coffee on June 20th when the capital of the two Bear funds vaporized. So we come finally to a line of Capt. Picard in a memorable Star Trek TNG episode … “Ideas?”
I don’t know who this guy is, but here’s support for the Administration from someone at a reputable paper.
“Investor should prepare for more of the same at best”, by Tony Jackson, Financial Times, August 12, 2007.
williamjbond (comment #3) -
I never thought the great cookie-jar affair was that big a deal in the scheme of things, although supposedly making off with $10s of millions of personal gain through accounting fiddles didn’t reflect well on the individuals. The derivatives thing was a lot more serious, although again to be fair the consensus seems to be that rule FAS 133 was really broken then anyway.
Yes the big GSEs are still behind on their reporting, although Fannie is supposed to be handing in their ’06 10-K next Thursday. That should give everyone food for thought. I don’t think they are going to try for their 1&2Q 10-Qs, though, which is unfortunate. But then, so much has changed in the environment just in the last few weeks it’s not clear those would tell us much.
And finally, Bill is retired now, but in fact was Fannie’s chief lobbyist for 20 years, so has every right to sound like a Fannie lobbyist