“There is one thing necessary to understanding what is happening and it is this: no one at U.S. banks, no one at the Federal Reserve, and no one in politics can accept the reality that real estate assets in this country remain oversupplied, overpriced and overleveraged.”
“It is that simple.”
—Kevin Depew, Five Things You Need to Know: Will the Bailout Succeed
The world economy is on edge as it awaits the next round of American roulette. The US Senate has voted to create a $US700 billion ($880 billion) rescue vehicle for distressed debt. But the bill now goes to the House of Representatives, which has already rejected the idea once.
What will happen if the House says yes? And if it says no? What is the prize for winning this high-stakes game of chance? And the consequences of losing?
If you strip away the jargon, the core problem is pretty simple. There is an estimated $US2 trillion in dubious debt instruments, tied to the subprime mortgage market, outstanding at the moment. The US banks and institutions that hold them need to do one of two things – either sell them, or put a value on them in their financial statements.
At the moment, they can do neither. Why not? Because there is no functioning market. It’s not like the American sharemarket, where there are dedicated market-making firms that are charged with the job of standing in the market to buy shares, come what may.
The ongoing turmoil in the financial markets has diverted me from my usual tax academic pursuits, including this blog, for which I apologize. This post explores the causes of that turmoil. My next post will explore solutions currently under consideration, including aspects of the so-called “$700 billion bailout.”
The current financial crisis has many causes, some long-term and structural. I focus here, however, on three immediate aspects of the crisis: the trigger, how problems generated by that trigger spread through the markets, and how this produced the liquidity freeze that persuaded Mr. Paulson and Mr. Bush to act (unsuccessfully thus far).
Read it all. This is a pretty good basic analysis. It is missing some important pieces, especially the 1999 decision to expand Fannie Mae and Freddie Mac’s purview and the role that had in encouraging more risky mortgages. Also, I disagree with him about Lehman, he is way too kind– it was a big mistake by the Fed. More about credit default swaps would have helped too.
Anyway, you take a look and see what you think–KSH.
What should Congress do now?
First, rescue the money markets and the toxic securities by refinancing the underlying mortgages — rather than bailing out the banks. In the Great Depression, Franklin Roosevelt’s Home Owners Loan Corp., a branch of the government, refinanced one out of every five mortgages. Roosevelt’s administration saved about 1 million Americans from foreclosure. No middlemen got rich.
If we can stop the wave of foreclosures, we brake the collapse in housing prices. The bondholders would get bought out at so many cents on the dollar, just as they would have in the Paulson plan. But with the Kuttner plan, homeowners are the primary beneficiaries. Under Paulson’s approach, the bondholders get bailed out but many homeowners still lose their home or keep paying Mafia mortgage rates. It’s just what you’d expect from a guy who still operates as if he were the chief executive of Goldman Sachs — which Paulson once was.
Second difference: The government should take over failing banks directly and get rid of toxic executives as well as the toxic investments they made.
[BOB] ABERNETHY: Father Martin, just step back just a minute and, quickly, what are the big lessons here about, maybe, things that go beyond just the bailout itself?
Fr. [JIM] MARTIN: Well, I think one thing is that, you know, these assets were highly valued because they were risky. In economics there’s a risk-return relationship, and I think one of the things we see that hasn’t been commented on is just that the CEOs sort of lost the sense of personal responsibility to their investors and, you know, to the people they were giving mortgages to. I mean, you know, you check out a lot of magazines in the past few months, they were talking about the coming collapse. It’s not, you know, it’s not as if people didn’t know this was going to happen, and yet the investment was still being made. So I think there’s a certain level, I agree with Jim Wallis, of personal responsibility that needs to be accepted by the CEOs. So in other words what I’m saying is it points out is that, you know, people really do have the responsibility for making conscientious decisions in the workplace.
[BOB] ABERNETHY: Jim Wallis, quickly.
Rev. [JIM] WALLIS: I think there’s an opportunity here for redemption. If our congregations begin to look at these questions — we ought to have adult Sunday school curriculum on money and how to be responsible in our economic lives. That could be a real opportunity for the pulpit to get involved here and start talking about what Christians and Jews and Muslims ought to do in responsible ways about how they live.
Under the agreement, Citigroup will absorb up to $42B of losses on a $312B pool of loans. The FDIC will absorb losses beyond that. Citigroup has granted the FDIC $12B in preferred stock and warrants to compensate the FDIC for bearing this risk. In consultation with the President, the Secretary of the Treasury on the recommendation of the Federal Reserve and FDIC determined that open bank assistance was necessary to avoid serious adverse effects on economic conditions and financial stability.
This is so typical of this nightmarish crisis we are in. Wachovia closed Friday at 10, and now it is pricing near 2. Because of the mess of what is really on these financial institutions balance sheets, no one knows what they are actually worth. Why would banks want to lend other banks when a bank like Wachovia can have this occur so quickly? How do they know that the bank they are lending to is not another Wachovia–KSH?
Update: A NY Times article is now here.
But we should be under no illusions that, even if it works as well as its authors hope (a large aspiration), it is already too late to avert a serious economic downturn ”” not just for the US, but for the world and, like the residents of New Orleans that fateful weekend three years ago, we seem ill-prepared for what is about to hit us.
I say this with great reluctance. It is no business of journalists (who, as someone once said, are like harlots, who wield power without responsibility) to go around scaring people. What’s more, until a few months ago I’ve been a relative optimist, convinced that we would get through this with not much worse than the kind of mild recession we’ve seen in the past 20 years. Now I think it might be time to panic.
The US is already in a recession that, even if financial conditions returned to normal today, would still be very unpleasant. In the quarter that ends tomorrow, it seems almost certain that US total output declined. Consumer spending and investment have been alarmingly weak in the past two months. On Friday we are quite likely to get another depressing report on the labour market, expected to show the ninth straight month of job declines in September. The housing market still seems to be getting worse, with sales falling faster than new construction, adding to the excess supply.
Britain’s economic activity is already declining, as is that of most of the big eurozone countries. So much for “decoupling”. We may have got into this predicament by different routes, but we’re all going the same way.
Although it was not widely known, Goldman, a Wall Street stalwart that had seemed immune to its rivals’ woes, was A.I.G.’s largest trading partner, according to six people close to the insurer who requested anonymity because of confidentiality agreements. A collapse of the insurer threatened to leave a hole of as much as $20 billion in Goldman’s side, several of these people said.
Days later, federal officials, who had let Lehman die and initially balked at tossing a lifeline to A.I.G., ended up bailing out the insurer for $85 billion.
Their message was simple: Lehman was expendable. But if A.I.G. unspooled, so could some of the mightiest enterprises in the world.
A Goldman spokesman said in an interview that the firm was never imperiled by A.I.G.’s troubles and that Mr. Blankfein participated in the Fed discussions to safeguard the entire financial system, not his firm’s own interests.
Yet an exploration of A.I.G.’s demise and its relationships with firms like Goldman offers important insights into the mystifying, virally connected ”” and astonishingly fragile ”” financial world that began to implode in recent weeks.
Although America’s housing collapse is often cited as having caused the crisis, the system was vulnerable because of intricate financial contracts known as credit derivatives, which insure debt holders against default. They are fashioned privately and beyond the ken of regulators ”” sometimes even beyond the understanding of executives peddling them.
That would be New York City’s Nehemiah program. The program started about 30 years ago by several church groups in the Bronx who saw row after row of desolation and sought to change it.
The groups set forth strict income guidelines to make sure that the homeowners had a sense of ownership over the homes and that they would fulfill their obligations. Those guidelines mean people are less likely to get in over their heads:
In the 27 years since the program started, fewer than 10 of the 3,900 households have defaulted on mortgages, a rate that is close to zero, said Michael Gecan, a senior organizer with the Metro Industrial Areas Foundation, one of the forces behind the program.
“We demanded down payments,” Mr. Gecan said, “and we resisted government attempts to have us waive down payments. Over the last six or eight years people kept suggesting various programs with zero down. We kept saying, ”˜That’s ridiculous ”” that’s how you get into mass foreclosures.’”
After a marathon round of negotiations that ended in the predawn hours on Saturday, Congressional leaders and Bush administration officials said they were nearing consensus on a $700 billion rescue plan for the nation’s financial system, and that a deal might be announced Sunday evening before the markets open in Asia….
On the bailout, Mr. Reid said, “We hope that sometime tomorrow evening we can announce there has been some kind of agreement in principle,” adding that it was crucial to send a reassuring message to the financial markets. “We may not have another day.”
Senator Judd Gregg, Republican of New Hampshire, who is the lead negotiator for Senate Republicans, also said there was an urgent need for action: “Failure to do this will lead to a massive fiscal meltdown in the credit markets, which will lead immediately to a meltdown on Main Street.”
In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980’s.
”From the perspective of many people, including me, this is another thrift industry growing up around us,” said Peter Wallison a resident fellow at the American Enterprise Institute. ”If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.”
JOE [KERNEN]: But when the more dire it looked, in terms of communicating, with some of these Senators, the three-month or one-month bill, again, started acting similar to what was happening on Thursday[of last week]. Now we averted that disaster on Thursday, but it’s already been three or four days. It’s almost as if these guys already forgot about the position that we were in. Do you think that accounted — we’re still susceptible to that happening again if it looked like they’re not going to go through with this?
[WARREN] BUFFETT: No, it would get worse. Last week will look like Nirvana (laughs) if they don’t do something. I think they will. I understand where they’re very mad about what’s happened in the past, but this isn’t the time to vent your spleen about that. This is the time to do something that gets this country back on the right track. What you have, Joe, you have all the major institutions in the world trying to deleverage. And we want them to deleverage, but they’re trying to deleverage at the same time. Well, if huge institutions are trying to deleverage, you need someone in the world that’s willing to leverage up. And there’s no one that can leverage up except the United States government. And what they’re talking about is leveraging up to the tune of 700 billion, to in effect, offset the deleveraging that’s going on through all the financial institutions. And I might add, if they do it right, and I think they will do it reasonably right, they won’t do it perfectly right, I think they’ll make a lot of money. Because if they don’t — they shouldn’t buy these debt instruments at what the institutions paid. They shouldn’t buy them at what they’re carrying, what the carrying value is, necessarily. They should buy them at the kind of prices that are available in the market. People who are buying these instruments in the market are expecting to make 15 to 20 percent on those instruments. If the government makes anything over its cost of borrowing, this deal will come out with a profit. And I would bet it will come out with a profit, actually.
—From a CNBC interview yesterday (all three parts of which are worth the time)
The median August sales price was $350,140, down from $588,670 a year ago. CAR chief economist Leslie Appleton-Young said it’s too early to call a bottom for prices, which will “experience additional downward pressure as we move into the off-peak season in the coming months, and will continue to face pressure from distressed sales,” she said.
What would you pay, sight unseen, for a house that nobody wants, on a hard-luck street where no houses are selling?
That question is easy compared to the one confronting the Treasury Department as Washington works toward a vast bailout of financial institutions. Treasury Secretary Henry M. Paulson Jr. is proposing to spend up to $700 billion to buy troubled investments that even Wall Street is struggling to put a price on.
A big concern in Washington ”” and among many ordinary Americans ”” is that the difficulty in valuing these assets could result in the government’s buying them for more than they will ever be worth, a step that would benefit financial institutions at taxpayers’ expense.
Anyone who has tried to buy or sell a house when the market is falling, as it is now, knows how difficult it can be to agree on a price. But valuing the securities that the Treasury aims to buy will be far more difficult. Each one of these investments is tied to thousands of individual mortgages, and many of those loans are going bad as the housing market worsens.
President Bush appealed to the nation Wednesday night to support a $700 billion plan to avert a financial meltdown on Wall Street, and he invited both major presidential candidates to join him and Congressional leaders at the White House on Thursday to forge a bipartisan compromise.
Warning that “a long and painful recession” could occur if Congress does not act quickly, Mr. Bush said the consequences could play out in “a distressing scenario,” including potential bank failures, job losses and inability for ordinary Americans to borrow money to buy cars or send their children to college.
“Fellow citizens, we must not let this happen,” he said.
The address, and the extraordinary offer to bring together Senator Barack Obama, the Democratic presidential nominee, and Senator John McCain, the Republican, just weeks before the election underscored a growing sense of urgency on the part of the administration that Congress must act to avert a far-reaching economic collapse.
It was the first time in Mr. Bush’s presidency that he delivered a prime-time address devoted exclusively to the economy, and it came at a time when deep public unease about shaky financial markets has been coupled with skepticism and anger directed at a government bailout that would be the most expensive in American history.
Unfortunately, there were also some serious negative consequences, particularly in the housing market. Easy credit — combined with the faulty assumption that home values would continue to rise — led to excesses and bad decisions. Many mortgage lenders approved loans for borrowers without carefully examining their ability to pay. Many borrowers took out loans larger than they could afford, assuming that they could sell or refinance their homes at a higher price later on.
Optimism about housing values also led to a boom in home construction. Eventually the number of new houses exceeded the number of people willing to buy them. And with supply exceeding demand, housing prices fell. And this created a problem: Borrowers with adjustable rate mortgages who had been planning to sell or refinance their homes at a higher price were stuck with homes worth less than expected — along with mortgage payments they could not afford. As a result, many mortgage holders began to default.
These widespread defaults had effects far beyond the housing market. See, in today’s mortgage industry, home loans are often packaged together, and converted into financial products called “mortgage-backed securities.” These securities were sold to investors around the world. Many investors assumed these securities were trustworthy, and asked few questions about their actual value. Two of the leading purchasers of mortgage-backed securities were Fannie Mae and Freddie Mac. Because these companies were chartered by Congress, many believed they were guaranteed by the federal government. This allowed them to borrow enormous sums of money, fuel the market for questionable investments, and put our financial system at risk.
The decline in the housing market set off a domino effect across our economy. When home values declined, borrowers defaulted on their mortgages, and investors holding mortgage-backed securities began to incur serious losses. Before long, these securities became so unreliable that they were not being bought or sold. Investment banks such as Bear Stearns and Lehman Brothers found themselves saddled with large amounts of assets they could not sell. They ran out of the money needed to meet their immediate obligations. And they faced imminent collapse. Other banks found themselves in severe financial trouble. These banks began holding on to their money, and lending dried up, and the gears of the American financial system began grinding to a halt.
With the situation becoming more precarious by the day, I faced a choice: To step in with dramatic government action, or to stand back and allow the irresponsible actions of some to undermine the financial security of all.
Journalists like simple stories with clear-cut villains who are easy for readers (and journalists themselves) to recognize. And so, as the financial crisis has brought Wall Street to its knees in recent weeks, it’s become so much easier for journalists to cope. Time Magazine, for instance, tells us in its current issue that Wall Street “sold out” America, while the New York Times decries “Wall Street’s ”¦.real estate bender.” John McCain has helped out the scribes by attributing the problems we now face to greed on Wall Street.
Listening to this sort of chatter, it’s easy to forget that this mess began with a heap of bad mortgages made by American consumers who never came within a hundred miles of the card sharps on Wall Street. The inability (and in a good deal of cases, the unwillingness) of these same ordinary Americans to pay back these loans, many of which are sitting in mortgage backed-securities held by institutions around the world, helped tilt us toward this systemic threat to our financial system. And even as we focus on bad bets and lousy leverage ratios on Wall Street, these toxic mortgages continue to unwind, and as they do, we are getting a better look at how they were made””and it’s not pretty. If it wasn’t clear before, it should be now, that speculation and fraud””much of it on the part of borrowers””were rampant.
As I have observed before, mortgage fraud soared in the run-up to this mess, and believe it or not, it’s continuing to rise. The FBI says that reports of suspicious mortgage activity increased by 10-fold from 2001 through 2007, and rose another 42 percent in the first quarter of 2008.
As Setser and Duy pointed out, we got a subsidy of $1000 a person from our friendly foreign funding sources. The bailout bill $700 billion figure (which could be larger, since that is the maximum outstanding at any one time; the real limit is the increase in the debt ceiling) amounts to $2000 a person. Will our creditors play ball and lend us the money? It isn’t at all clear that they will, at least at current interest rates. They have become decidedly cool on buying agency paper. The man on the street in Asia and Europe is taken aback by the events of the last two weeks. Funding the US has become controversial in China, and may be in other major lenders. And a rise in interest rates would considerably undermine the supposed benefits of the program.
The sorry fact is the US has consumed at an unsustainable level. We need to reduce consumption and increase savings (and reducing debt is a form of savings).
Read it all and especially take the time to look at the main useful charts.
The most obvious solution is to pay more than 25 cents on the dollar and then demand something in return for the premium ”” namely, a stake in any firm that participates in the bailout. Congressional Democrats have been pushing for such a provision this week, and it’s one of the most important things they have done.
The government would then be accomplishing three things at once. First, it would take possession of the bad assets now causing a panic on Wall Street. Second, it would inject cash into the financial system and help shore up firms’ balance sheets (which some economists think is actually a bigger problem than the bad assets). And, third, it would go a long way toward minimizing the ultimate cost to taxpayers.
Why? The more that the government overpays for the assets, the larger the subsidy it’s providing to Wall Street ”” and the more it is pushing up the share prices of Wall Street firms. As Senator Jack Reed, Democrat of Rhode Island, notes, the equity stakes allow the government to recapture some of the subsidy down the road. It’s a self-correcting mechanism.
Some details of a bailout will have to remain vague, in part so that Treasury officials have the flexibility to respond to an obviously fluid situation. But Congress can still do a lot this week to make sure the final cost is a lot closer to, say, $100 billion than $700 billion.
Whether or not tomorrow’s accounts of today’s turmoil prove David Owen of Dresdner Kleinwort right; whether or not this is the beginning of the end of the dollar’s pre-eminence in the world’s central banks and foreign exchanges, the economic landscape has undoubtedly changed forever.
The US taxpayer bail-out of America’s banking sector is an event whose significance will reverberate for many years. What it means for free markets, for the way Western economies are run, for the prosperity of the world economy, must remain to be seen.
But as investors scrambled to make sense of last week’s events, already one conclusion was all but irrefutable ”“ the US dollar will have to take another major fall.
With financial markets in flux and a massive government rescue package in the works, financial reporter and New York Times columnist Gretchen Morgenson looks into what’s involved in the nearly $700 billion deal.
One central concern: The way troubled banks’ assets get valued when the federal government buys them. “Depending on how [the bailout program] is operated, and how the assets are valued before taxpayers are forced to buy them, it could bloat our final bill for this mess while benefiting the very institutions that got us into it,” Morgenson wrote in a recent column.
Morgenson talks to Terry Gross about strategies the government might employ to value the assets taxpayers are buying from endangered institutions ”” and how regulators might earn back some of the trust they’ve lost in recent weeks.
1. You two gentlemen have been wrong about the Housing crisis, missed the leverage problem, and understated the derivative issue. Recall the overuse of the word “Contained.” Indeed, you two have been wrong about nearly everything financially related since this crisis began years ago.
Question: Why should we trust your judgment on the largest bailout in American history?
2. How are you pricing the purchase of these damaged assets? Is the taxpayer paying 22 cents on the dollar? 5.5 cents? If there is no market price for this junk paper, how are you going to determine a purchase price?
President Bush’s proposed solution, which he wants Congress to authorize immediately, tells taxpayers to write a check for $700 billion and trust the government and Wall Street to do the right thing ”” with inadequate regulation and virtually no oversight.
We agree with Senator Barack Obama that the administration’s plan lacks regulatory muscle, and we agree with Senator John McCain when he said: “When we’re talking about a trillion dollars of taxpayer money, ”˜trust me’ just isn’t good enough.”
Nearly everyone agrees that the there will have to be another very big bailout. The financial system, gorged on its own excesses, cannot stabilize without intervention. The $700 billion would be used to buy up the bad assets that are presumably clogging the system.
To protect the American taxpayer, Congress must ensure that the bailout comes with clear ground rules and vigilant oversight. In an appalling, though familiar fashion, the ground rules proposed by the Bush administration are wholly unacceptable ”” as are its tactics.
Most economists accept that the nation’s financial crisis ”” the worst since the Great Depression ”” has reached such perilous proportions that an expensive intervention is required. But considerable disagreement centers on how to go about it. The Treasury’s proposal for a bailout, now being negotiated with Congress, is being challenged as fundamentally deficient.
“At first it was, ”˜thank goodness the cavalry is coming,’ but what exactly is the cavalry going to do?” asked Douglas W. Elmendorf, a former Treasury and Federal Reserve Board economist, and now a fellow at the Brookings Institution in Washington. “What I worry about is that the Treasury has acted very quickly, without having the time to solicit enough opinions.”
The common denominator to many reactions is a visceral discomfort with giving Treasury Secretary Henry Paulson Jr. ”” himself a product of Wall Street ”” carte blanche to relieve major financial institutions of bad loans choking their balance sheets, all on the taxpayer’s bill.
There are substantive reasons for this discomfort, not least concerns that Mr. Paulson will pay too much, thus subsidizing giant financial institutions. Many economists argue that taxpayers ought to get more than avoidance of the apocalypse for their dollars: they ought to get an ownership stake in the companies on the receiving end.
The financial markets are in quite fragile condition and I think absent a plan they will get worse,” Bernanke said.
Ominously, he added, “I believe if the credit markets are not functioning, that jobs will be lost, that our credit rate will rise, more houses will be foreclosed upon, GDP will contract, that the economy will just not be able to recover in a normal, healthy way.”
GDP is a measure of growth, and a decline correlates with a recession.
Dodd later spoke disparagingly of the administration’s proposal. “What they have sent us is not acceptable,” he told reporters after presiding over a lengthy Senate Banking Committee hearing at which Bernanke and Treasury Secretary Henry Paulson urged swift action by Congress.
Inspired in part by Paul Volcker, Nicholas Brady and Eugene Ludwig, and announced last week, the Paulson plan is a pure establishment play. It would assign nearly unlimited authority to a small coterie of policy makers. It does not rely on any system of checks and balances, but on the wisdom and public spiritedness of those in charge. It offers succor to the investment banks that contributed to this mess and will burn through large piles of taxpayer money. But in exchange, it promises to restore confidence. Somebody, amid all the turmoil, will occupy the commanding heights. Somebody will have the power to absorb debt and establish stability.
Liberals and conservatives generally dislike the plan. William Greider of The Nation writes: “If Wall Street gets away with this, it will represent an historic swindle of the American public ”” all sugar for the villains, lasting pain and damage for the victims.”
He approvingly quotes the conservative economist Christopher Whalen of Institutional Risk Analytics: “The joyous reception from Congressional Democrats to Paulson’s latest massive bailout proposal smells an awful lot like yet another corporatist love fest between Washington’s one-party government and the Sell Side investment banks.”
Thanks to their criticism, the plan will be pinned back. Oversight will be put in place. But the plan will probably not be stopped. The markets would tank. There is a hunger for stability, which only the Treasury and the Fed can provide.
So we have arrived at one of those moments. The global financial turmoil has pulled nearly everybody out of their normal ideological categories. The pressure of reality has compelled new thinking about the relationship between government and the economy. And lo and behold, a new center and a new establishment is emerging.
As we’ve worked through this period of market turmoil, we have acted on a case-by-case basis ”” addressing problems at Fannie Mae and Freddie Mac, working with market participants to prepare for the failure of Lehman Brothers, and lending to A.I.G. so it can sell some of its assets in an orderly manner. We have also taken a number of powerful tactical steps to increase confidence in the system, including a temporary guaranty program for the U.S. money market mutual fund industry. These steps have been necessary but not sufficient.
More is needed. We saw market turmoil reach a new level last week, and spill over into the rest of the economy. We must now take further, decisive action to fundamentally and comprehensively address the root cause of this turmoil.
And that root cause is the housing correction which has resulted in illiquid mortgage-related assets that are choking off the flow of credit which is so vitally important to our economy. We must address this underlying problem, and restore confidence in our financial markets and financial institutions so they can perform their mission of supporting future prosperity and growth.
We have proposed a program to remove troubled assets from the system. This troubled asset relief program has to be properly designed for immediate implementation and be sufficiently large to have maximum impact and restore market confidence. It must also protect the taxpayer to the maximum extent possible, and include provisions that ensure transparency and oversight while also ensuring the program can be implemented quickly and run effectively.
The market turmoil we are experiencing today poses great risk to U.S. taxpayers. When the financial system doesn’t work as it should, Americans’ personal savings, and the ability of consumers and businesses to finance spending, investment and job creation are threatened.
The ultimate taxpayer protection will be the market stability provided as we remove the troubled assets from our financial system. I am convinced that this bold approach will cost American families far less than the alternative a continuing series of financial institution failures and frozen credit markets unable to fund everyday needs and economic expansion.
Here’s a core problem with the Paulson-Bernanke $700 bailout: Once the new rules of the financial system are set, a bunch of very smart people will get paid a ton of money by hedge funds and the like to game that system. It would be the height of naivety to believe that regulators can write a system that can’t be gamed.
With that many pols at the helm, it’s no wonder that most analysts have portrayed Fannie and Freddie as if they were unregulated renegades, and rarely mentioned HUD in the ongoing finger-pointing exercise that has ranged, appropriately enough, from Wall Street to Alan Greenspan. But the near-collapse of these dual pillars in recent weeks is rooted in the HUD junkyard, where every [Andrew] Cuomo decision discussed here was later ratified by his Bush successors.
And that’s not an accident: Perhaps the only domestic issue George Bush and Bill Clinton were in complete agreement about was maximizing home ownership, each trying to lay claim to a record percentage of homeowners, and both describing their efforts as a boon to blacks and Hispanics. HUD, Fannie, and Freddie were their instruments, and, as is now apparent, the more unsavory the means, the greater the growth. But, as Paul Krugman noted in the Times recently, “homeownership isn’t for everyone,” adding that as many as 10 million of the new buyers are stuck now with negative home equity””meaning that with falling house prices, their mortgages exceed the value of their homes. So many others have gone through foreclosure that there’s been a net loss in home ownership since 1998.
It is also worth remembering that the motive for this bipartisan ownership expansion probably had more to do with the legion of lobbyists working for lenders, brokers, and Wall Street than an effort to walk in MLK’s footsteps. Each mortgage was a commodity that could be sold again and again””from the brokers to the bankers to the securities market. If, at the bottom of this pyramid, the borrower collapsed under the weight of his mortgage’s impossible terms, the home could be repackaged a second or a third time and either refinanced or dumped on a new victim.
Those are the interests that surrounded Cuomo, who did more to set these forces of unregulated expansion in motion than any other secretary and then boasted about it, presenting his initiatives as crusades for racial and social justice.
The Federal Reserve took a number of actions to increase liquidity and stabilize markets. Notably, to address dollar funding pressures worldwide, we announced a significant expansion of reciprocal currency arrangements with foreign central banks, including an approximate doubling of the existing swap lines with the European Central Bank and the Swiss National Bank and the authorization of new swap facilities with the Bank of Japan, the Bank of England, and the Bank of Canada. We will continue to work closely with colleagues at other central banks to address ongoing liquidity pressures. The Federal Reserve also announced initiatives to assist money market mutual funds facing heavy redemptions and to increase liquidity in short-term credit markets.
Despite the efforts of the Federal Reserve, the Treasury, and other agencies, global financial markets remain under extraordinary stress. Action by the Congress is urgently required to stabilize the situation and avert what otherwise could be very serious consequences for our financial markets and for our economy. In this regard, the Federal Reserve supports the Treasury’s proposal to buy illiquid assets from financial institutions. Purchasing impaired assets will create liquidity and promote price discovery in the markets for these assets, while reducing investor uncertainty about the current value and prospects of financial institutions. More generally, removing these assets from institutions’ balance sheets will help to restore confidence in our financial markets and enable banks and other institutions to raise capital and to expand credit to support economic growth.
At this juncture, in light of the fast-moving developments in financial markets, it is essential to deal with the crisis at hand.