By G.L.C., on September 16th, 2008
It has finally happened: the federal takeover of Fannie Mae and Freddie Mac, which together own or guarantee almost half of the $12 trillion home mortgage debt. The takeover came after inspectors poring over the books of the two companies concluded that the accounting methods used by Freddie Mac had overstated the capital cushion of the company. The methods used to bolster the capital cushion have caused serious concerns among regulators. Freddie Mac’s portfolio has many securities backed by subprime loans, but the company has not written down the value of these loans to reflect the current market price. The two companies have also inflated their financial positions by relying on deferred tax assets – Fannie Mae’s worth increased by $36 billion and Freddie Mac’s by $28 billion. Without tax deferred assets, the value of both companies would fall below the regulatory requirements.
The takeover is being seen as necessary to help stabilize the mortgage industry in the short term. But it does not answer the all-important question of how best to finance home mortgages in the United States.
The lender’s retention of credit risk and maturity matched finding are two key characteristics of safe, efficient, fixed rate mortgage lending. In the mortgage market, these two characteristics are missing to a great extent. Lenders have used the securitization process to pass the risk to others. The transaction cost of securitization is high, particularly if the mortgages are refinanced at a lower interest rate. Maturity mismatching has been prevailing at most lenders, including Fannie Mae and Freddie Mac, since the early 1980s.
One answer to the question is to introduce covered bond financing for mortgages. These bonds are on balance sheet borrowings and secured by mortgages owned by the issuer of the bonds. The lender can safely hold on its balance sheet the fixed rate mortgage it has made.
Covered bonds are new to the United States. Only two lenders – Bank of America and Washington Mutual – issue them. But in Europe, they have been issued for over two centuries. Today there are approximately $3 trillion of these outstanding in Europe. Since these bonds are on balance sheet borrowings, it acts as an incentive for good lending decisions: the lender would be stuck with lending errors.
The authorities are now taking steps making covered bonds more popular. The United States Treasury has already issued a set of best practices for issuing covered bonds. New Jersey Rep. Scott Garrett introduced a legislation for providing statutory protection for investors of covered bonds similar to the protection enjoyed by investors of covered bonds in Europe.
Covered bonds have the potential to fund a significant portion of the $10 trillion outstanding in home mortgages today. With covered bonds, the lenders need not sell their fixed rate mortgages into a secondary mortgage market. Instead, they can safely keep their mortgages.
The federal takeover of Fannie Mae and Freddie Mac has only demonstrated that the present mortgage infrastructure is inefficient and extremely risky. The introduction of covered bonds in such a scenario is a welcome step in the right direction.
By Evelyn Black, on September 4th, 2008
Ever since Bill Clinton remarked, “It’s the economy, stupid!” the phrase has become a prominent part of the American political lexicon. This time around, we hear it all the time mouthed by pundits, and yet, watching the avalanche of political ads from where I live (in Michigan, a battleground state), it seems to me to be less about the economy and more about the patriotism and personal character of each respective candidate.
Plenty of “stupids” both implied and explicit are being bandied about.
Serious thoughts about the economy? Not so much.
Meanwhile, the U.S. economy has deep, unprecedented problems. Very serious problems. Problems so large that I think it is no exaggeration to say that they threaten to tank the United States politically, eventually relegating us to the world status of, say, Iceland – only without any of the socialized perks like healthcare and forward thinking energy policies.
While voters worry about who is wearing a flag pin and who will or will not raise their personal income taxes, inflation is hitting record levels; levels not seen in 17 years. The inflation rate for July alone was 1.9%. If the Fed raises interest rates (one conventional way to tame inflation), then mortgage rates will rise and lending will freeze up even more than it already has, driving the already catastrophic housing sector into an even deeper downward spiral, with the attendant loss of even more jobs, and yet another increase in foreclosures.
If inflation continues at this rate, the results will be just as toxic. Already there is talk of another economic stimulus rebate package, even though the first one was horrendously expensive and barely caused a blip on the consumer purchases screen. People needed that money to pay bills.
So there are no easy answers, but what strikes me in this campaign is that few are even asking the questions. Right now, Fannie Mae and Freddie Mac stock continues to deteriorate (20% in the past week alone) and the buzz is not about whether the recently passed rescue package will be used, but when and how. Remember, the rescue was tacked onto a foreclosure relief bill that was stuck in Congress for a year while representatives argued about “moral hazard” at an individual homeowner level. Once it turned corporate, boom, that bill was pushed right through, with the caveat, “We will likely never have to use this.”
Did anyone ever believe that?
Nouriel Roubini, the economics professor who correctly predicted the subprime crash and whom a recent New York Times article calls “Dr. Doom,” expects the cost of the Fannie/Freddie bail-out to hit $1.5 trillion before it’s all over. The famously bearish Roubini is quoted as saying, “A good third of the regional banks won’t make it,” and more disturbingly, “Our biggest financiers are China, Russia and the gulf states. These are rivals, not allies.” Roubini expects the worst to come throughout most of 2009, with a gradual recovery toward the end of that year, but he also notes, ominously,
We’re in uncharted territory where standard economic theory isn’t helpful.
He isn’t the first to say so. Henry Paulson of the U.S. Treasury has said as much, and all anyone has to do is look at Ben Bernanke’s face every time he speaks to Congress to understand instantly that we are in deep and confusing trouble. The man constantly looks like he’s about to wet himself.
Anyone who reads my posts for Amateur Economists can guess without any help which direction my personal politics lean, but I want to put it to the voters that, whatever your personal beliefs and political inclinations, now is not the time to indulge in American politics as usual with the chest thumping and flag waving and name calling and Boilermaker contests. Now is a time to listen very hard to policy making statements from both sides, to examine voting records and past behavior, and more than anything to ask yourselves how you will survive the coming hard times if no one who understands them is at the helm.
Thus far, what economic “policy” we have had has been reactive and seat-of-the pants. We’ve been plugging up holes in a leaky dike with wads of chewing gum. I don’t know if we have six months to waste, but it will be at least that long before a new administration is firmly in place and probably longer before that administration is able to formulate anything resembling an active response to the oil problem, the housing problem, the credit crunch, the bank failures, the crumbling infrastructure, the loss of American industry and jobs, declining wages, the healthcare crisis, and so much more.
John McCain owns seven homes, some of them condominiums, and all of them expensive. Barack Obama really was born in the U.S., does have a birth certificate here, and owns a million dollar home (just one though) near the Chicago law school where he used to teach. Both of them wear flag pins.
There. Now can we get serious?
By G.L.C., on August 15th, 2008
The Federal Home Loan Mortgage Corporation (Freddie Mac) and the Federal National Mortgage Association (Fannie Mae) together own or guarantee almost half of the $12 trillion home mortgage debt. These are two of the largest financial institutions in the country.
Although Freddie Mac and Fannie Mae are government sponsored enterprises, they are privately owned. They enjoy special privileges. They need not register their securities with the government, pay state and local income taxes, and are conferred special treatment for investment purposes. The securities issued by them have the aura of a government guarantee. In the credit markets, these securities are priced as low risk investments. This enables them to place their securities at lower yields in the financial markets than would have been otherwise possible.
Both companies were created to facilitate the availability of mortgage finance to homeowners at affordable rates.
When the sub prime crisis hit America, the fortunes of these two companies were affected to a great extent. The widespread repossession and distress sale of home through out America caused a general decline in home prices which led to negative equity and delinquency in respect to several mortgages that these two companies had owned or guaranteed. They were terribly over-leveraged to such an extent that the edifice came crashing down. The problems were so serious that the government had to step in and pass a law to prevent these two companies from collapsing.
There are some lessons to be learned from all this. The concept of privately owned entity and government sponsored enterprise are contradictory. Lenders carefully consider the financial health of a privately owned entity and limit exposure to prudent level. They are subject to market regulations such as registration of securities, payment of state and local income tax, etc.
A government sponsored enterprise has an aura of implicit federal government backing. It enjoys several benefits and is not subject to strict scrutiny by lenders and investors. It is not subject to the same market regulations as a privately owned entity.
The government has so far managed to keep the liabilities of Freddie Mac and Fannie Mae out of its balance sheet. But because they are government sponsored enterprises, the government may be forced to turn to the tax payer to bail them out.
The shareholders of Freddie Mac and Fannie Mae have made huge profits over the years on account of the special privileges the companies enjoyed as government sponsored enterprises.
Because of the government sponsored enterprise status these two privately owned entities enjoy, the shareholders of these two companies have been able to rake in profits, but now that these two companies are in financial distress, they have turned to the government who had to bail them out. In the end it is the tax payer who is forced to pick up the tab for the financial mismanagement of two privately owned entities because they happen to be government sponsored enterprises.
The new law does not address the issue at all. So long as these two companies enjoy special privileges as government sponsored enterprises, the shareholders will rake in the profits and the government will have to step in (at the cost of tax payers) every time these companies are in financial distress. The law should have made these companies subject to tougher market regulations.
By G.L.C., on August 6th, 2008
Fannie Mae and Freddie Mac together own or guarantee almost half of the $12 trillion home mortgage debt. In an attempt to rein in Fannie Mae and Freddie Mac, President Bush, on July 30, signed into law a package to resurrect the mortgage industry by pumping in $300 billion to help distressed homeowners get more affordable, government-backed mortgages and get out from under risky mortgages they cannot afford. The new law creates a stronger regulator for the two companies and gives the government the option to take equity stakes if the two companies run into trouble. In order to spur home buying, it offers tax breaks, sets up the first national licensing system for mortgage brokers and loan officers, and raises the limit on the size of mortgages that Fannie Mae and Freddie Mac can guarantee. The markets welcomed the new law and the shares of the two companies initially rose.
But whether the new law will succeed in reining them in is doubtful. The main reason the law might fail is the immense lobbying clout of Fannie Mae and Freddie Mac, which is imminent from the fact that a proposal to eliminate their lobbying budgets was not even put to a vote on the Senate floor. Majority Leader Harry Reid refused to allow a vote on Republican Jim Reid’s amendment to bar political donations and lobbying by the two companies.
Lobbying by Fannie Mae and Freddie Mac is nothing new. According to an editorial in The Wall Street Journal, the political action committees of the two companies have already distributed roughly $800,000 to U.S House and Senate members this election cycle.
According to the Fannie Mae Foundation website, Jesse Jackson’s Citizenship Education Fund has received $660,000 from Fannie Mae alone since 1996. In the 1990’s Jesse Jackson accused these companies of discriminatory lending practices, but the allegations disappeared once the money started flowing.
On the positive side, the law aims to alleviate home foreclosures via a government guarantee that both penalizes the lenders and gives the government a share of the upside if prices recover. But this provision is voluntary and is likely to have only a few takers. Throwing government cash at a market that is already heavily distorted by tax breaks and subsidies is certainly not a good idea, especially at a time when house sales, if not prices, look at last to be bottoming.
There is virtually no protection for the American taxpayer. It imposes no changes in management or approach on the companies and no penalties on shareholders. The current arrangement allows managers and shareholders to take all the profits and leave the losses to the taxpayer. Under the pretext of protection, the new law gives the treasury secretary the right to dictate terms if the government does have to stump up equity capital and create a new regulator.
The new law might not succeed in reining in the two companies. It has too many loopholes. Loopholes apart, unless lobbying by the two companies is barred, the taxpayer might end up paying a heavy price to save these companies. There is no reason to permit these two companies to lobby Congress when government departments are not allowed to do so.
By Evelyn Black, on August 5th, 2008
 If you aren’t feeling seasick yet from watching financial markets shoot up and then plunge over and over again over the course of the past year, you must be one of those sane people who ignores the market unless a line is spotted extending down the block from your own personal bank and brokers are raining down from rooftops like cats and dogs. If you are one those lucky few, good for you!
The rest of us are a little queasy at this point.
Since November of last year we have witnessed the kind of drama on Wall Street that belongs in a horror movie, not in a field of finance that impacts our 401(k)s. We’ve watched the Fed, Congress, and the President react with this, that, and the other emergency measure, and with each magic trick, we held our collective breath and watched and waited to see what came next.
While it’s great that the Fed and our branches of government are able to think creatively and act nimbly in the face of possible financial systemic meltdown, it would be even more wonderful if it seemed that anyone actually had a handle on how to smooth the waters with consistent policy that is forward-thinking rather than reactive. It strikes me that each emergency fix (the last one being the Fannie/Freddie rescue package) leaves us less confident than before. Lack of confidence in a financial system is, in general, a bad thing. So while we are in a lull here (knock on wood), I’d like to raise the question, “What, if anything, is the hard choice that will get us back on track over the long run?”
On Sunday, the New York Times ran an editorial about ailing banks and a request by private equity firms for the Fed to drop regulations preventing them from running banks into which they invest large sums of money. Currently, federal law prohibits this to prevent conflict of interest and a too-great concentration of economic power into elite hands. With so many banks hurting for capital and in need of cash infusions, it must be tempting for the Fed to take this proposal seriously and quietly allow something that nine out of ten ordinary people won’t notice anyway let alone understand.
The Times makes the point that this is a terrible idea, not the least of the arguments against it being that it is private equity firms and financiers who operate outside the scope of bank regulation who got us into this mess in the first place. By creating and promoting highly-speculative, mortgage-backed investment securities, they nearly crashed the entire system. To back off on regulation right at at time when what we need badly is more, not less, oversight is tantamount to giving the fox the key to the hen house and hoping that it will all just work itself out, somehow.
The real problem of course is, where is the money banks need going to come from?
Congress can pass all the bail-out bills it wants, but the fact remains, the U.S. is not exactly rolling in it. Cash, that is. If regulations are not relaxed so that private equity firms can bail out banks and then run them however they see fit, what will happen to the banks?
The banks will fail, that is what will happen to them. The one possibility that we rarely hear put forward as a serious solution is that maybe that is exactly what needs to happen. Why are we trying to prop up a banking system that made one disastrous greedy decision after another without regard to the consequences of those actions? If the free-market is self-regulating (and that’s another discussion entirely, the question of whether or not it really is), then why don’t we let it regulate itself by weeding out the weak?*
To take an even longer view, at some point the U.S. will have to set actual policy and stop jumping in with wads of emergency-measure chewing gum to plug the financial dikes. Why do we have a private organization (the Fed) calling the shots on regulation and deregulation that directly hits the pocket books of ordinary people? We are all paying for this: all of us except the CEOs and high rollers who jumped with golden parachutes or escaped with cash before the train started to derail. Those people, those few at the very top, are mostly coming out unscathed. That’s wrong. Everyone knows it is wrong. No one is speaking to that injustice much less taking any aggressive action to change it.
Instead, we have vultures hovering and foxes circling, holding out wads of cash and asking for special favors. And Congress, after having very self-righteously accomplished exactly nothing in regards to energy policy (Democrats wanted to slap the hands of oil speculators who aren’t responsible for high gas prices, and Republicans wanted to drill offshore even though it won’t help either), is now adjourned and the country is talking about whether or not Barack Obama has anything in common with Paris Hilton and Brittany Spears.
That is insanity on a plate.
The hard, longterm fix is to find a way to tie money to actual value again. I know this will sound dusty and lame to fast-track types who are energized by leverage, but somebody has to say it, and since I’m already old I don’t mind throwing it out there. You can make money by moving money around, scrambling numbers, and gambling on outcomes for awhile, but eventually the smoke clears, the mirrors crack, and what do you have? You have what we are looking at right now.
I have three modest proposals, none of which will be taken seriously even in my dreams, but here they are:
1) Create a comprehensive and aggressive national energy policy which includes subsidies for development of alternative energy, generous tax rebates for homeowners who invest in it or in energy conservation, aggressive development of alternatively-fueled vehicles, and redesign and rebuilding of infrastructure. This alone will create new jobs and reduce our dependence on foreign oil. It should be our top priority. Right now it isn’t even on the edge of the map. Energy policy? What energy policy?
2) Require lending institutions to reduce the principal on their property-backed loans to a number that is more in line with the actual value of the property, and then take the loss on the difference. This will cause some financial institutions to go under. Oh well.
3) Re-examine and re-work banking regulations so that banks cannot skirt their fiduciary responsibilities by running around Depression Era safeguards using investment houses and third party financiers. The American people should be involved in this, meaning that it should go through Congress and be discussed publicly at length, not hammered out in private at the Federal Reserve.
If we have to foot the bill for misconduct, we should get a say in what the rules are and how they are enforced. It strikes me that this should be the very least we could do in the interest of fairness and longterm success. It distresses and angers me that to date so little has been done.
The next wave of defaults is just around the corner. How about getting a comprehensive plan together before it hits instead of after?
I don’t know how much more nausea I can personally take.
*Editor’s note: For the Austrian economics point-of-view on allowing Fannie Mae and Freddie Mac to fail on their own, see J.D. Seagraves’ article “Fannie Mae and Freddie Mac: It’s Time for the U.S. to Let Go.”
By Evelyn Black, on July 29th, 2008
Not too long ago, I confess I was in a rather panicked state of mind about the economy. This was after Bear Stearns tanked but before IndyMac was seized by the FDIC. I thought that if the U.S. government could intervene in a big way and refinance homeowners who were facing foreclosure, then the free fall in housing values could be stopped and the economy could be stabilized.
Now that a housing rescue bill is about to be signed by the president, I’m not so sure.
The bill contains a variety of features, including incentives for first time home buyers and the now infamous Freddie and Fannie bailout. However, the part of the bill meant to help families facing foreclosure will only apply to a small portion of homeowners.
Certain requirements must be met in order for a borrower to be eligible for the program. First, the borrower must live in the home. Second, the mortgage has to be at least 31% of the borrower’s gross monthly income. Third, the borrower’s income must be verified even if the initial mortgage was a ’stated income’ mortgage that required no verification. Fourth, the mortgage company or bank that made the initial loan must agree to a refinance at no more that 90% of the home’s current value.
In other words, the bank holding the mortgage has to agree to take a loss or the whole deal is off.
We don’t really know if lenders will agree to this last requirement. A loss of 10% doesn’t sound that bad on the surface, but the terms are 90% of the home’s current value. In some parts of the U.S. where the housing bubble was especially out-of-control, home values have already dropped by as much as 30%, so if a buyer has a 100% “creative” sub-prime loan on a property like that, the lender will have to agree to a 40% loss. Thus far, lenders have not been anxious to rework loans or agree to short sales on homes facing foreclosure. It’s hard to know why they would be motivated to do so now.
Other terms are also problematic. If a borrower makes $32,000 a year, the mortgage payment on the soon-to-be-foreclosed property would have to be in excess of $826 a month in order for the borrower to qualify. That will cut out a lot of people in trouble on their loans. So will the income verification requirements. While it is certainly sound and sensible to require verification, chances are good that if the buyer couldn’t produce it for the original loan or couldn’t get a loan with proper income verification, that buyer won’t be able to get the refinance either.
Estimates on the total number of foreclosures expected within the coming year range from three to five million. Say the lower number is correct. That means the help this bill provides is a possibility for about 13% of the homeowners currently facing foreclosure. And of those 13%, only the ones who can get their original lender to accept a loss of anywhere from 10-40% will be successful.
That’s not very encouraging.
Before Bear Stearns failed, Benjamin Bernanke was asked about how to stabilize the housing market, and he made a suggestion that he said he knew would never be taken but he thought might work. His suggestion was that each original lenders rework the loans made during the housing bubble so that the loans were more in line with the property’s current actual value; that is, that each lender take a loss by reducing the principal on the loans. That would immediately make the loans good: the property value would match the loan against it. He knew however, that lending institutions would be loathe to do this.
Again and again we come back to this issue of lender responsibility. We all know that individual people can and do make terrible financial decisions. Faced with the prospect of rapidly inflating home values, lots of people jumped into loans that didn’t make sense on properties they really couldn’t afford, hoping it would all work out over the long haul as their homes grew more and more valuable.
Financial institutions however have a fiduciary responsibility to themselves and their customers to be smarter than that and to take the long view. We all know now that they did not do anything remotely close to that. In fact, not only were too many sub-prime “creative” loans made, they were then repackaged and sold as rock solid securities in ways that spread the contagion throughout the entire financial system.
Looking back, I think Bernanke had it right the first time: the correction should occur at the initial lending institution, and if it goes down as a result, so be it. That’s the market at work, right? Doing what it does best, killing off the weak and the poor decision makers. What we have now is the government stepping in to offer tepid help to a very few and attempting to back private bad debt with public bad debt.
The bailout portion of the bill is fodder for another post.
By even the most conservative reckoning, housing values still have a long way to fall before the market stabilizes. Many are putting that bottoming-out somewhere around 2010 or even beyond. In the worst case scenario, home values drop so precipitously that even “good” loans go upside down (that is, the borrowers suddenly owe more than the home is worth) and Fannie and Freddie have to actually start tapping Uncle Sam for cash to stay solvent.
If that happens, the terms of the rest of the bill won’t really matter anymore.
I think the bill can work if it isn’t used. That’s a weird place to be, and not a comfortable one.
By J.D. Seagraves, on July 28th, 2008
Conservatives talk about how great America’s “free market” is, while those on the political left are critical of the “free market’s excesses.”
What are they talking about?
We have nothing even closely resembling a “free market” in the United States, and the latest news surrounding Fannie Mae, Freddie Mac, and the Federal Reserve underscores that point.
People are generally confused about Fannie and Freddie: Just what or who are they? Well, let’s start with Fannie: Fannie Mae is the nickname given to the Federal National Mortgage Association (FNMA), an agency created four years after the Federal Housing Administration (FHA), which was one of FDR’s New Deal programs. The FHA, born in 1934, sought to “standardize” mortgages by insuring loans that conformed to government guidelines. The FNMA (Fannie Mae) would then buy these mortgages from the originators and pool them into marketable securities – i.e. financial assets that could be bought and sold by investors. An FNMA security might contain 100 mortgages, for example, and that way, if five of those mortgages failed, investors would only lose out on 5% of their investment. In this way, the government sought to lower the “credit risk” premium of mortgages and make homeownership more affordable to average Americans.
Sounds good, right? Well, there’s always a catch. But first, let’s continue with Freddie Mac.
In 1970, the government gave Fannie Mae the authority to purchase and securitize any mortgage – not just those that adhered to FHA guidelines – and created the Federal Home Loan Mortgage Corporation (FHLMC – “Freddie Mac”) to do Fannie’s old job. Now the government had it’s hands in virtually every kind of mortgage imaginable – though exactly where this power was enumerated in the Constitution is unclear.
Of course, Fannie and Freddie aren’t truly government agencies. In rejecting socialism, the government opted for fascism: government partnership with business. Fannie and Freddie are “privately owned” publicly traded stocks on the New York Stock Exchange, so their profits are privatized…but their losses are always socialized.
Since the mortgage meltdown – created by the Federal Reserve’s inflationist monetary policies – Fannie and Freddie’s stocks have been in the toilet. Over the past couple of weeks, each of the firms has lost billions in market capitalization. On July 10, Fannie closed at $13.20 and Freddie at $8 – the 52-week highs for the stocks are $70.57 and $67.20, respectively. During the next day’s trading, Fannie and Freddie hit session lows of $6.68 and $3.89.
And then the Fed intervened.
Chairman Bernanke announced that the Fed would stand by to bail out the firms, and the stocks – down as much as 40% for the day – rebounded, closing at $10.25 and $7.75, respectively.
Think this isn’t a big deal? Consider this: The swing from $6.68 to $10.25 for Fannie Mae represented a change in value worth nearly $3.5 billion, and Freddie’s swing from $3.89 to $7.75 was worth $2.5 billion. In all, $6 billion changed hands on Friday, all based on a few words from the Fed chairman. The investors who threw in the towel, recognizing that, in a free economy, Fannie and Freddie would be done-for, were suckers. Those who stepped in to buy the stocks at that point, confident that the government would intervene, profited by billions.
And they call this a “free” market?
Just imagine if some investors might have had some advance knowledge that Bernanke would make those comments.
By G.L.C., on July 20th, 2008
The subprime crisis in the U.S. has resulted in the decline of many companies. Many banks including large ones had to write off millions. The decline is not limited to banks and home loan companies alone.
Out of the total $12 trillion in mortgage debt today, two companies – Fannie Mae and Freddie Mac – own or guarantee half of the debt. Both were established by Congress to make homes affordable for lower and middle income families. They do not provide home loans. Both buy mortgages from banks and home loan companies allowing them to make even more mortgages. They take on the risk of possible default.
The decline of Fannie Mae and Freddie Mac is not an overnight event. It has been building up over the years. Some experts feel the main reason for the decline is their unfair insulation from the real world – they are not subject to the same financial standards and taxes as their competitors. They are also exempt from state and federal taxes.
To be fair, the government did try to regulate them by setting up the Office of Federal Housing Enterprise Oversight in the early 1990s.
They were required to meet certain capital reserve requirements but still much less than their competitors. When the accounting scandals broke out at both companies a few years ago, the government had the perfect chance to set up a powerful regulator and rein them in, but the fear of stemming the housing boom probably held the government back.
It would be wrong to blame the lack of regulation alone for the decline of these two companies. The Securities and Exchange Commission tried to get more actively involved in regulating them, but both companies stymied their efforts.
Instead of addressing their critics, these companies forged alliances with them and other activist groups and made huge contributions to non-profit groups. These alliances and contributions were made to buy off the activists and groups and to make it more difficult for them to criticize the companies.
Congress is now debating on a legislation which if passed could give these companies even more power and allow them to venture into new mortgage-related businesses. Instead of making these companies more powerful, what Congress needs to do is to set up a regulator who can effectively regulate these companies and, at the same time, decide on some sort of a capital cushion for them.
The value of Fannie Mae and Freddie Mac’s mortgage assets are declining along with home prices everywhere. If these companies fail, the taxpayers could be left with the losses.
By Evelyn Black, on July 17th, 2008
As I write this, Treasury Secretary Henry M. Paulson’s announcement that the Bush administration will indeed shore up Fannie Mae and Freddie Mac is all over the news and still sinking in. After opening slightly higher Monday morning, Wall Street dipped back into negative territory as analysts attempted to digest the bail-out news.
What can it mean for the average person?
If you’ve been listening to the news, you’ve probably heard that it means that the American taxpayer can expect at some point to carry the brunt of the subprime lending debacle losses. That is, if the Bush Administration is able to ram their plan through Congress (and they almost certainly will be able to do this), at some point the money to back the bad loans currently bundled into Fannie Mae and Freddie Mac securities will literally come from our own individual pockets in the form of tax dollars.
That price tag could be as high as 5.5 trillion dollars. In fact, the price tag could end up being so high, that along with Congressional approval for the bail-out itself, the Bush administration will also need permission to bump up the ceiling on the federal debt by as much as 50%. The national debt is already so large that at the current rate of spending we will not be able to pay even the interest portion on it by 2050, and at that point it will actually exceed our gross national product.
So how can we possibly bump it up 50%? As the title of this website points out, I’m an amateur economist, so maybe I am missing something here, but didn’t we just borrow a load of money from China so we could send out economic stimulus checks that were refunds on the taxes most of us paid last year? We borrowed that money, the money for our tax refunds, so again, I have to ask, where is this money for these bail-outs coming from? Are we just going to print some more up?
I have looked all through my bank accounts and I confess, I can’t pick up even a few pennies of Fannie Mae and Freddie Mac’s problems, and it gets worse every day here in Michigan, where I live, where the unemployment rate is over 10% and growing and gas is currently about $4.30 a gallon.
I don’t even know how we are going to pay for fuel oil this winter. I ordered it early, hoping to head off whatever ungodly price will be charged come September or October, but so many people had the same idea that the oil company still hasn’t delivered it. They can’t keep up with the phone calls let alone the oil deliveries in the dead heat of summer, and now I hear all of us red-blooded, can-do types are going to bail out the fat cats at Fannie Mae and Freddie Mac too.
Wow, talk about piling on the pressure.
After 9/11, the President urged the American people to go shopping and go on vacation as if nothing had happened; to spend money and keep spending, or the terrorists win. So people did that. We spent money. We spent money we didn’t have. We spent money that didn’t exist in any universe, not even in the alternate Bizzaro Universe at Bear Stearns. Now, having spent up all the money, we are supposed to come up with some more money to help out giant lending institutions.
Like I said, I’m still waiting on my fuel oil: I’m a little light in the wallet this week.
Talking heads universally agree that the federal government almost has to bail out these giant institutions or risk destabilizing not just U.S. markets but the markets of the entire world. And yet, as we lurch from one economic disaster to the next in this country, each one bigger and scarier than the last one, we are bleeding credibility. Does anyone seriously think that anybody is at the wheel anymore? I don’t think so. And as that sinks in, things will begin to fall apart in a very big way.
OPEC is about a hair away from changing over to euros instead of dollars because of our instability and waffling, and once that happens, the dollar will fall harder than a fruitcake on December 26th.
Here are a few other implications of the “solution” to the latest catastrophe on Wall Street:
More Bank Failures. The FDIC is out reassuring the world that just because it shut down IndyMac Bank Saturday and just because it expects up to 150 more bank failures in the coming year, this is really nothing to be concerned about since during the savings and loan fiasco in 1994 its list of troubled institutions topped 575. In 1994 I made quite a bit more money than I do now, and so did most of the people who work for a living in the U.S. Not a good way to make me feel better, FDIC, try again.
Loss of Confidence in the U.S. We are living on borrowed money, literally. We borrow from China and Japan and the Mideast just to pay the basic costs of running our government. So far, these countries continue to loan us money because we are a major market for their products. But as we continue to not manage our own finances in any kind of sane or coherent way, they will begin to rethink their lending. No law exists that says they have to keep lending us cash. In fact, as developing nations buy more and more of their own products (as in China, where a consumer middle class is now emerging), these nations will have less and less reason to lend to us.
Higher Mortgage Rates. It is going to get more expensive and more difficult now to get a mortgage anywhere in the U.S., and it will be nearly impossible in some places. This will only make the housing crisis worse, which will only terrify Wall Street even more.
More Assets Sold. On the other hand, our current situation makes commercial real estate in the U.S a fabulous bargain for overseas investors. As more U.S. corporations resort to selling off their assets to raise cash, this will result in more cash flowing out of the U.S. and into the already deep pockets of foreign bargain hunters.
Violence. Seriously, at some point it will get ugly here. Working people in the U.S. are already stretched to the limit, and more and more people are not working. In a city close to where I live, a bicyclist was recently stopped by a motorist who was frustrated with having to suddenly share the road with so many non-motorized vehicles. The motorist beat the bicyclist within an inch of his life. Biking accidents that involve bikes being struck by cars are up 80% in some parts of the state this year alone.
When my kids were little, they used to complain about having to clean up the kitchen when they didn’t make the mess. I’d point out to them that I spent the better part of most days cleaning up after them, and I was glad to do it; that part of being a family means you clean up after each other and you don’t gripe about it.
OK, but in this case, I guess I want to know, when are the big guys going to cut us little guys some slack? When do I get to borrow the family Mercedes?
When do I get my multi-million dollar golden parachute?
I’m not greedy. A single million would be plenty, that’s all I really want or need. Send it in care of www.amateureconomists.com. And Quatar? Stop calling me.
I don’t answer my phone anymore.
By Evelyn Black, on July 16th, 2008
The recent failure of IndyMac bank came after a week of constant reassurance from its corporate handlers that everything was fine, really, just fine. Then, on Monday, July 14, after a harrowing weekend spent scrambling for solutions to the Fannie Mae and Freddie Mac mess, George Bush went before press conference cameras to reassure the American people that everything is fine, really, just fine.
I don’t know about you, but my immediate response to that was, “Oh God, we’re all screwed!”
I did calm down though. (At least for now I did, check with me later this week and that may change.) All of that news footage of people lined up outside IndyMac to get their money helped me remember that, hey, we do have a bit of help here: the Federal Deposit Insurance Corporation, created after the Great Depression to prevent bank runs by insuring depositors’ money up to $100,000 per customer.
Can you really get your money back if your bank fails? What if you have more that 100K? What about your investments? How can you tell if your bank is on the list of 90 that may be in trouble this year? What follows are some basic precautionary measures you can take right now, along with information that may help:
Know Your FDIC insurance limits.
Deposits at retail banks include products like checking accounts, savings accounts, and CDs. You are insured through FDIC for up to $100,000 at each retail bank where you have these deposits. If you are married and your accounts are held jointly, you have $100,000 each, so you are actually covered for up to $200,000 on all of your jointly held deposits at one bank. IRA accounts are insured for up to $250,000, and that is in addition to the $100,000 each for ordinary deposits.
What if you have more than $100,000 on deposit? You can move anything in excess of that $100,000 to another financial institution, where you will get another $100,000 in FDIC coverage. Should you do this? Probably not, unless you are currently keeping that money in a shaky regional bank. Even then, you want to think twice about it, then think again. Don’t act out of fear. That’s what starts a bank run.
If you have more than the $100,000 limit on deposit and the bank is seized by FDIC, you will get a percentage of the amount over the limit if your bank is shut down. Right now at IndyMac the FDIC is projecting 50-75% refunded on everything over $100,000 depending on how much cash the bank can raise when assets are sold off. So, say you had $150,000 on deposit. You’ll get your $100,000 back no problem. On the $50,000 over the limit you’ll get between $25,00 and $38,000.
So if you have lots more than $100,000 in a single bank and that bank is a smallish regional bank, you may want to review your strategy. Keep in mind that most CDs carry a penalty for early withdrawal, so you will have to factor that into your decision.
Keep Some Cash On Hand.
I advise people to do this even in ordinary times. You never what will happen: a storm blows out the electricity for your city and you can’t get to your money for a day or two. An emergency arises such that even a trip to an ATM is too much wasted time. You never know. It doesn’t hurt to have a couple hundred tucked away at home, in a box in the freezer, under your mattress, anywhere you feel safe keeping it. Most homeowners insurance policies will cover up to $200 in cash if you experience a break-in, so I wouldn’t keep much over $200, but do keep some money at home. That way, whatever happens, you won’t panic, and you have some milk and gas money to carry you through.
Research Your Financial Institution.
I read the New York Times daily, but any paper that carries stock prices and financial information will do, and lots of information can be found online. Do a news search under your bank’s name and see what comes up. Compare your bank’s stock performance with the performance of comparable banks. Read the press releases sent out by the bank itself. They are usually listed right on the stock page under the description of the bank. Do you see any red flags?
Red flags include a rapid drop in stock prices since November of 2007, heavy investment in home equity lines and mortgages, recent CEO turnover, and press releases stating that everything is fine, just fine, and all rumors are false. Banks don’t issue press releases saying everything is fine unless something is wrong.
However, even if your money really is in one of the stressed regional banks, you should still think twice before pulling all of it and moving it somewhere else. The reason IndyMac failed as fast as it did was that people panicked and started to pull all their money all at once.
Most of the depositors will in fact get every penny of their money back in the event of a bank failure. Bank runs are self-fulfilling prophecies: A few people get scared, that spreads, and pretty soon it’s a not so wonderful life all over again. I personally work for a regional bank on the short list for big trouble, and I have all my money there. Am I going to pull it? No. How can I advise other customers to stay with us if I pull my own money out of fear? I can’t do it, and besides, I’m not very rich anyway.
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