Topic: Finance, Banking & Monetary Policy

The Coming FHA Bail-Out

The taxpayers continue to get hit for Uncle Sam’s profligate ways in guaranteeing and insuring loans to virtually anyone and everyone who wanted to buy a house.  The financial fall-out continues, and this time it isn’t Fannie Mae and Freddie Mac.  It is the Federal Housing Administration.

Reports the Wall Street Journal:

The Federal Housing Administration, hit by increasing mortgage-related losses, is in danger of seeing its reserves fall below the level demanded by Congress, according to government officials, in a development that could raise concerns about whether the agency needs a taxpayer bailout.

The rising losses at the FHA, part of the U.S. Department of Housing and Urban Development, come as the agency has rapidly increased its role in guaranteeing loans in an attempt to stabilize the housing market.

It isn’t clear how the rising losses may affect home buyers. Options for the agency could include politically unpalatable choices, such as asking for taxpayer funds to boost reserves or increasing the premiums borrowers pay for the insurance offered by the agency. Agency officials say if there is a shortfall, they don’t have to do anything except report it to lawmakers. But some mortgage and housing analysts see trouble ahead. “They’re probably going to need a bailout at some point because they’re making loans in a riskier environment,” says Edward Pinto, a mortgage-industry consultant and former chief credit officer at Fannie Mae. “…I’ve never seen an entity successfully outrun a situation like this.”

Oh well, it’s only money.  When you have a national debt of nearly $12 trillion, face another $10 trillion in red ink over the next decade, and have accumulated $107 trillion in unfunded liabilities for Medicare and Social Security alone, what’s a few billion dollars more?

What Is ‘Unreasonable’ Compensation? And Who Gets to Decide?

As could be expected, the effects of the financial crisis — and people’s reaction thereto — are starting to make their way to the least political branch of government, the judiciary.  The Supreme Court this term will be hearing several cases that could have serious repercussions on our economic recovery, one of which led us to file an amicus brief.  Here’s the situation:

The Investment Company Act of 1940 places on investment advisers a fiduciary duty with respect to the compensation they receive for the services they provide their clients. In the case of Jones v. Harris Associates, shareholders in various mutual funds contend that their adviser fees were excessive and violated the ICA. The Seventh Circuit, the federal appellate court based in Chicago, affirmed the judgment of the district court that the fees were not excessive but also expressly disapproved of the  methodology for evaluating such claims used by the Second Circuit (based in New York). Judge Frank Easterbrook’s opinion explains that the ICA creates a fiduciary duty but does not act as a rate regulator, and that judicial price-setting does not accompany fiduciary duties. Judge Richard Posner, writing for five judges, dissented from the denial of an en banc rehearing. The Supreme Court agreed to review the case to settle the circuit split.

Our brief supports the investment adviser and makes three arguments:

  1. All persons have a fundamental human right to whatever compensation their contracting partners freely and honestly choose to pay them.
  2. Courts have no power to second-guess the reasonableness of any salary or compensation agreement honestly and freely signed by both contracting parties.
  3. The ICA’s fiduciary duty requires only fair dealing, not any particular outcome.

Thanks to Cato adjunct scholar Tim Sandefur for spearheading this effort, and to Cato legal associate Matthew Aichele for helping with much of the attendant busywork.

One Regulator to Rule Them All

Part of the dominant narrative in Washington on the causes of the financial crisis is that competition among financial regulators allowed financial institutions to choose the weakest regulator, and also encouraged regulators to weaken their supervision and enforcement in order to attract more entities toward their charter.  Hence the response of several prominent Democrat congressional leaders and the Obama administration calling for an elimination of both the Office of Thrift Supervision (OTS) and the Office of the Comptroller of the Currency (OCC), and their merger into a single “super” bank regulator.

But is this narrative based on fact or analysis, or simply mere assertion?  Let’s start with a few counter-factuals: Fannie and Freddie could not choose their regulator, nor could Bear or Lehman.  The worst-performing U.S. institutions at the very center of the crisis had no choice in their regulator. 

And of course, this was not simply a U.S. crisis.  Northern Rock had no ability to choose its regulator.  The UK, like much of the world, does not have multiple bank supervisors, but only a single supervisor.  In fact, only three developed countries have multiple bank supervisors:  the United States, Germany and Liechtenstein.  If this was a crisis driven by competition among bank regulators, then most of the world would have been spared. 

What is the factual basis for merging the OTS and the OCC?  Apparently the proposal rests upon the observation that both AIG and Countrywide owned thrifts at the time of their failure.  In addition, the failure of thrift IndyMac was one of the largest bank failures to date.  Therefore, the OTS must have been the weak link.  However, both AIG and Countrywide acquired federally chartered thrifts late in the game; their failures were already “baked in the cake” long before they acquired thrifts.  And in both cases: 1) the thrifts were very small parts of their balance sheets, and 2) the failure of AIG and Countrywide did not result from their thrift subsidiary.  In relation to IndyMac, most of the entities regulated by the OTS specialize in mortgage finance, hence it should not be surprising that in the aftermath of a housing bubble, those engaging in mortgage finance fail at a greater rate.

Also it is worth remembering that prior to the savings and loan crisis, when there really was a significant difference between bank and thrift charters, thrifts could not choose to maintain their current business model and also flip charters. 

Since the case for merging regulators seems pretty weak, here’s an easy solution to address concerns regarding charter shopping:  require the FDIC to base deposit insurance premiums on the historical and expected losses by charter.

Housing Bailouts: Lessons Not Learned

The housing boom and bust that occurred earlier in this decade resulted from efforts by Fannie Mae and Freddie Mac — the government sponsored enterprises with implicit backing from taxpayers — to extend mortgage credit to high-risk borrowers. This lending did not impose appropriate conditions on borrower income and assets, and it included loans with minimal down payments. We know how that turned out.

Did U.S. policymakers learn their lessons from this debacle and stop subsidizing mortgage lending to risky borrowers? NO. Instead, the Federal Housing Authority lept into the breach:

The FHA insures private lenders against defaults on certain home mortgages, an inducement to make such loans. Insurance from the New Deal-era agency has enabled lending to buyers who can’t make a big down payment or who want to refinance but have little equity. Most private lenders have sharply curtailed credit to those borrowers.

In the past two years, the number of loans insured by the FHA has soared and its market share reached 23% in the second quarter, up from 2.7% in 2006, according to Inside Mortgage Finance. FHA-backed loans outstanding totaled $429 billion in fiscal 2008, a number projected to hit $627 billion this year.

And what is the result of this surge in FHA insurance?

The Federal Housing Administration, hit by increasing mortgage-related losses, is in danger of seeing its reserves fall below the level demanded by Congress, according to government officials, in a development that could raise concerns about whether the agency needs a taxpayer bailout.

This is madness. Repeat after me: TANSTAAFL (There ain’t no such thing as a free lunch).

C/P Libertarianism, from A to Z

AFL-CIO Wants to Tax Stock Trades…to Stop Speculation

Earlier this week, the AFL-CIO, building upon a suggestion made last week in the UK, proposed that the federal government impose a 1/10 of 1 percent tax of all stock trades.  The union group argues that such a tax would reduce non-productive speculative activity in the stock market.

First of all, we have all sorts of transfer taxes on housing, and yet we still had a housing bubble.  So much for small taxes stopping speculative activity.  If an investor expected to double his money, it seems quite a stretch to believe that such a small tax would discourage him.

More importantly, our recent financial crisis was not triggered by too much equity (like stocks) but by too much debt.  In taxing stock transactions, we only add to the already favorable treatment of debt compared to equity, encouraging even greater leverage in our financial system.

The real purpose of this tax on speculation becomes apparent when the AFL-CIO suggests what the money should be used for…building new infrastructure that would require the hiring of unionized workers.  The AFL-CIO should stop hiding behind the spin of stopping speculation and directly engage in the real debate:  the massive size of our federal government and the unsustainable fiscal path we are on.

Bailouts Make Money, If You Ignore Losses

Just when you think the headlines could not get any more absurd, the Wall Street Journal declares today that the “Bailouts Yield Returns Amid Risk.” while yesteday’s Financial Times lets us know that the Federal Reserve is turning a profit on its lending programs.

What is missing from these headlines is that while some loans and investments have provided a positive return to taxpayers, the overall programs themselves are estimated to cost the taxpayers hundreds of billions.  Overall the government has received about $30 billion in dividends, premiums for guarantees, and interest payments:  $7 billion in TARP dividends from banks, $14 billion for the Federal Reserve from purchases of mortgage-backed securities and other investments, and $9 from the FDIC’s bank debt guarantee program.

While $30 billion may sound like a substantial amount of money, it is less than a tenth of the $356 billion that the Congressional Budget Office tells us we will never see back from TARP.  And the Fed’s income from purchasing Fannie and Freddie securities will also amount to about a tenth of the ultimate losses we are likely to suffer from bailing out those entities.  In regard to the FDIC’s debt guarantee program, premiums are paid up front, making that look like income, while the guarantees will remain outstanding for several years.  Given that there is currently almost $340 billion in FDIC guaranteed bank debt outstanding, all it would take is a loss rate of 2.6% on that debt to wipe out any premiums collected so far.

Before Washington starts to spend all its newfound earnings, we should all stop and remember that these bailouts continue to leave the taxpayer in a pretty big hole.

When Governments Are Forced to Compete, the Result Is Better Policy and More Liberty

A story in USA Today is a perfect illustration of the liberalizing power of tax competition. In an effort to attract more jobs and investment, states are competing with each - even taking the aggressive step of advertising in high-tax states. This does not guarantee that states will always use the best approach since states sometimes try to lure companies with special handouts, but tax competition generally encourages states to lower tax rates and control fiscal and regulatory burdens. The same process works internationally, which is precisely why international bureaucracies controlled by high-tax nations are seeking to thwart fiscal competition between nations:

Las Vegas is running ads in California warning businesses they can “kiss their assets goodbye” if they stay in the Golden State. In New Hampshire, economic development officials pick up Massachusetts business owners at the border in a limousine and give them VIP treatment and a pitch about why they should relocate there. Indiana officials, using billboards at the borders and direct appeals to businesses in neighboring states, are inviting them to ‘Come on IN for lower taxes, business and housing costs.’ As states struggle to keep jobs in a continuing recession, they are no longer hoping businesses in other states happen to notice their lower taxes, cheaper office space and less-stringent regulations. They are taking the message directly to them and taking shots at their neighbor’s shortcomings. …No one does it more unapologetically than the Nevada Development Authority. The agency has picked on California before, but its $1 million campaign, launched this month, ratchets up the mockery of California’s budget deficits and IOU paychecks. ‘It’s all done tongue-in-cheek. But the underlying deal is, we want this business,’ Nevada Development Authority President and CEO Somer Hollingsworth said. …’They do mask the nastiness of their message with humor, but this time, their ads are over the top,’ said [California Assemblyman] Solorio, a Democrat from Santa Ana.