Topic: Finance, Banking & Monetary Policy

Dismal Jobs Report

The loss of 263,000 nonfarm jobs is another depressing economic statistic reinforcing the prospects of a jobless and joyless economic recovery. Job losses were widespread, but concentrated in construction, manufacturing, retail trade and government.

Employers want to fire, not hire.  The reasons for this lie in Washington, where lawmakers are busy piling on spending, taxes, and mandates.  From an employer’s perspective, each new hire is a liability.  The Obama administration’s economic recovery plan, which was centered on job creation, is now a manifest failure. The stimulus brew it concocted has proven to be an economic depressant.

In an op-ed in today’s Wall Street Journal, Meredith Whitney highlights another serious economic drag on the economy: a continuing credit crunch.  All the Obama Treasury and Fed lending programs have only served to direct credit to large companies, while small business — the engine of economic growth and job creation — has been starved of credit.  The Treasury and Fed have a corporatist economic model, in which the favored few are benefited at the expense of the many.  Their credit allocation policies have worked as a further drag on job creation.

Fixing Fannie Is Essential

This past week witnessed continued debate in congressional committees over changes to our financial regulatory system.  Perhaps catching the most attention was Fed Chairman Ben Bernanke’s appearance before House Financial Services. 

Sadly missing from all the noise this week was any discussion over reforming those entities at the center of the housing bubble and mortgage meltdown:  Fannie Mae and Freddie Mac.

While many, including Bernanke, have identified the “global savings glut” as a prime force behind the historically low interest rates that drove the housing bubble, often missed in this analysis is the critical role played by Fannie and Freddie as channels of that savings glut.  After all, the Chinese Central Bank was not plowing its reserves into Countrywide stock; it was putting hundreds of billions of its dollar reserves into Fannie and Freddie debt.  Fannie and Freddie were the vehicle that carried excess world savings into the United States.

Had this massive flow of global capital been invested in productive activities, or even just prime mortgages, it is unlikely tha we would have seen such a large housing bubble.  Instead, what did Fannie and Freddie do with its Chinese funds?  It invested those funds in the subprime mortgage market.  At the height of the bubble, Fannie and Freddie purchased over 40 percent of private-label subprime mortgage-backed securities.  Fannie and Freddie also used those funds to lower the underwriting standards of the “prime” whole mortgages it purchased, turning much of the Alt-A and subprime market into what looked to the world like prime mortgages.

Given the massive leverage (at one point Freddie was leveraged 200 to 1) and shoddy credit quality of mortgages on their books, why were the Chinese and other investors so willing to trust their money to Fannie and Freddie?  Because they were continually told by U.S. officials that their losses would be covered.  At the end of the day, Fannie and Freddie were not bailed out in order to save our housing market; they were bailed out in order to protect the Chinese Central Bank from taking any losses on its Fannie/Freddie investments.  Adding insult to injury is the fact that the Chinese accumulated these large dollar holdings in order to suppress the value of their currency, enabling Chinese products to be more competitive with American-made products.

While foreign investors have been willing to put considerable money into Wall Street, without the implied guarantees of Fannie and Freddie, trillions of dollars of global capital flows would not have been funneled into the U.S. subprime mortgage market.  As Washington seems intent on continuing to mortgage America’s future to the Chinese, that at minimum it seems that fixing Fannie and Freddie might help insure that something more productive is done with that borrowing.

Inflation Warning

In the last few days, we have witnessed an almost unprecedented chorus of warnings about inflation prospects by senior Fed officials. Dallas Fed President Richard Fisher said the Fed must be prepared to tighten monetary policy by raising short-term interest rates with “alacrity.” President Charles Plosser of Philadelphia had spoken of the need to raise interest rates before unemployment returns to normal in order “to prevent the Second Great Inflation.” The comments of the two Reserve Bank presidents reinforce those made by Fed Governor Kevin Warsh.

Financial markets are confused because the Fed’s policy-making committee (the Federal Open Market Committee) had just indicated its intention to keep interest rates low for an extended period. The inflation warnings represent an internal debate that has gone public. Formal dissents from the FOMCs policy directive have reportedly been discouraged. So Fed officials are in effect offering up virtual dissents in public speeches. Confidence in Chairman Bernanke’s policy is waning.

Most economic forecasters profess to see little inflation risk. They need to reconsider their forecasts in light of the inflation warnings from within the central bank.

Geithner Ignores Bailout History

Perhaps the biggest problem with the Obama plan to “reform” our financial system is the impact it would have on the market perception surrounding “too big to fail” institutions.  In identifying some companies as “too big to fail” holders of debt in those companies would assume that they would be made whole if those companies failed.  After all, that is what we did for the debt-holders in Fannie, Freddie, AIG, and Bear.  Both former Secretary Paulson and Geithner appear under the impression that moral hazard only applies to equity, despite debt constituting more than 90% of the capital structure of the typical financial firm.

Geithner believes he’s found a way to solve this problem - he’ll just tell everyone that there isn’t an implicit subsidy, and there won’t be a list of “too big to fail” companies.  Great, why didn’t I think of that.  After all, the constant refrain in Washington over the years that Fannie and Freddie weren’t getting an implicit subsidy really prepared the markets for their demise.

Even more bizarre is Geithner’s assertion that the government can force these institutions to hold higher capital, maintain more liquidity and be subjected to greater supervision, all without anyone knowing who exactly these companies are.  Does the Secretary truly believe that these companies’ securities disclosures won’t include the amount of capital they are holding?  Whether there is an official list or not is besides the question, market participants will be able to infer that list from publicly available information and the actions of regulators. 

One has to wonder whether Geithner spent any of his time at the NY Fed actually watching how markets work.  Before we continue down the path of financial reform, maybe it would be useful for our Treasury Secretary to take a few weeks off to study what got us into this mess.  We’ve already been down this road of denying implicit subsidies and then providing them after the fact. Maybe it’s time to try something different.

Taking Over Everything

“My critics say that I’m taking over every sector of the economy,” President Obama sighed to George Stephanopoulos during his Sunday media blitz.

Not every sector. Just

This president and his Ivy League advisers believe that they know how an economy should develop better than hundreds of millions of market participants spending their own money every day. That is what F. A. Hayek called the “fatal conceit,” the idea that smart people can design a real economy on the basis of their abstract ideas.

This is not quite socialism. In most of these cases, President Obama doesn’t propose to actually nationalize the means of production. (In the case of the automobile companies, he clearly did.) He just wants to use government money and government regulations to extend political control over all these sectors of the economy. And the more political control achieves, the more we can expect political favoritism, corruption, uneconomic decisions, and slower economic growth.

Robbing Peter to Pay Paul

The FDIC’s insurance fund, which it uses to pay off despositors in failed banks, is getting low. One way it can bolster its reserves is to draw on a $100 billion line of credit from the Treasury. Instead, however,

Senior regulators say they are seriously considering a plan to have the nation’s healthy banks lend billions of dollars to rescue the insurance fund that protects bank depositors. That would enable the fund, which is rapidly running out of money because of a wave of bank failures, to continue to rescue the sickest banks.

A brilliant scheme to avoid another taxpayer bailout? Not really.

The banks are willing to lend because the FDIC will pay them a good interest rate. Repayment is virtually guaranteed because the FDIC can always draw on its line of credit. Thus the banks are getting a better deal than they would in the marketplace (that’s why they are doing this), so the scheme is a backdoor way of further bailing out the banks.

Why go through this charade? Apparently, using the Treasury credit line

is said to be unpalatable to Sheila C. Bair, the agency chairwoman whose relations with the Treasury secretary, Timothy F. Geithner, have been strained.

“Sheila Bair would take bamboo shoots under her nails before going to Tim Geithner and the Treasury for help,” said Camden R. Fine, president of the Independent Community Bankers. “She’d do just about anything before going there.”

Instead, the FDIC will con the taxpayers. The FDIC has no choice under existing policy, of course, but to pay off depositors of failing banks. They should just be honest about how who is paying for it.

C/P Libertarianism from A to Z

FDIC Plan to Borrow from Banks Just Back-door Way of Putting the Taxpayer on the Hook

With the declining balance of the Federal Deposit Insurance Fund, and more bank failures likely in the days ahead, the FDIC is looking for novel ways to avoid borrowing from Treasury to cover its expected shortfalls.  One proposal being floated is to have the FDIC borrow from healthy banks to cover the costs of bank failures.  Without borrowing from either the Treasury or the banks, FDIC would likely have to raise insurance premiums on all insured banks.

While the scheme is imaginative, it is in reality no different than borrowing from the Treasury.  Banks, in exchange for a loan, would receive a government bond.  Does anyone doubt that these bonds would not simply be backed by the FDIC, but also backed by the Treasury?  In effect the plan is no different than FDIC borrowing from the Treasury and the Treasury selling bonds to the banks to cover the FDIC’s borrowing. Why the FDIC and Treasury would prefer a direct FDIC borrowing from banks is that it hides the real cost of the borrowing from the American taxpayer.

If we are going to continue to put the taxpayer on the hook for the behavior of the banks, let’s at least be honest about it.