Trepidation
Over thirty years ago, when I taught at Dunwoodie, the Seminary of the Archdiocese of New York, there was a student who had a perpetually furrowed brow. His favorite expression was: “As if we didn’t have enough trouble, now this!”
Well, the prospects facing us when moon day’s markets open is enough to furrow the brow of the most intrepid.
Here’s an excerpt from the editorial in Saturday’s Wall Street Journal:
[S]peaking of ugly, yesterday’s markets showed one more nasty side effect of the Fannie Mae panic: fear of rising inflation. Gold popped by $23 an ounce, and at $965 is back at the heights it reached during the March run on Bear Stearns. Oil also bounced up as the dollar fell, a sign that investors think the Fed will react to the Fannie fears by delaying any monetary tightening even longer than it already has.
If there’s any other good news in all this, it is that the scandal of Fannie and Freddie is at last coming into public focus. The Washington political class has nurtured and subsidized these financial beasts for decades in return for their campaign cash and lobbying support. Wall Street and the homebuilders also cashed in on the subsidized business, and also paid back Congress in cash and carry.
The losers have been the taxpayers, who will now have to pay the price for this collusion. Maybe the press corps will even start reporting how this vast confidence game could happen.
And the New York Times (or at least its columnists) are, for a change, on the same page. In today’s Times there’s Gretchen Morgenson:
IT’S dispiriting indeed to watch the United States financial system, supposedly the envy of the world, being taken to its knees. But that’s the show we’re watching, brought to you by somnambulant regulators, greedy bank executives and incompetent corporate directors…..
It wasn’t as if this problem came out of left field. Fears that Fannie and Freddie were getting too big have been a recurring theme in recent years. And Congress has had ample opportunity to create a new regulator that would be vigilant about ensuring the safety and soundness of both companies.
But even after both companies were found to have accounted for their results improperly, Freddie Mac in 2003 and Fannie Mae in 2004, Congress failed to act. As a result, Fannie and Freddie were allowed to become high-growth companies and stock market darlings.
“These companies would have been fine had they been forced to be the cyclical utilities they were intended to be,” said Josh Rosner, an analyst at Graham-Fisher, an independent research firm in New York. “They would be healthy and able to help the markets in this time of illiquidity.”
Instead, they are in trouble and their woes are infecting the entire stock market….
“The real outrage is that none of this had to happen,” said William A. Fleckenstein, co-author of “Greenspan’s Bubbles: The Age of Ignorance at the Federal Reserve” and president of Fleckenstein Capital in Issaquah, Wash. “We did not have to ruin the financial system and ruin the financial lives of a huge chunk of the middle class in the United States.”
“It is crystal clear that the Fed not only made mistakes, they had the pompoms out, cheering for deregulation,” he adds. “Until people recognize why we are in this mess, I don’t see how we get out of this thing.”
A week ago, Bridgewater Associates, a research firm, estimated that losses from the credit crisis we’re now mired in might amount to $1.6 trillion when all is said and done.
We’ll have to wait years to see if this is accurate. But whatever the number is, it will also represent, in stunning red ink, the cost to society of financiers who are shortsighted and greedy and regulators who don’t regulate.
Of course, Fanny and Freddie meant gravy for our fearless political class, as another Times article makes clear:
The dominant role Fannie and Freddie play today is no accident. The companies, Wall Street firms, mortgage bankers, real estate agents and Washington lawmakers have built up an unusual and mutually beneficial co-dependency, helped along by robust lobbying efforts and campaign contributions.
In Washington, Fannie and Freddie’s sprawling lobbying machine hired family and friends of politicians in their efforts to quickly sideline any regulations that might slow their growth or invite greater oversight of their business practices. Indeed, their rapid expansion was, at least in part, the result of such artful lobbying over the years.
And as Fannie and Freddie grew, so did the fortunes of Wall Street, which reaped rich fees from issuing debt for the two companies, as well as the mortgage and housing industries, which banked billions of dollars as the housing market boomed.
Even after accounting scandals arose at the two companies a few years ago, attempts to push through stronger oversight were stymied because few politicians, particularly Democrats, wanted to be perceived as hindering the American dream of homeownership for the masses.
Lots of perks came with Fannie and Freddie’s charters and government backing: exemptions from state and federal taxes, relatively meager capital requirements, and an ability to borrow money at rock-bottom rates.
James A. Johnson, a longtime member of the Washington establishment who previously worked as a campaign adviser to former Vice President Walter F. Mondale, ran Fannie for most of the 1990s.
“Jim Johnson was the architect of Fannie’s lobbying strategy. He was the muscle guy, if you will. The guy who would walk the halls of Congress,” said Bert Ely, a banking consultant in Arlington, Va., and longtime critic of the companies. Freddie, Mr. Ely said, soon copied Fannie’s playbook.
Naturally, as happened at Dunwoodie after Compline, magnum silentium descends. The Times reports:
Mr. Johnson could not be reached for comment. Fannie declined to comment; Freddie did not respond to an interview request.
Bur what would Phil Gramm say?
E. J. Dionne’s article “Capitalism’s Reality Check” gets into a deep-rooted problem in current American capitalism which invited this disaster to happen: the unregulated banking and real estate industries were allowed to pocket the money paid by the buyers, but those sellers assumed no risk — they sold the mortages to other unregulated companies. For the banks and real estate companies it was pure gravy. So they sold to unqualified buyers.
Maybe the seven deadly sins should be taught in the schools, including especially greed.
The Dionne article is at:
http://www.washingtonpost.com/wp-dyn/content/article/2008/07/10/AR2008071002264.html?referrer=emailarticle
The United States has a 19th century financial regulatory structure that is woefully in adequate to deal with the realities of 21st century financial markets. We have over 115 state and federal regulators who each regulate a slice of the financial services market, which includes banking, securities, futures, pensions, and insurance. For the past two decades, other nations including our major competitors (UK, Germany, Japan) have been consolidating and modernizing their financial regulatory structures to deal with the growth of financial conglomerates and hybrid financial products. The United States needs to do the same. The Treasury Blueprint is one vision of how this could be done. Alternatively, we could create a single financial services regulator as the UK, Germany, and Japan have done. I discussed this option at lenght in an article back in 2005, which is available on the Social Science Research Network at: http://ssrn.com/abstract=757010
A single financial regulator has a significant advantage over our current system: Accountability. If a market failure occurs in the financial markets because of inadequate regulation, it is clear who is responsible. In the UK, when Northern Rock Bank failed, Parliament held hearings and held the UK Financial Service Authority officials accountable. They have already taken steps to prevent similar failures in the future. In the U.S., we dither as agencies argue which of them is most responsible for the mess that we are in and what should be done about it.
From Ellizabeth Brown’s abstract: ” The current U.S. financial regulatory regime suffers from a range of problems, including an inability to anticipate and plan for future financial crises . . . and the capture of agencies focused on a single sector of the financial services industry by the firms that they regulate.”
Wow, Ms. Brown! You are indeed a prophet. Are other economists starting to get at the fundamental problems with the whole system? At least Bernanke sees that reform is needed in the financial markets. But how deep will his reforms go?
I pretend to no special expertise on the matter, but clearly we are all affected by the melt-down. Reading E.J. Dionne’s piece what struck me was the absence of mention of Congress’s complicity in the matter, Congressman Frank not withstanding.
Perhaps Elizabeth Brown could offer further perspective.
But really? Just as in the Savings and Loan debacle in the 80′s, the stock market bust in the 90′s and the banks, Again now, we saw it coming but greed kept it alive. It is not the regulations that are lacking it is leadership and the courage to enforce the laws.
Forgive me for questioning the incipient prevailing wisdom here, but thus far, I’d have to say, ‘What’s the big deal’?
I’d welcome testimony from anyone in the forum on how the travails of Fannie and Freddie have affected them personally in any material way.
This story in the NY Times suggests that the losers so far are the investors in the two organizations.
http://www.nytimes.com/2008/07/12/business/smallbusiness/12money.html?_r=1&th&emc=th&oref=slogin
Of course it’s a shame when people lose money in investments, but unfortunately that is the nature of investing – sometimes the market goes down.
It’s the combination of private investors and government guarantees for Fannie and Freddie that should give us pause – istm that is a recipe to shield investors and managers from the consequences of imprudent or corrupt decisions. Cf your local electric or gas company.
Jim–
I’m no expert on Fannie and Freddie, but they do have an important role in the U.S. economy that could affect each of us if they falter. There was a story today on NPR about how the fingerprints of Fannie and Freddie, as secondary mortgage market institutions, are on more than 50% (I forget the exact number that was cited) of the mortgages in the U.S., often unbeknowst to homeowners. While there might not be a direct connection between a homeowner and Fannie/Freddie, there are direct connections between these institutions and the lenders that homeowners deal with for mortgages. Without Fannie and Freddie in full operation, as buyers of the mortgages negotiated by the lenders, the cash flow to lenders for creating more mortgages would dry up significantly, and there would be less money available for lenders to lend to homeowners. Less mortgage money would result in decreased home ownership. Fannie and Freddie also play another significant role. They issue bonds on the mortgages they hold, and those bonds trade as securities on the open market. The insolvency, real or perceived, of Fannie and Freddie would have many negative effects on both the securities markets and the housing markets.
In addition, though Fannie and Freddie were federally-created and are federally-chartered, they are now stock corporations. Still, many people perceive the two entities as having at least the implicit financial backing of the U.S. Government. You may have heard the expression over the last several days that Fannie and Freddie are “too big to allow them to fail.” There are trillions of dollars at risk if they fail, and that is why Bush has been hinting at a possible bail out, which, as you can imagine, would cost U.S. taxpayers hundreds of billions of dollars.
I’m not so sure a bail out will be necessary, but both Fannie and Freddie have significant problems, as the articles excerpted by Fr. Imbelli reveal. There seems to be plenty of blame to spread around for the financial condition the two institutions are in at the present time.
Hi, William,
It’s true that the consequences could be dire, if either or both fail, or if the federal government is forced to assume direct responsiibility. At the very least, we’d be looking at a weaker dollar, a bear stock market, and a severe credit crunch in the short term for houses. And it could be much more serious than that – it could be the leak in the dike that leads to worldwide financial turmoil.
What prompted my dissenting view was the tone I was sensing in some of these links and comments here that somehow capitalism or the fee market is responsible for the problem. In fact, to the extent that FM squared made foolish decisions about absorb risky loans, most likely it was done with the knowledge that the Federal Government would bail them out of whatever hole they dug for themselves. Kind of like rich kids off at school, on a bender but knowing that dad would always be there in the end to post bail and settle the liquor store tab.
What these two orgs do for the mortgage industry is indispensible, but it’s not the only possible model. There are ways to offload risk that don’t involve the Federal government’s implied or explicit guarantee.
At any rate, nothing too terrible has happened (yet). It’s quite possible that these seas will subside without any more ships sinking.