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March 6 2007 (Reuters)
Fed chief says investments held by Fannie Mae and Freddie Mac should be 'anchored' to their affordable housing mission.
Large investment portfolios held by mortgage finance companies Fannie Mae and Freddie Mac may imperil the broader economy and should be "anchored" to their affordable housing mission, Federal Reserve Chairman Ben Bernanke said in a speech Tuesday.
Investments by Fannie and Freddie "should be anchored to a clear and well-defined public purpose," Bernanke said, adding: "An obvious and worthy candidate is the promotion of affordable housing."
Subprime woes: How far, how wide?
Fed officials have often argued that the combined $1.4 trillion investment portfolios held by government-sponsored enterprises, or GSEs, such as Fannie and Freddie, are so large and unwieldy that they present a systemic risk to the broader economy and so should be curtailed.
AntiSpin: Bernanke recently jumped on the GSE reform bandwagon. Okay, not exactly a bandwagon. A little red wagon–a rusty little red wagon–one that few in Wasington have the political appetite to ride in. No lasting group ever seems to collect in the wagon. Each new rider replaces the last, in rotation, much as at the GSEs themselves, which serve as political perk appointments for favored FIRE economy supporters. The position of GSE critic is not a career.
Emil W. Henry, Jr., Assistant Secretary for Financial Institutions at the U.S. Department of the Treasury gave the most eloquent warning back in June 26, 2006 when he made the following remarks at a Housing Policy Council of the Financial Services Roundtable.
There are times when certain words or phrases are used or overused to such an extent that they verge on losing their meaning. As anyone in the room today with teenage children understands, the impact of a parent's drumbeat of cautionary words, on any topic, can over time, diminish with repetition. As the public GSE reform discussion crescendos, I fear we may be at such a point with the phrase "systemic risk". If you have followed the arc of the GSE debate for the past few years then you will note that the terms "systemic risk" and "GSEs" are inextricable. However, such repetition could make the likelihood of a systemic event occurring seem more the stuff of intellectual musing than hard reality.
It is important to note that these types of concerns are not simply theoretical. Like the case of a single gunshot setting off an avalanche, there are times when even seemingly modest or localized events in particular financial markets can trigger adverse consequences of enormous proportions. One recent example of this type of event is global financial turmoil in 1998.
In August of 1998, Russia's external debt amounted to roughly $100 billion--a tiny fraction of global debt. And yet that event led to panic and volatility in financial markets that ultimately triggered the Long Term Capital Management (LTCM) implosion and a period of significant financial distress. LTCM pursued a convergence trading strategy. It established very large positions across many markets, many of which were essentially bets that liquidity, credit, and volatility spreads would return to more normal levels. Instead, spreads widened sharply in the financial turmoil following the Russian default and LTCM suffered losses greatly exceeding that predicted by conventional risk models. The LTCM crisis laid bare the dangers of excessive leverage and perhaps more importantly, put a white hot light on creditors' and counterparties' over-confidence in the "hedged" nature of that fund's portfolio and strategy.
If the Russian default could have such wide-reaching ramifications, you can understand why this Administration is so deeply concerned about the potential market repercussions of a deterioration in the financial conditions of a GSE, which collectively have more than $2 trillion of outstanding debt.
Risk #1: Sheer size of the GSEs' investment portfolio
Since 1990, the mortgage investment business of both of the housing GSEs has grown rapidly. From 1990 through 2003, Fannie Mae's mortgage investments increased from $114 billion to $902 billion. Freddie Mac's growth in mortgage investments was even more dramatic. From 1990 through 2003, Freddie Mac's mortgage investments increased from $22 billion to $660 billion. Today's combined GSEs' mortgage investment portfolios still total almost $1.5 trillion. By any standard, these are huge investment portfolios.
Risks #2: Lack of Market Discipline
To underscore [the] lack of discipline, imagine for just a moment if some of our most prominent complex financial institutions announced major accounting improprieties, significant restatements and serial failings and shortcomings in risk management and internal controls, and then further announced the cessation of annual reports and other standard disclosure materials. Does anyone in this room doubt the ferocity of "market discipline" that would sweep down upon these institutions in the form of higher borrowing costs for market-based funding and heightened counterparty scrutiny?
Risk #3: Level of interconnectivity between the GSEs' mortgage investment activities and the other key players in our Nation's financial system
As of December 31, 2005, commercial banks held $264 billion in GSE debt obligations (while not specifically broken out on call reports, given the relative size of the GSEs, the bulk of these obligations are likely those of Fannie Mae, Freddie Mac, and the FHLBanks). In comparison to bank tier-1 capital, GSE debt obligations exceeded 50 percent of capital for 54 percent of these commercial banks, and GSE debt obligations exceeded 100 percent of capital for 34 percent of these commercial banks. In addition, the GSEs' interest rate positions are highly concentrated and pose significant risks to a number of large financial institutions.
As with every other perverse side-show in the Frankenstein Economy freak show, we can expect the GSE mess to resolve itself in the usual politically expedient way–in crisis.It is important to note that these types of concerns are not simply theoretical. Like the case of a single gunshot setting off an avalanche, there are times when even seemingly modest or localized events in particular financial markets can trigger adverse consequences of enormous proportions. One recent example of this type of event is global financial turmoil in 1998.
In August of 1998, Russia's external debt amounted to roughly $100 billion--a tiny fraction of global debt. And yet that event led to panic and volatility in financial markets that ultimately triggered the Long Term Capital Management (LTCM) implosion and a period of significant financial distress. LTCM pursued a convergence trading strategy. It established very large positions across many markets, many of which were essentially bets that liquidity, credit, and volatility spreads would return to more normal levels. Instead, spreads widened sharply in the financial turmoil following the Russian default and LTCM suffered losses greatly exceeding that predicted by conventional risk models. The LTCM crisis laid bare the dangers of excessive leverage and perhaps more importantly, put a white hot light on creditors' and counterparties' over-confidence in the "hedged" nature of that fund's portfolio and strategy.
If the Russian default could have such wide-reaching ramifications, you can understand why this Administration is so deeply concerned about the potential market repercussions of a deterioration in the financial conditions of a GSE, which collectively have more than $2 trillion of outstanding debt.
Risk #1: Sheer size of the GSEs' investment portfolio
Since 1990, the mortgage investment business of both of the housing GSEs has grown rapidly. From 1990 through 2003, Fannie Mae's mortgage investments increased from $114 billion to $902 billion. Freddie Mac's growth in mortgage investments was even more dramatic. From 1990 through 2003, Freddie Mac's mortgage investments increased from $22 billion to $660 billion. Today's combined GSEs' mortgage investment portfolios still total almost $1.5 trillion. By any standard, these are huge investment portfolios.
Risks #2: Lack of Market Discipline
To underscore [the] lack of discipline, imagine for just a moment if some of our most prominent complex financial institutions announced major accounting improprieties, significant restatements and serial failings and shortcomings in risk management and internal controls, and then further announced the cessation of annual reports and other standard disclosure materials. Does anyone in this room doubt the ferocity of "market discipline" that would sweep down upon these institutions in the form of higher borrowing costs for market-based funding and heightened counterparty scrutiny?
Risk #3: Level of interconnectivity between the GSEs' mortgage investment activities and the other key players in our Nation's financial system
As of December 31, 2005, commercial banks held $264 billion in GSE debt obligations (while not specifically broken out on call reports, given the relative size of the GSEs, the bulk of these obligations are likely those of Fannie Mae, Freddie Mac, and the FHLBanks). In comparison to bank tier-1 capital, GSE debt obligations exceeded 50 percent of capital for 54 percent of these commercial banks, and GSE debt obligations exceeded 100 percent of capital for 34 percent of these commercial banks. In addition, the GSEs' interest rate positions are highly concentrated and pose significant risks to a number of large financial institutions.
We got more good macro news today. For example...
Factory Orders Dive Amid Broad Declines
March 6, 2007 (Martin Crutsinger - AP Economics Writer)
Orders to U.S. Factories Fall by Largest Amount in 6 1/2 Years in January
Orders to U.S. factories fell by the largest amount in 6 1/2 years in January, reflecting widespread declines across a number of industries.
The Commerce Department reported that total orders dropped by 5.6 percent in January, the biggest decline since July 2000, a period when the economy was slowing sharply in advance of an actual recession which began in 2001.
The government said that orders for big-ticket durable goods plunged by 8.7 percent, even bigger than the 7.8 percent drop that had been reported a week ago. That report, which increased worries about the economy's health, played a role in the 416-point single-day drop in the Dow Jones industrial average a week ago.
The report on factory orders, coupled with other data showing weaker-than-expected activity, have raised concerns that the current economic slowdown may be more serious than previously expected.
Good news if you're a financial markets speculator, that is. The markets cheered the news, with the DOW and NASDAQ rising 1.3% and 1.9% respectively. This is the kind of evidence that the Fed needs to deliver the three juicy rate cuts that Goldman Sachs expects this year. March 6, 2007 (Martin Crutsinger - AP Economics Writer)
Orders to U.S. Factories Fall by Largest Amount in 6 1/2 Years in January
Orders to U.S. factories fell by the largest amount in 6 1/2 years in January, reflecting widespread declines across a number of industries.
The Commerce Department reported that total orders dropped by 5.6 percent in January, the biggest decline since July 2000, a period when the economy was slowing sharply in advance of an actual recession which began in 2001.
The government said that orders for big-ticket durable goods plunged by 8.7 percent, even bigger than the 7.8 percent drop that had been reported a week ago. That report, which increased worries about the economy's health, played a role in the 416-point single-day drop in the Dow Jones industrial average a week ago.
The report on factory orders, coupled with other data showing weaker-than-expected activity, have raised concerns that the current economic slowdown may be more serious than previously expected.
Still, the economic and market environment remains confused. We read variously that the economy is "recovering," "strong," "slowing," and "weaker than expected." There is little agreement on where we are in the current economic cycle. The confusion stems from the misguided attempt by economists to see the economy as an industrial/Keynesian economy versus a FIRE economy dominated by finance. An economy that runs on finance lives and dies on liquidity.
(Liquidity was the topic of Fed governor Kevin M. Warsh's speech yesterday, Market Liquidity: Definitions and Implications. It's a good refresher for those looking for "definitions," but the speech is light on the "implications," which are of the central banking motherhood and apple pie variety, "This attention to our dual mandate--to maintain stable prices and maximum sustainable employment--supports investor confidence in the economy and the considerable benefits conferred by liquidity.")
Keynesian Economics for Dummies says that when an economy is in recession, the government should step on the gas–boost the money supply and run fiscal deficits to stimulate demand and boost the economy until it is growing again. Then, as a second step–and this step is key–after the economy starts to grow again, the government needs to take its foot off the gas–cut the money supply and reduce deficits. But what if the government never really took its foot off the gas, and failed to take effective steps to reduce the money supply and deficit spending, because every time they try, the markets go haywire? What if the economy heads into another recession after the last round of stimuli produced an increase in unfunded government liabilities (Medicare, Social Security, and government pensions) from $20 trillion to $50 trillion in only six years? When a broad measure of the money supply which took over 200 years, from the inception of the USA until 1984, to grow to $1 trillion but only the past ten months to add another $1 trillion?
Looks like we'll find out soon enough.
We have gained another adherent to our 1999 Ka-Poom theory. Our favorite Telegraph UK editor Ambrose Evans-Pritchard reports in Goldman Sachs warns of 'dead bodies' after market turmoil:
"There has been an amazing amount of leverage on currency markets that has nothing to do with real economic activity. I think there are going to be dead bodies around when this is over," he said. "The yen carry trade has reached 5pc of Japan's GDP. This is enormous and highly risky, as we are now seeing."
"This is going to go on for longer because there has unquestionably been a global financial bubble. Eventually, central banks will reflate but it will have to get worse first."
By "it" we can assume he means the market correction presaging recession that that will allow central banks to cut rates later this year, as Goldman Sachs has predicted. Goldman appears to be planning a major Ka-Poom disinflation/inflation trade."This is going to go on for longer because there has unquestionably been a global financial bubble. Eventually, central banks will reflate but it will have to get worse first."
Maybe Goldman isn't warning of "dead bodies." Maybe Goldman's praying for them.
Bloggers Ka-Poom graph embed code:
HTML Code:
<object height="400" width="850"><embed src="http://www.itulip.com/video/kapoom.swf" type="application/x-shockwave-flash" wmode="transparent" height="400" width="850"></object>
Yet! Hint Hint!!!
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