July 15, 2008
WHEN FUNDAMENTALIST RHETORIC MEETS POLICY REALITY:
Every Time I Try to Crawl Out, They Pull Me Back in! (Grasping Reality with Both Hands: The Semi-Daily Journal Economist Brad DeLong, 7/11/08)
The chance that American taxpayers will actually lose any money if Ben Bernanke and Henry Paulson decide that Fannie and Freddie need government support is very low:
* The interest payments they have coming in are greater than the interest payments they have going out.
* Their government guarantee is itself a very valuable asset that they have made a lot of money off of in the past and will make more off of in the future.
* They are not even in liquidity trouble--unless they begin to have problems rolling over their discount notes...
* As long as it is generally understood that they are too big to fail, they should not even have liquidity problems--absent a depression that bankrupts many currently-solvent homeowners, that is.
Nevertheless, there is now a risk that Fannie and Freddie will need some form of government support in the next month:
* The situation could require a lot of government-provided liquidity at any moment
* It and might even require more liquidity than the Federal Reserve can provide with its current balance sheet. Either the Fed needs to be given the power to pay interest on reserves immediately--so that it can swap interest-paying reserve deposits for mortgages next week--or this has to become not Fed but Treasury business.
The game the Fed and the Treasury are playing right now is as follows:
* Keep risky asset prices from collapsing...
* So that the flow of savings to finance construction and manufacturing expansion continues...
* So that employment declines in construction and supporting occupations are roughly balanced by employment expansions in export and import-competing manufacturing and supporting occupations...
* So that the economy does not fall into a depression deeper than that of 1982...
* In which case all bets are off
Supporting Fannie and Freddie may be something Ben Bernanke and Henry Paulson decide we need to do in order to win this keep-the-economy-near full employment game:
* They are not in the business of rescuing feckless financiers from bankruptcy.
* If their actions do have the consequence of rescuing some feckless financiers from bankruptcy, that is a side effect of their keeping the financial crisis from spilling over and destroying the jobs of millions of Americans.
* To have the government step back in order to teach feckless financiers a lesson is simply not worth destroying the jobs of millions of Americans.
* They are grownups with good judgment and as much experience in this business as anybody.
* They are backstopped by committee chairs--Chris Dodd and Barney Frank--of equally good judgment.
Bernanke and Paulson have asked for additional regulatory authority:
* They should get it.
* Fannie's and Freddie's troubles make it more and more clear that the financial-market deregulation agenda of the late 1990s that Phil Gramm spearheaded was a more serious mistake than almost of any of us realized back at the time...
* There are a bunch of options if push comes to shov:
o Having the government formally guarantee GSE debt.
o Having the government provide capital to the GSEs.
o Having the government guarantee GSE preferred.
o Putting the GSEs into "conservatorship."
* The moral-hazard worriers in the Treasury will probably favor the last--that option penalizes GSE shareholders in the same way that Bear Stearns and LTCM shareholders and principals were penalized. The cautious will favor the first option, as running the least risk of aggravating uncertainty.
The conservative case, that you should let such institutions fail in order to teach people a lesson about risk, is at obvious odds with the desire to get folks to accept such new institutions as privatized Social Security that are specifically designed to exploit greater risk-taking.
Nationalization: A Solution for Housing (Sebastian Mallaby, July 14, 2008, Washington Post)
ationalization is healthier than the other options.Posted by Orrin Judd at July 15, 2008 11:35 AM
Start with the fact that, despite loud official denials until last night, the government will have to inject money into the mortgage lenders. Intervention may be precipitated as early as today if Freddie has trouble with its plan to borrow $3 billion in the markets. Even if the lenders escape the bond market equivalent of a bank run, which is what destroyed Bear Stearns, they are likely to succumb to a variant that might be called an "equity run."
Investors know that Fannie and Freddie need to raise fresh capital, diluting existing shareholders. So they have been marking the shares down, which means that, to raise any given sum, Freddie and Fannie must sell an even greater percentage of themselves to new investors. The prospect of a larger dilution drives the stock down further, setting off a vicious cycle: Last week the firms' shares lost nearly half their value. The upshot: Fannie and Freddie can't raise the equity that everyone knows they need.
If public money is going to be injected, the question is how to provide it. For politicians squeamish about nationalization, the easiest course is to have the Fed lend to Fannie and Freddie. The Fed confirmed last night that it stood ready to act, and after all that has happened over the past year, the public would probably accept emergency Fed loans as part of the new normal. But in addition to bailing out private investors and undermining market discipline, a Fed rescue would put taxpayers on the hook with little to no compensatory upside.
If the government is going to risk taxpayers' cash, it should inflict punishment on private players and demand an equity-type payoff. So the issue is whether to become a minority shareholder or, at the other extreme, the sole one.
Paulson made clear last night that he favors a minority stake. But from a purely financial perspective, it would be better to buy the whole caboodle. If the government is going to supply a rescue, why share the upside? The worry about adding to the federal debt turns out to be a digression. Although Fannie and Freddie owe an astronomical amount, they are owed a roughly similar amount. The net effect of nationalization on the federal debt would be modest.