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Showing posts from August, 2008

The Future of Fannie and Freddie (in a nutshell)

I wrote about the destruction of Fannie Mae and Freddie Mac and the meaning of moral hazard. Right on cue came this statement from Jason Furman, the economic policy director for Obama campaign, in an interview with The Financial Times:

Mr. Furman indicated that Mr Obama could back further intervention to support Fannie and Freddie, but said “there must be no bail-out” of “shareholders or management”. Fannie and Freddie had a “problematic business model – heads they win, tails the taxpayer loses”. He said: “Any fix for their problems needs to be part of a longer term solution that revises that business model.”The 38-year old Mr. Furman is a protégé of Bob Rubin.

There you have it.

Know-nothings and the Current Systemic Crisis

Reporting from Jackson Hole, Wyoming, where the “leading banking policymakers” were concluding their annual meeting, The Financial Times wrote: More than a year into the credit crisis, the world’s top central bankers admit that they are still in the dark as to what its ultimate impact on the global economy will be.The governor of the Bank of Israel, presumably one of the world’s top central bankers, had this to say: “There is an enormous amount of uncertainty about where we stand at the moment”. A former deputy governor of the Bank of Japan, upped that and spoke of “exceptional uncertainty”.

So once again it was confirmed: the world’s top central bankers – and top fund managers and top regulators and top academics, in short all those who were top enough in finance to be invited to Jackson Hole – have absolutely no idea whatsoever as to what is taking place around them.

How do you proceed then, when you do not know where you are and what lies ahead? What guides you?

The answer, I suppose,…

The Meaning of Moral Hazard

The dictionary definition of moral hazard is “the possibility of loss to an insurance company arising from the character, habits or circumstances of the insured”. In the parlance of modern risk management, that is called reputation risk.

But being vacated by a modern equivalent has not meant the demise of moral hazard. On the contrary, the term has been usurped for use in an ideological war. Its new meaning is “the prospect that a party insulated from risk may behave differently from the way it would behave if it were fully exposed to risk”. This modern meaning is deceiving on two levels.

First, moral hazard always refers to the government rescue/bailout of a private business. So in bringing up moral hazard, it is the involvement of the government that is being criticized. In this way, the populace is conditioned to reject or, at least, grow distaste for, government “paternalism”. Needless to say, when the going gets tough, the government does what it has to do, moral hazard or not. Se…

Mission Accomplished: The Destruction of Fannie Mae and Freddie Mac (Epilogue)

The destruction of Fannie Mae and Freddie Mac is an example of the self-destructive tendency of speculative capital materialized in the actions of its blind agents. The agents are blind in the sense of being concerned only with facilitating the movement of speculative capital to and from arbitrage relations, no matter what the consequences. If the consequences are ever contemplated, they are shooed away like a fly.

Were we to magically turn into spirits, travel back in time to early 2001 and warn the members of Financial Services Forum by playing a tape of the events that unfolded, each one of them would echo Lady Macbeth who asked the spirits “to stop up the access and passage to remorse, that no compunctious visitings of nature shake my fell purpose”.

It is not a murderous resolve, however, but the instinct to go “with the flow” that would cause the financial executives to dismiss our warnings. The instinct is a practical one. It is a realization of the subjugation of the individual t…

Mission Accomplished: The Destruction of Fannie Mae and Freddie Mac (Part 2 of 2)

The lucrative business of Fannie Mae and Freddie Mac had attracted the attention of the private financial firms. They had created Structured Investment Vehicles (SIVs) that approximately mimicked the business model of the GSEs. The SIVs borrowed at the lower rates in the commercial paper market and purchased higher yielding assets, mostly mortgage-based CDOs. Between 1998 and 2001, the CDO assets of the SIVs more than doubled to $85 billion.

Rising home prices and low interest rates had kept the mortgage supply line going. Naturally, Fannie Mae and Freddie Mac also benefited from this market. Their balance sheets, too, expanded as they kept issuing bonds and purchasing mortgages.

But while the demand continued to grow, the supply began to flatten; even in a strong housing market there were only so many qualified buyers. “Qualified” is the key. Because Fannie and Freddie guaranteed the mortgages, they naturally wanted to limit their exposure to potential default. So they had put in place…

A Time For Goats To Be Had

A friend asked what I thought of the U.S. housing market, whether an end to the crisis was in sight.

Returning from the hunt, the Iranian king runs into a peasant.

‘Where from, peasant?’ the king inquires.

‘From the bazaar, Your Majesty. Had a house, sold it for a goat.’

‘You damn fool,’ the kind explodes. ‘You sold a house for a goat?’

‘I worry not,’ says the peasant. ‘If the reign of His Majesty continues, next year I will buy it back for a chicken.’