An unknown Wall Streeter says that Treasury Secretary Geithner and the Obama economic team are the Emperor with no clothes… if this guy is saying it… everyone is saying it…
From Bloomberg… Doug Dachille, chief executive officer of First Principles Capital Management LLC, talks with Pimm Fox about the U.S. government’s decision to provide additional aid to GMAC Inc., Fannie Mae and Freddie Mac. Dachille also discusses the Build America Bonds program.
Mr. Dachille says…
“We’ve stuffed all the problems in the closet… we haven’t solved the problems… we’ve papered them over at this point…
The Treasury Secretary said this about the challenges to our national economic and finanical system… in an interview from Slate…
“GROSS: There have been, and continue to be, calls for you to go. How do you deal with those?
GEITHNER: I spent most of my professional life in this building. Watching the politics of the things we did in the past financial crises in Mexico and Asia had a powerful effect on me. The surveys were 9-to-1 against almost everything that helped contain the damage. And I watched exceptionally capable people just get killed in the court of public opinion as they defended those policies on the Hill. This is a necessary part of the office, certainly in financial crises. I think this really says something important about the president, not about me. The test is whether you have people willing to do the things that are deeply unpopular, deeply hard to understand, knowing that they’re necessary to do and better than the alternatives. We’ll be judged on how we dealt with the things that were broken in the country. We broke the back of the worst financial panic in three generations, more effectively and at a much lower cost than I think anybody thought was possible.
I guess history will decide which of these two gentlemen called it right… but I imagine that history will judge that the Mexican and Asian crisis established the principle of “global moral hazard”… it was these bailouts engineered by Robert Rubin and others that convinced global hot money that no sovereign default would create too severe a haircut… that some consortium of nations would guarantee bondholders…
Well… who will bail out US Treasury holders when the time comes?
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Lessons of the Mexican financial crisis from the Cato Institute…
Regulatory Failures, Credit Growth, and the Onset of the Crisis
The financial sector also underwent a substantial liberalization, which, when combined with other factors, encouraged an increase in the supply of credit of such magnitude and speed that it overwhelmed weak supervisors, the scant capital of some banks, and even borrowers.[1]
Several factors contributed to facilitate the abundance of credit: (1) improved economic expectations; (2) a substantial reduction in the public debt;[2] (3) a phenomenal international availability of securitized debt (see Hale 1995);(4) a boom in real estate and in the stock market; and (5) a strong private-investment response.
Poor borrower screening, credit-volume excesses, and the slowdown of economic growth in 1993 turned the debt of many into an excessive burden. Nonperforming loans started to increase rapidly. A process of adjustment of the balance-sheet position of the private sector, underway by the second half of 1993, and the late adoption by some commercial banks of prudent policies were signs that nonperforming loans had exceeded reasonable dimensions before 1994.[3]
The substantive causes of the debt increase were:[4]
1. The financial sector was liberalized: lending and borrowing rates were freed, the forced channeling of credit was abolished, and bank reserve requirements were eliminated.
2. Banks were hastily privatized, in some instances with no due respect to “fit and proper” criteria, either in the selection of new shareholders or top officers (see Honohan 1997: 13, and Ort z 1997). It must be noted, however, that on average the banks remained in government hands for half of the expansionary period.
3. Several banks were purchased without their owners proceeding to their proper capitalization. Shareholders often leveraged their stock acquisitions, sometimes with loans provided by the very banks bought out or from other reciprocally collaborating institutions.
4. The expropriation of the commercial banks in 1982 contributed to their loss of a substantial amount of human capital during the years in which they were under the government. With these officials institutional memory migrated as well.
5. Moral hazard was increased by the unlimited backing of bank liabilities.
6. There were no capitalization rules based on market risk. This encouraged asset-liability mismatches that in turn led to a highly liquid liability structure.
7. Banking supervision capacity was weak to begin with, and it became overwhelmed by the great increase in the portfolios of banks. Part of this weakness originated in the political stature of government-appointed CEOs when banks were still government owned.
8. There was a substantial expansion of credit from the development banks.
9. From December 1990 on, foreigners were allowed to purchase “domestic” (short-term) government debt. Since domestic public debt decreased during this period, the purchases of Cetes by foreigners enhanced the purchasing power of their domestic sellers.
10. Short-term, dollar-indexed, peso-denominated Mexican government securities, Tesobonos, were issued at the end of 1991, although not in large amounts except during certain periods.
These experiences are not unique to Mexico. As Lindgren et al. (1996: 100) point out, “Formerly regulated banks may lack the necessary credit evaluation skills to use newly available resources effectively.”[5] And they concluded: ``Unless properly overseen, liberalization can result in too rapid growth of bank assets, over-indebtedness and price-asset bubbles” (p. 107).
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Recovering global economy still scarred by crisis
December 31, 2009 – 10:12AM
The global economy that was headed for an abyss at the start of 2009 now appears in recovery, but remains fragile and scarred by the worst crisis in decades.
The year began with major economies on the brink of disaster in what turned into the steepest global slump since the Great Depression, before a modest second-half comeback in most of the world.
US gross domestic product (GDP) sank at a horrific 6.4 annual per cent pace in the first quarter, dragged down by a housing market collapse that hammered the financial sector and the rest of the economy. Jobs were being lost at pace of 700,000 per month.
The eurozone saw a 2.5 per cent GDP slide – a potential 10 per cent annualised drop – in the first quarter that was the worst on record and offered the prospect of economic meltdown. Japan’s economy was falling at an a 14.2 per cent rate.
“The world economy is facing a deep recession,” the International Monetary Fund warned in January.
A study by economists at the University of California and Trinity College of Dublin found that world trade fell faster and stock markets plunged further in the first year of this crisis than in 1929-30, and that the decline in manufacturing was as severe as the start of the Great Depression.
“At the same time, the response of monetary and fiscal policies, not just in the United States but globally, was quicker and stronger this time,” the economists wrote.
Governments launched stimulus programs of hundreds of billions of dollars, and central banks cuts rates to record lows – near zero in the United States and Japan – while pumping trillions into the banking system to help restore credit flows.
Slowly, the efforts seem to have borne fruit. The main economies are growing, even if the pace is less than spectacular.
“To date, the results are mixed,” C. Fred Bergsten, director of the Washington-based Peterson Institute for International Economics, said in a recent speech.
Bergsten said the interventions “appear to have arrested the precipitous downward slide and, in most cases, restored at least some positive momentum.”
Nariman Behravesh, chief economist at research firm IHS Global Insight, says central banks led by the Federal Reserve deserve credit for “unorthodox monetary policy” including so-called quantitative easing, or pumping more money into the financial system, averting a global depression.
“The difference between now and the Great Depression was that in the 1930s, the Fed allowed the money supply to shrink and wasn’t aggressive enough,” Behravesh said.
The US economy expanded at a 2.8 per cent pace in the third quarter after four quarters of contraction. Japan grew at a more moderate 1.3 per cent pace in July-September, based on the latest revision.
The 16-nation eurozone saw 0.4 per cent growth over the quarter, a sluggish annual pace, after five quarters of contraction.
China, which saw a slowdown but avoided recession, had third-quarter growth accelerating to 8.9 per cent in an expansion built on stimulus cash and bank lending.
Globally, the IMF projected in October that growth would be 3.1 per cent in 2010, after an estimated 1.1 per cent global contraction, the worst since World War II.
Morgan Stanley economist Joachim Fels and associates project 4.0 per cent global growth for 2010, but just 2.0 per cent in the advanced economies of the Group of 10.
Fels said the economies will see “creditless recoveries” where banks are reluctant to lend and predicted “a jobless G10 recovery” with unemployment still high in the US, Europe and Japan.
Behravesh said economies are still seeing a “hangover” from a series of bubbles.
“It wasn’t just housing.” he said. “It was an equity bubble in China and commodity bubbles. Many bubbles were inflated, and when they burst, it left a hangover. The Dubai (debt) problem is a hangover from an oil bubble.”
Others argue that the global economic problems, instead of being solved, have been shifted in government rescues, with the exit strategy unclear.
“Toxic assets have basically been swept under the rug,” says David Rosenberg, chief economist at Gluskin Sheff & Associates in Toronto.
“Whatever bad assets have been resolved have almost entirely been placed on the books of governments and central banks, which now have their own particular set of risks, as we have witnessed very recently in places like Dubai, Mexico, Spain, Greece, UK, the Baltic states, not to mention at the state and local government level in the United States.”
AFP
From Credit Writedowns…
The dust has settled a bit on the Treasury’s recent decision to give Fannie Mae and Freddie Mac a green light to nationalize our mortgage problem. Calculated Risk says the move was not necessarily done on Christmas Eve to escape notice. And it was not done to socialize future losses via Fannie and Freddie. It is just a precautionary move to make sure the economic policies already enacted stick in case of a “low probability event.” Calculated Risk feels this the decision is a “nothingburger.”
I take a more negative view. I see Fannie Mae and Freddie Mac as a means of manipulating interest rates and distorting the allocation of resources and funneling precious capital investment into a housing sector which suffers a dreadful amount of overcapacity. This is bubble economics pure and simple and it will fail spectacularly.
First of all, Fannie Mae and Freddie Mac were always ridiculously undercapitalized. This gave them a lot of phantom profits during the boom years as a result of leverage. However, when the bust occurred and they were nationalized, American taxpayers had hundreds of billions of dollars of losses foisted onto them – a perfect example of privatized gains and socialized losses aka kleptocracy.
So, Fannie and Freddie are now wards of the state – government agencies, if you will. Yet, incongruously, the heads of these government agencies may get $6 million salaries each. And none of the bonuses and stock option gains based on phantom profits of the last decade have been clawed back, now have they? Obviously, this is yet another example of crony capitalism in a bailout culture which enriches the well-connected at the expense of the middle class.
In my view, these agencies have always served a dubious purpose and should be wound down and eliminated entirely. Arnold Kling says it well:
Since August of 2008, I have advocated winding down Freddie and Fannie. Any other policy courts mischief.
For years, U.S. housing policy was to encourage the use of mortgage credit to the maximum extent by as many people as possible. We see the results. The new policy is to encourage as many people to stay in homes that they should not have bought in the first place for as long as possible. The result of this new policy, as I have predicted from its onset, is to perpetuate the crisis.
The significance of the unlimited backing of Freddie Mac and Fannie Mae is that it represents the unwillingness of policymakers to back away either from subsidizing mortgage credit or from trying to keep the wrong people in the wrong housing units with the wrong ownership arrangement. Instead, if they were to let the market work, those who cannot afford their mortgages but who could afford the rent would become renters, and those who cannot afford the rent would move out and rent elsewhere. Again, as a taxpayer I would gladly pay moving expenses for these people rather than pay to keep them in their homes as “owners.”
Let’s put aside arguments over the alleged burying of news on Christmas Eve and the alleged expectation of future losses to be socialized. Almost nine of ten mortgages are now underwritten by Fannie Mae and Freddie Mac. Leaving this aside, the mortgage moves by Freddie and Fannie is obviously part of an orchestrated campaign to reduce long-term mortgage interest rates. The Federal Reserve itself has bought $1.25 trillion of mortgage-backed securities. Federal Reserve officials openly admit this. Witness recent comments by NY Fed EVP Brian Sack:
It is important to recognize that the LSAP programs differ from the Fed’s liquidity policies in terms of their policy intent. The LSAPs were not aimed at supplying liquidity to financial institutions or at reducing systemic risk. Instead, they were intended to support economic activity by keeping longer-term private interest rates lower than they would otherwise be.
The Federal Reserve is not only manipulating short-term interest rates but also clearly manipulating long-term interest rates as well. Their excuse? Trying to reduce artificially inflated risk premia aka credit markets still not reflective of the fundamentals. Risk premia or not, how is this a good thing? It is yet another command and control fantasy that will cause capital to flow erroneously to a sector that is already swamped with REO sales and potential shadow inventory. While some may think, this misallocation of capital is necessary and can work to arrest the decline in house prices (hence the happy talk about no further losses at Fannie and Freddie), I am not so sure. House prices are still too high in many areas of the country relative to income, rents and other reliable long-term metrics. These policies to buy up mortgages only perpetuate this disconnect. Eventually, inflation-adjusted house prices must revert to mean as reflected in price to income and price to rent. I do not see how they can do so without a real loss for taxpayers at Fannie and Freddie.
http://www.creditwritedowns.com/2010/01/manipulating-mortgages.html
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