Bernanke-“Grave”

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Karim writes:

Not a word you often see a Fed Chairman use:

….stabilization of our financial system is an essential precondition for economic recovery. I urge the Congress to act quickly to address the grave threats to financial stability that we currently face.

He outlined the channels in which this impacts the economy in this paragraph:

Ongoing developments in financial markets are directly affecting the broader economy through several channels, most notably by restricting the availability of credit. Mortgage credit terms have tightened significantly and fees have risen, especially for potential borrowers who lack substantial down payments or who have blemished credit histories. Mortgages that are ineligible for credit guarantees by Fannie Mae or Freddie Mac–for example, nonconforming jumbo mortgages–cannot be securitized and thus carry much higher interest rates than conforming mortgages. Some lenders have reduced borrowing limits on home equity lines of credit. Households also appear to be having more difficulty of late in obtaining nonmortgage credit. For example, the Federal Reserve’s Senior Loan Officer Opinion Survey reported that as of July an increasing proportion of banks had tightened standards for credit card and other consumer loans. In the business sector, through August, the financially strongest firms remained able to issue bonds but bond issuance by speculative-grade firms remained very light. More recently, however, deteriorating financial market conditions have disrupted the commercial paper market and other forms of financing for a wide range of firms, including investment-grade firms. Financing for commercial real estate projects has also tightened very significantly.

When worried lenders tighten credit, then spending, production, and job creation slow.

Separately, he stated that:

  • Economic activity was ‘decelerating broadly’ and that second half growth would be ‘appreciably below potential’
  • He noted improved housing affordability but also that th
  • He cited the usual ‘over time’ for the economy to improve and that inflation would moderate ‘later this year and next’, with significant uncertainty attached to both forecasts.


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Greed and irresponsibility

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This displays a profound misunderstanding that is also likely shared by the McCain campaign.

From an email from the Obama campaign to supporters sent last night.

Friend —

The era of greed and irresponsibility on Wall Street and in Washington has created a financial crisis as profound as any we have faced since the Great Depression.

While not technically incorrect in terms of defaults and a few other financial measures, the financial crisis of the depression resulted in a collapse in GDP and double-digit unemployment. This financial crisis hasn’t even yet caused two quarters of negative GDP, and unemployment of 6.5% isn’t (yet) anywhere near the levels of recent recessions.

Congress and the President are debating a bailout of our financial institutions with a price tag of $700 billion or more in taxpayer dollars. We cannot underestimate our responsibility in taking such an enormous step.

The $700B is not the price tag for tax payers. The fiscal cost is equal to the losses government might take if they overpay for the securities they are purchasing.

Whatever shape our recovery plan takes, it must be guided by core principles of fairness, balance, and responsibility to one another.

Agreed, and a good working knowledge of public accounting would go a long way to getting there.

Please sign on to show your support for an economic recovery plan based on the following:

• No Golden Parachutes — Taxpayer dollars should not be used to reward the irresponsible Wall Street executives who helmed this disaster.

• Main Street, Not Just Wall Street — Any bailout plan must include a payback strategy for taxpayers who are footing the bill and aid to innocent homeowners who are facing foreclosure.

• Bipartisan Oversight — The staggering amount of taxpayer money involved demands a bipartisan board to ensure accountability and oversight.

Show your support and encourage your friends and family to join you:

http://my.barackobama.com/ourplan

The failed economic policies and the same corrupt culture that led us into this mess will not help get us out of it. We need to get to work immediately on reforming the broken government — and the broken politics — that allowed this crisis to happen in the first place.

Yes, like putting controls in place to minimize fraudulent loan applications. But I suspect lenders have already done that.

And we have to understand that a recovery package is just the beginning. We have a plan that will guarantee our long-term prosperity — including tax cuts for 95 percent of families, an economic stimulus package that creates millions of new jobs and leads us towards energy independence, and health care that is affordable to every American.

Increasing demand before cutting our crude and gasoline imports will result in deteriorating terms of trade and a declining standard of living.

It won’t be easy. The kind of change we’re looking for never is.

Particularly when no one in Washington seems to understand public accounting.

But if we work together and stand by these principles, we can get through this crisis and emerge a stronger nation.

Yes, worst case the fiscal ‘automatic stabilizers’ will get us through as they always have.

Thank you,

Barack


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700BB

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On Wed, Sep 24, 2008 at 4:51 AM, Sean asks:

Do u think treasury will manage their new mortgage portfolio like a conventional manager – hedging the negative convexity with swaps and swaptions?

Good question!

I wouldn’t; they might.

It wouldn’t serve public purpose to do that. It would add to volatility.

Just doing the exchange reduces volatility as the government absorbs it, which I see as serving public purpose.


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Re: Amendment of ERISA

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(an email exchange)

Good find!

yes, this had to have contributed to the boom/bust and encouraged/sustained the rampant lender fraud that has resulted in the elevated defaults.

hopefully the pension funds have learned their lessons (the hard way, unfortunately but as always seems to be the case) and will dig deeper than just using the ratings agencies and diversification when they invest.

Warren

>   
>   On Wed, Sep 24, 2008 at 2:50 AM, Eric Tymoigne wrote:
>   
>   
>   All,
>   
>   I have finally found what I have been looking for a while.
>   
>   ERISA was amended on November 2000 to allow Pension Funds and Employer
>   benefit program to buy ABSs with investment grade below A, and to buy senior
>   tranches of CDOs as long as they have an investment grade of at least AA (at
>   least is how I interpret the sentence “the Amendment permits inclusion of
>   assets with LTVs in excess of 100%. However, securities backed by such
>   collateral (a) must be senior (i.e., non-subordinated) securities and (b) must
>   be rated in either of the two highest generic ratings categories by a rating
>   agency.”).
>   
>   All this, it seems to me that this is what has allowed, or at least initiated,
>   what we have seen in the 2000s. CDS, CDOs-squared, under-regulated
>   mortgage companies etc. were all there already but not until this came up did
>   the all thing got out of hand and subprime mortgage started to boom.
>   
>   Any thoughts?
>   
>   Best,
>   Eric
>   


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2008-09-24 USER

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MBA Mortgage Applications (Sep 19)

Survey n/a
Actual -10.6%
Prior 33.4%
Revised n/a

 
The MBA index of loan requests for home purchases fell 10 percent to 342.2.

Not good, but down from a larger spike last week, and still well above the lows.

Housing still looks to have bottomed albeit from very low levels.

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MBA Mortgage Purchasing (Sep 19)

Survey n/a
Actual 342.2
Prior 380.4
Revised n/a

 
A move down after a larger spike up, still off the bottom.

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MBA Mortgage Refinancing (Sep 19)

Survey n/a
Actual 2043.4
Prior 2300.0
Revised n/a

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MBA Mortgage Applications TABLE (Sep 19)

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MBA Mortgage Applications TABLE 2 (Sep 19)

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MBA Mortgage Applications TABLE 3 (Sep 19)

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MBA Mortgage Applications TABLE 4 (Sep 19)

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Existing Home Sales (Aug)

Survey 4.94M
Actual 4.91M
Prior 5.00M
Revised 5.02M

 
A bit worse than expected, prior revised up a bit. Still looks like it’s past the bottom.

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Existing Home Sales MoM (Aug)

Survey -1.2%
Actual -2.2%
Prior 3.1%
Revised 3.5%

 
Also worse than expected, and last month revised up.

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Existing Home Sales YoY (Aug)

Survey n/a
Actual -10.7%
Prior -12.8%
Revised n/a

 
Declines still dimishing.

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Existing Home Sales Inventory (Aug)

Survey n/a
Actual 4.255M
Prior 4.575M
Revised n/a

 
Good size drop as foreclosures get liquidated.
Along with plunging new home inventories and a lot of existing homes not livable, it looks to me like supply is starting to get thin.

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Existing Home Sales ALLX 1 (Aug)

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Existing Home Sales ALLX 2 (Aug)


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Why it matters how the 700 billion is accounted for

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It would be counter productive to add the $700 billion to the budget deficit calculation if the proposal goes through and is executed, since Congress is likely to take measures to somehow constrain spending or increase revenues to try to ‘pay for it’. This would be highly contractionary at precisely the wrong time.

Note that if the Fed buys mortgage securities it doesn’t add to the deficit, while the Treasury buying the same securities does? And in both cases treasury securities are sold to ‘offset operating factors’; either way, Fed or Treasury, the government exchanges treasury securities for mortgage securities.

When any agent of the government buys financial assets, that particularly spending per se doesn’t add to aggregate demand, or in any way or directly alter output and employment.

Yet here we are listening to the Fed Chairman, the Treasury Secretary, and members of Congress talking about $700 billion of ‘taxpayer money’ and a potential increase in the deficit of $700 billion.
And no one argues with statements like ‘it is even more than we spent in Iraq’ and ‘that much money could better spent elsewhere’. Unfortunately for the US economy, this supposed addition to the deficit is likely to negatively impact future spending, perhaps at the time when it’s needed most to support demand.

I recall something like this happened in 1937, when revenues collected for social security weren’t ‘counted’ as part of the Federal budget, and the millions collected to go into the new trust fund
were in fact simply a massive tax hike. Unemployment went from something like 12% to maybe 19% (and stayed about that high until WWII deficit spending brought unemployment down to near zero). After that happened much was written regarding public vs private accounting and the cash flow from social security and other programs was subsequently counted as part of the federal budget calculation, as it is today, and for the same reason.


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How bad off is Goldman?

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Selling a convertible preferred that cheap – a 10% coupon with a below market strike???- seems to mean things aren’t all that rosy at Goldman???:

Berkshire will buy $5 billion of perpetual preferred stock that carries a 10 percent dividend. It also will receive warrants to buy $5 billion of common stock at $115 per share, exercisable within five years.

The market seems to like it, for the moment.


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Reuters: Obama says bailout may delay other programs

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(email to J. Galbraith – one of Obama’s economic advisers)

Hi,

The ‘bailout’ adds nothing to aggregate demand and should not be a factor regarding other spending initiatives.

Any chance you can straighten him out on this?

Warren

Obama: Wall St bailout may delay spending programs

by Steve Holland
NEW YORK, Sept 23 (Reuters) – Democratic presidential nominee Barack Obama said on Tuesday a $700 billion Wall Street rescue plan would likely delay some campaign spending promises, as the reality sank in of the costs of the mammoth bailout.

Obama, who faces Republican John McCain in their first face-to-face debate on Friday in Mississippi, said if elected he might have to phase in some of his plans such as an overhaul of the U.S. health care system.


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Congressional confusion

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Congress seems confused over who are the bad guys that need to be punished.

They seem to be leaning towards punishing shareholders if their management decides to accept any form of federal assistance under the new plan.

This puts management in a bind: sell a few securities to the Treasury and let shareholders lose value to the government, or muddle through and don’t dilute the shareholders.

Management is likelty to do what’s best for management, and sell securities to the Treasury and sell the shareholders up (down?) the river. Just like they do when they issue a convert when stock prices fall, to shore up capital.

But Congress also thinks management needs to be punished with some form of salary and bonus caps. This would discourage management from utilizing whatever new facilities Congress comes up with. Which also makes shares less valuable.

Looks like a lose/lose for the shareholders?

It seems to me if Congress finds anyone at fault (whatever that means) it would be managers rather than shareholders.

What have shareholders done wrong, even in theory? It’s a stretch to come up with anything.

And who are the shareholders? Pension funds, ira’s, individuals? Why are they the objects of Congressional wrath?

With each government intervention, shareholders have been a favorite target to justify the utilization of ‘taxpayer money’ (whatever that means with an asset purchase).

Congress isn’t looking at who’s at fault, they are only looking to minimize risk to ‘taxpayer money’, even if that means taking funds from innocent shareholders.

Congress can be counted on to do what they think is best for them politically. So with something like 75% of the voters owning shares, it seems odd that they are the target.

And, of course, none of this address aggregate demand which is the key to output and employment (the drivers of corporate prosperity) and share holder value.


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Bernanke

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Karim writes:

Most of testimony explaining actions of recent weeks. Direct comments on economy below. Focus on enabling financial conditions to improve ‘for a protracted period’ means that in Bernanke’s mind that hikes are off the table for a ‘protracted period’ and cuts may be on the table if inflation cooperates.

Notably, stresses in financial markets have been high and have recently intensified significantly. If financial conditions fail to improve for a protracted period, the implications for the broader economy could be quite adverse.

While perhaps manageable in itself, Lehman’s default was combined with the unexpectedly rapid collapse of AIG, which together contributed to the development last week of extraordinarily turbulent conditions in global financial markets. These conditions caused equity prices to fall sharply, the cost of short-term credit–where available–to spike upward, and liquidity to dry up in many markets. Losses at a large money market mutual fund sparked extensive withdrawals from a number of such funds. A marked increase in the demand for safe assets–a flight to quality–sent the yield on Treasury bills down to a few hundredths of a percent. By further reducing asset values and potentially restricting the flow of credit to households and businesses, these developments pose a direct threat to economic growth.


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