Does this apply to the free cash balances as well? I am not familiar with American rules – and my knowledge of Canadian rules may well be out of date – but I believe that in Canada the cash in a brokerage account is treated as a loan to the brokerage and may be used in the course of their business. The securities must be segregated, and the cash in registered accounts (our answer to 401(k)) must be segregated, but not excess cash held in an ordinary margin or cash account.

Investors are protected by the Canadian Investor Protection Fund but, while the fund size is certainly adequate to take care of the small shops, it would be instantly swamped if one of the big firms were to require support.

What is most worrying to international observers like myself is the “sweep it under the rug” “speak no evil” response to these problems.

Lockhart has been pushing for better capitalization of the GSEs for some time and achieved considerable support – except in congress.

I don’t think anybody in this particular drama wants to sweep anything under the rug – but authority must be coupled with responsibility. Cuomo has issued orders to the GSEs:

Knowing this, Fannie Mae and Freddie Mac cannot afford to continue buying Washington Mutual mortgages unless they are sure these loans are based on reliable and independent appraisals.”

Such an order exceeds his mandate, as Lockhart so admirably points out:

Your demand that two federally-chartered and federally-regulated Enterprises cease doing business with a major federally-charterd bank, which you have not charged or subpoenaed, unless certain conditions stipulated by you are met.

The regulators – and in this particular case, the NY AG – are entirely too fond of throwing their weight around and using the threat of extended, messy investigation in lieu of actual court proceedings.

It’s not quite corrupt, but it’s not quite clean government either.

“raises doubts about the value of their even though they are government backed”

Well, a lot of things that I would never touch have been government backed. How long ago was it that Russia defaulted on its commitments?

“Now it is fair to argue that taxpayers might wind up footing the bill”

What makes you assume that the taxpayers are capable of footing the bill for a collapse? Last I checked, they were borrowing about 2 billion a day just to make ends meet, while bridges are collapsing and tax revenues on the municipal, state and federal levels are all declining. Not to mention that the American taxpaers are clearly over extended in terms of mortgage debt, credit card debt, auto debt, student loan debt etc, etc,
What is most worrying to international observers like myself is the “sweep it under the rug” “speak no evil” response to these problems. That kind of response is dishonest and is a very big reason why the aggegate creditworthiness of all things American is declining in the eyes of the rest of the world.

With all due respect (I am going to sound unduly cranky because I have to run to a meeting and don’t have time to craft my tone, so don’t take offense) I did not say that the investigation calls into question the value of Fannie’s and Freddie’s securities. The Bloomberg piece did, which leads me to believe, not having seen the full transcript of the Cuomo press announcement, that he made a few more derogatory statements. And even if he didn’t go beyond the investment bank comparison, that alone is pretty bad.

I am objecting to Cuomo putting Fannie and Freddie’s paper in the same category as privately issued mortgage paper. Per the comments above, it enjoys government backing. Now it is fair to argue that taxpayers might wind up footing the bill, but that is not what Cuomo was saying. His comments could cause concern among uninformed investors. That is what I believe Lockhart objected to, and I think his views are reasonable.

And Cuomo is not a regulator. Lockhart is.

Love your posts, but I do have a bit of nitpicking on this one.

Your Bloomberg quote indicates that the investigation itself calls into question the value of Fannie and Freddie’s securities, not that Cuomo did so. I don’t think it’s fair to accuse Cuomo of fomenting panic.

The problem is that in the current environment where AAA rated assets may not just fall in value but end up being worth nothing (which seems to be a possibility for some CDO cubed and maybe even squared products), any regulator doing his job right can’t help but add to the worries.

You imply that the securities market needs certainty about credit quality and that no one should be looking under the rug at the GSEs. I think the opposite: awareness of risk is what this market needs. I know that this means higher interest rates, lower asset prices, BKs/insolvencies and most likely recession, but the oft lauded risk mitigating financial innovation of recent years was really a ruse based on the idea that risk could be offloaded to systemic irrelevance when in fact it could not and in reality was always there and still is. The problem we have is that risk is not priced in to a variety of asset prices. Going back to the assumption that risk can be avoided or endlessly offloaded is the last thing we need. Every investment is always risky, even sovereign debt (just ask foreign holders of garbage, err I mean, dollar denominated sovereign debt.) The awakening of concern, or “fear” if you prefer, and curious delving into risk exposure are the only good things that have happened to the markets in years. A generation of investors who think that they can avoid all risk and that if they make mistakes the government will bail them out is the cadre we now have to finance the global economy and support innovation, do you really think that they’ll get things right? When I work with someone I want it to be someone who knows they are taking risks and carefully examines and prepares for those risks, not someone who assures me they’ve offloaded it to some third party or that some provident big brother will come to save us from our folly. Certainly I agree that degrees and types of risk should be differentiated, but the naïve perception of riskless ventures and unquestionably sound credit must end.

formerlyknownasJS

If you read the post, and clicked through on the link, the comment was about retail brokerage accounts. You are not exposed to default risk in a brokerage account. You are not a creditor. A broker acts as an agent and maintains a segregated account. The risks you are exposed to occur either if your broker embezzles, or if you give them discretion and they churn your account or put you in crappy investments that pay them high fees. As I said, fraud is easier to execute in a bull market than a bear market.

The risk arises out of the current environment is that firms like Merrill have to cut bonuses to their brokers, who have nothing to do with the firm’s problems, and their good brokers leave. But again, brokers tend to take their accounts with them (although firms may have better contracts in place to impede that. I’m not current on that issue).

If you had a brokerage account at Citi (as opposed to deposits in excess of FDIC limits) you proved my point.

Thanks for the link, but remember, the concern is about the reaction of the public at large. The stock prices of investment banks have been tumbling. They have already made $40 billion in writedowns and much larger writeoffs are expected. Investment bankers also pay themselves very handsomely, which will become more controversial as the search for the guilty widens.

Anon of 5:42 AM,

As 6:12’s comment shows, the answer to your question isn’t as straightforward as you might imagine. The Bloomberg article used the word “guarantee” while I didn’t, since the guarantee is not formal. See this article, which has this section in its abstract:

This article provides the most comprehensive statutory analysis to date of the federal government’s implied guarantee of Fannie Mae and Freddie Mac’s financial obligations. Fannie and Freddie together have $4.45 trillion in mortgage-related obligations. The magnitude of their obligations can only be understood in comparison to the amount of outstanding U.S. government debt – $5.04 trillion. Given the ongoing meltdown of the residential mortgage market, it is important that the implied guarantee be understood for what it is, a contingent liability of the federal government.

and this discussion from James Hamilton in a talk he made at the Fed’s Jackson Hole conference:

This acquisition of mortgages was enabled by issuance of debt by the GSEs which currently amounts to about $1.5 trillion. Investors were willing to lend this money to Fannie and Freddie at terms more favorable than are available to other private companies, despite the fact that the net equity of the enterprises– about $70 billion last year– represents only 5% of their debt and only 1.5% of their combined debt plus mortgage guarantees. If I knew why investors were so willing to lend to the GSEs at such favorable terms, I think we’d have at least part of the answer to the puzzle.

It’s a game of chicken. And one thing that’s very clear to me is that this is not a game that the Fed wants to play, because the risk-takers are holding the ace card, which is the fact that, truth be told, the Fed does not want to see the GSEs default. None of us do. That would be an event with significant macroeconomic externalities that the Fed is very much committed to avoid.
So even among people who have looked at this matter, opinion varies.

GSEs have govt. charters, but the backing for their debts is assumed, not legislated. As a practical matter the govt. would be vey unlikely to default. Here’s a pretty nice paper from the Atlanta Fed:

http://tinyurl.com/2m66qr

It’s about FHLB, but also covers backing of other GSEs.