Nouriel Roubini has consistently been accurate in predicting the course of our snowballing credit crisis, and has also made some important intellectual contributions to the discussion. such as how the breakdown of the Bretton Woods system has lessons for the future of our Bretton Woods 2 currency program.
But in my view, Roubini’s post today is his most important contribution to date. Sadly, I anticipate, just like his early warnings of coming financial trouble, that it will be ignored.
Roubini argues that restructuring Fannie’s and Freddie’s debts is not an awful prospect. They have large books of, by housing standards, pretty decent assets. He estimates that the haircut required would be only 5%, which could either be handled via principal restructurings or payment reductions.
Moreover, a cynical supporting observation comes from Michael Shedlock, who points to a MarketWatch story:
FreedomWorks would like to point out that a bailout is a transfer of possibly hundreds of billions of U.S. tax dollars to sophisticated investors and governments overseas.
The top five foreign holders of Freddie and Fannie long-term debt are China, Japan, the Cayman Islands, Luxembourg, and Belgium. In total foreign investors hold over $1.3 trillion in these agency bonds…
FreedomWorks President Matt Kibbe commented, “The prospectus for every GSE bond clearly states that it is not backed by the United States government. That’s why investors holding agency bonds already receive a significant risk premium over Treasuries.”
“A bailout at this stage would be the worst possible outcome for American taxpayers and mortgage holders, who have been paying a risk premium to these foreign investors. It would change the rules of the game retroactively and would directly subsidize the risks taken by sophisticated foreign investors.”
“A bailout of GSE bondholders would be perhaps the greatest taxpayer rip-off in American history. It is bad economics and you can be sure it is terrible politics.”
But the flaw in Kibbe’s reasoning is the notion that the Federal government would handle a rescue in an up-an-up fashion, in which the expense would be explicit. It’s a given, as discussed in a related post, that the salvage operation will seek to hide the costs and, if the past is any guide, be successful at it too.
Roubini’s entire post, “Insolvency of the Fannie and Freddie Predicted Here Two Years Ago. What Happens Next? Or How to Avoid the ‘Mother of All Bailouts’,” is worthwhile. Here is the meat of his proposal:
The issue now is: what happens next to Fannie and Freddie?….
The conventional answer is that their shareholders get fully wiped out but that their creditors (those holding the $5 trillion of these agencies’ debt and their other liabilities) are made whole…
First notice that….. investors always expected that the liabilities of the two GSEs would be eventually backed by the U.S. government. And in spite of the decade long rhetoric….that Fannie and Freddie were private firms…. the reality was different: these were effectively public institutions – not private ones – used by the government (especially this administration) to pursue public policy goals. The hawkish rhetoric about the “moral hazard”….was thrown out of the window the moment the housing and mortgage bust started. Instead, for the last few months the GSEs – that were already bleeding and becoming insolvent on their own portfolio – have been used by the government to back stop the mortgage markets….
To minimize the financial cost of this farce the administration should stop pretending that these are private institutions and go ahead and take them over and nationalize them ….The financial costs of this farce include the $50 billion of subsidy that the GSEs bondholders/creditors are receiving every year as the spread of the agency debt over Treasury is now close to 100bps (100bps on $5 trillion of liabilities is equal to $50 billion)….. But if the government is going to bail them out – because the consequences of a capital levy on their bondholder will destroy the mortgage and housing markets – the government should at least make this implicit liability (the guarantee of the $5 trillion debt of the GSEs) explicit and thus save the U.S. taxpayer that $50 billion subsidy…
….let us consider …what should be done in an ideal world? The simple answer is that we need to limit as much as possible the moral hazard of a bailout of Fannie and Freddie….And such a bailout is neither necessary, appropriate nor desirable.
Of course most of Wall Street, domestic and foreign investors and Congress are already screaming and begging “Bail us out, bail us out!” …. But these screams of “the sky will fall” if we don’t rescue Fannie and Freddie are vastly exaggerated and incorrect for a number of reasons.
First, notice that the hit that bondholders will take will be limited in the absence of their bailout. With a debt/liabilities of about $5 trillion and expected insolvency – as of now and in the worst scenario of $200 to $300 billion – the necessary haircut is relatively modest: either a reduction in the face value of the claims of the order of 5% (if the mid-point hole is $250 billion) or – for unchanged face value – a very modest reduction in the interest rate on their debt after it has been forcibly restructured.
Second, a 5% haircut is much smaller than the 75% haircut that the holders of Argentine sovereign bonds suffered in 2001-2005, much smaller than the haircuts that holders or Russian and Ecuadorean debt suffered after those sovereign defaults, and much smaller than the 30% haircut that holders of corporate bonds suffer on average when a corporation goes into Chapter 11 and its debt is restructured. So why should Uncle Sam – i.e. eventually the U.S. taxpayer – pay that $250 billion bill when investors in the U.S. and around the world can afford it? The same investors are getting a fat subsidy of $50 billion a year (whose NPV is much bigger than $250 billion) for holding claims that now provide a 100bps spread above Treasuries and are under the implicit guarantee of a full bailout.
Third, of the two options we need to pick one: either we formally guarantee those claims and start paying the Treasury yield on that debt saving the tax payer that $50 billion subsidy; or if we maintain the subsidy a credit event in the form of a small haircut because of insolvency would be the fair cost that such investors pay for earning the extra spread over Treasuries.
Fourth, while the haircut would reduce the market value of such agency debt and inflict mark to market losses to investors such losses are already priced by the fact that the widening of the agency debt spread relative to Treasuries – from 10bps to about 100bps – has reduced the mark to market value of such agency debt. So, in the current legal limbo of insolvent GSEs whose debt is however not formally guaranteed the persistence of the spread would lead to those $250 billion mark-to-market losses regardless of a formal default, restructuring and haircut on that debt. We may as well resolve that insolvency and restore the positive net worth of the GSEs by doing the haircut.
Fifth, a haircut on the debt of the GSEs does not need to destroy their business, the mortgage market or the housing market. The best debtor is a solvent debtor that has restructured and reduced its unsustainable debt burden: that is why firms coming out of a Chapter 11 process that reduces their debt burdens are viable businesses ready again to produce goods and services in a viable and profitable way. The worst thing that can happen to the GSEs is to remain as zombie comatose insolvent institutions whose debt burden is not restructured and who are barely propped by an implicit government lifeline. Do we really believe that GSEs with unrestructured debt kept alive in a zombie government “conservatorship” (the solution now most likely preferred by the U.S. administration) could function properly and continue their service of supporting the mortgage and housing market? Lets instead clean them up first and make them financially viable – after an out-of-court Chapter 11 style debt reduction – so as to ensure that they keep on providing the public goods that they are alleged to give.
Sixth, the existence of GSEs….is a major part of the overall U.S. subsidization of housing capital that will eventually lead to the bankruptcy of the U.S. economy. For the last 70 years investment in housing – the most unproductive form of accumulation of capital – has been heavily subsidized in 100 different ways in the U.S.: tax benefits, tax-deductibility of interest on mortgages, use of the FHA, massive role of Fannie and Freddie, role of the Federal Home Loan Bank system, and a host of other legislative and regulatory measures.
The reality is that the U.S. has invested too much – especially in the last eight years – in building its stock of wasteful housing capital (whose effect on the productivity of labor is zero) and has not invested enough in the accumulation of productive physical capital (equipment, machinery, etc.) that leads to an increase in the productivity of labor and increases long run economic growth. This financial crisis is a crisis of accumulation of too much debt – by the household sector, the government and the country – to finance the accumulation of the most useless and unproductive form of capital, housing, that provides only housing services to consumers and has zippo effect on the productivity of labor. So enough of subsidizing the accumulation of even bigger MacMansions through the tax system and the GSEs.
And these MacMansions and the broader sprawl of suburbian/exurban housing are now worth much less – in NPV terms – not only because of the housing bust and the fall in home prices but also because: a) the high oil and energy prices makes it outrageously expensive to heat those excessively big homes; b) households living in suburbian and exurban homes that are far from centers of work, business and production that are not served by public transportation are burdened with transportation costs that are becoming unsustainable given the high price of gasoline. So on top of the housing bust that will reduce home values by an average of 30% relative to peak high oil/energy prices make the same large homes in the far boonies of suburbia/exurbia worth even less – probably another 10% down – because of the cost of heating palatial MacMansions and because of the cost of traveling dozens of miles to get to work in gas guzzling SUVs. Thus, it is time to stop this destruction of national income and wealth that a cockamamie decades long policy of subsidizing the accumulation of wasteful and unproductive housing capital has caused….
Will this optimal policy solution – an haircut for bondholders – be undertaken? Most likely not as the political economy of housing, mortgages and of “privatizing profits and socializing” losses may dominate the policy outcome. Financial institutions love a system where they gamble recklessly, pocket the profits in good times and let the fisc (taxpayer) pay the bill when their reckless behavior triggers a financial crisis; this is socialism for the rich. That is why you already hear the whole Wall Street Greek chorus moaning for a bailout of the GSEs. But the financial costs of this financial crisis – the worst since the Great Depression – are mounting so fast that any bailout will become fiscally extremely expensive.
Indeed, my initial estimates of $1 to $2 trillion dollars of losses from this financial crisis did not include the bailout of Bear Stearns’ creditors, the bailout of the GSEs bondholders, the fiscal costs of the Frank-Dodd bill, the fiscal costs a severe U.S. recession that is mushrooming an already large fiscal deficit, the fiscal cost of bailing out – a’ la Bear Stearns – the last four remaining major independent broker dealers (as the time for such independent broker dealers is now gone as – given their wholesale overnite funding – they are subject to bank-like runs much more severe than for banks), the cost of bailing out the Federal Home Loan Bank system (another GSE system that pretends to be private and that has been happily propping up or bailing out – to the tune of hundreds of billions of liquidity support – illiquid and insolvent mortgage lenders). Switching the informal guarantee of GSEs debt to a formal government guarantee would by itself increase the US gross public debt by $5 trillion and effectively double it.
Thus, soon enough, if we fiscalize all of these losses the U.S. may fast lose its AAA sovereign debt rating and eventually end up like an insolvent banana republic. It is thus time to put a stop to the coming “mother of all bailouts” starting with a firm stop to the fiscal rescue of Fannie and Freddie, institutions that have behaved for the last few years like the “mother of all leveraged hedge funds” with their reckless leverage and reckless financial activities.
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Best Roubini post ever.
U.S.A. the country of the socialism… for the rich!
Lenin bless America!
I am puzzled by the statement that the 100 basis point spread over treasuries which the (largely foreign) bond holders of $5 trillion receive as a premium is
paid by the “taxpayer”. Isn’t it paid by those whose
homes are financed with GSE sponsored mortgages which, if the bonds were direct federal obligations, would be less expensive because they were based on
Treasury debt? Can someone help me with this?
RK:
The whole theory behind the GSEs is that it lowers US homeowner’s (US taxpayer’s) mortgage costs by providing mortgage lending at treasury rates.
Thus if there is a 100 basis point spread for GSE debt over treasuries, yet the implicit guarentee IS valid, that is a 100 basis point transfer going from US homeowners to debtholders for no reason.
So yes, it is exactly that
RK — the terms on existing mortgages wouldn’t change just b/c the US government guaranteed the debt issued to finance those mortgages. So the windfall would go in the first instance entirely to the existing “creditors” of fanny and freddie, who bought bonds with a risk premia and end up with Treasuries. If Fannie and Freddie then could operate with a full guarantee, they would be able to pay more for mortgages (pushing interest rates down) b/c their own borrowing costs fell.
bsetser
Greatpost. It does however miss the point about the sovereign holdings. When Countrywide got bailed out BAC already had $2B into it. The Treasury simply can not punish the very folks who keep the US gov’t open for business. If this subtle cramdown were to occurr, might the Chinese just decide that the Treasuries are not looking so good anymore? Sester needs to weigh in here….
Then again BB and HP could promise the Chinese no opposition to a potential take over LEH.
Excellent analysis by Roubini. He flushed out all the relevant issues.
However, the 5% haircut on the $5 trillion debt is cited as the “worst-case scenario”. On what set of assumptions is that based?
If US home prices fall by 40% nationwide and stay down for the next 5 years, are the losses really limited to a 5% haircut?
This is a critically important issue, as the loss dollar amounts could vary widely based on the assumptions used.
Secondly, if as Roubini suggests, the bondholders are made to take a loss, then the Fannie Mae debt could no longer be rated as AAA. What credit rating would the debt then have? And in that case, how much demand for buying that debt would there then be after the fact? What yield would then be required on the debt?
This is also critically important, because Fannie/Freddie now account for 80% of all mortgage securitizations. They are literally the only thing left holding up the US real estate market. There ability to continue doing this is dependent on being able to continually issue new debt and use that money to purchase mortgages from the banks. If the debt borrowing costs for Fannie/Freddie rise sharply (due to bondholders taking a haircut), then those costs will be passed on to mortgage borrowers nationwide (much higher mortgage rates).
I understand that there are no painless solutions, but I think it is important to know what are the real consequences of each policy option.
It is interesting that at the same time we are committing more unproductive capital to the housing market through a potential bailout of the GSEs, the NIH budget has been flat over the last few years in nominal terms (negative in real terms), and spending on science continues to suffer (as this article illustrates).
http://www.dailytech.com/article.aspx?newsid=12332
Great post. Really gets te blood flowing. But I feel the urge to ask a basic question.
Why are the GSE investors entitled to a free bailout at the taxpayers’ expense?
They bought GSE investments and received the interest rate premium over alternative comparable US treasuries. They made a bet, took some risk and were paid extra for that. Now that the bet turned south, it’s expected the taxpayers are the ones who’ll have to cover. How’s that fair? Further, it may increase the moral hazard by incentivizing other s down the road, to make similar inappropriate types bets.
Is there an alternative? Possibly, I’m no expert in the banking or investment field, but have a thought. Why not make these folks pay the price in a different way. If the government has to be a backstop anyway, let’s make that relationship more explicit in the form of an insurance program. The government doesn’t automatically take on the guarantee of GSE investments. Rather, it starts to offer all those who invested in GSE obligations the opportunity to buy insurance. It’s a way for the taxpayers to be reimbursed for at least some of the potential losses that arise.
Setting up a new government insurance program would preclude forcing GSE investors into taking a haircut. Rather, they have the freedom to opt in to the insurance by paying an upfront premium (and probably a small continuing annual premium). Alternatively, the GSE investors would be given the opportunity to avoid buying the insurance, and ride out the storm without any extra cost. Probably not all investors would opt in. Those whose investments have shorter redemption horizons may choose may be more likely to roll the dice. However, it would seem that some number of long term investors might be willing to gamble also. This could reduce the potential exposure to the taxpayers
It seems backstopping individual GSE investments might be better than the Government nationalizing the GSE’s themselves. IMHO, the markets function best when government limits its role to referee, sometimes as protector and rarely as a participant. Keep the GSE’s private and they work better, while at the same time still providing investors freedom of choice.
The tricky part would be how to price the premiums. One possibility is to look at the average spread between rates offered by GSE’s and comparable termed treasury obligations for the years 2004 through 2007 (since most experts seem to agree that the real problem subprime, Alt-A and CDO obligations arose during those years), figure out the cumulative premium paid by the GSE’s to investors and use that as a starting point to somehow price the insurance needed to opt in. On an ongoing basis, the premiums rates could be tied to performance and financial metrics of Fanny and Freddie.
I think the markets will function better over the long term if the government’s role is that of a less direct player. The insurance alternative may provide more of the systems type protection “at the edges”(as persuasively argued in other posts by Yves and Richard Kline) to the government by keeping it separate from directly guaranteeing most real estate mortgages in the market. It might restore a level of confidence that could help stabilize things without as much risk to taxpayers.
Any solution is going to have to include the Federal Home Loan Banks, so add that to your all-in cost The government should grit its teeth and double or triple GSE capital with a form of preferred stock. Shock to the system, sure, but problem solved. Those institutions are needed (but get rid of mortgage interest deductability).
Lots of silly math and goofy conclusions. The gov’t/taxpayers haven’t been paying a plugged nickel to the GSE’s nor their bondholders. The logic presented is simply wrong.
There’s lots more unevidenced assertions and simimlar mental gaffs in the article.
Lots of silly math and goofy conclusions. The gov’t/taxpayers haven’t been paying a plugged nickel to the GSE’s nor their bondholders.
This is the most absurd thing Ive read. How about the lower interest rate in perpetuity that comes with an implicit gov’t guarantee. How about spreads going from 10 to 100? Kill em with facts as they say..
Since you bring up Chapter 11, let’s put this bankruptcy context to see how truly stupid a bailout looks.
Your haircut model (whichever version would get adopted) is effectively the same as standard Chapter 11 procedure, a debtor-in-possession reorganization. The creditors get haircuts, and the company proceeds with a new and (hopefully) improved business model. I would note that the average bankruptcy creditor would consider itself blessed if it received only a 5% haircut. Even if Roubini is wildly optimistic and the haircut is 25%, that’s still a pretty good deal by bankruptcy or government default standards.
In some Chapter 11 cases, a guarantor or major creditor will take over the debtor to protect itself from the other claimants. In the Freddie/Fannie case, the US wants to take over even though it is neither a creditor nor a guarantor, and its reason for the takeover is to protect not itself but the other creditors. Imagine what would happen if a bank, a major creditor in a bankrupt real estate development, told its shareholders it was taking over the development so it could protect the other creditors while leaving the shareholders out to dry. This is what the bailout really is.
The fundamental need for these institutions is what I question. The only thing they have guaranteed is home price inflation. There was a time when you saved for a home and not just for a down payment. We have all been turned into renters of in this country and we just rent from a bank.
We have lost an understanding in what the purpose in credit is. Convenience and not need. Those who need credit should never be allowed to possess it and those who do not need it can afford to pay for it.
We will see an end to this debt cycle when this is common wisdom in a five year old and not until then.
knute rife,
You seem to forget that Fannie and Freddie are government sponsored enterprises. They operate by a Federal charter which confers substantial advantages upon them, probably the most important of which is exemption from state and local taxes.
If needed, Congress could pass a law in about two nanoseconds to allow them to restructure their debt without resort to Chapter 11. Even though the GSEs sure aren’t AAAs on their own, there is no imminent risk of bankruptcy or nonpayment.
Not gonna happen, but the point is it could be done, and given that the GSEs are not normal companies but created to pursue public goals, giving them special treatment would not set a precedent for private companies.
Fannie describes its charter here:
http://www.fanniemae.com/faq/cs_faq1.jhtml?p=FAQ
So just who might it be that has the most vested intrest and the most to gain in see these to go under? HUMMmmmmmmmmmmmmmm
Well, based on stuff I’ve been reading of late, Bill Gross @ PIMCO has been buying agencies very aggressively over the past 2-3 months.
IF both FNM and FRE have much higher cash interest income and guarantee fees than cash interest expense and non-interest expense (and they do), then the only way they get in real economic trouble is if the market for some reason were to stop letting them roll their short-term financing deals. Even though the panic level in the markets are about as high as I’ve seen in the past 25 years, I don’t see the markets running away from the two GSE’s. Of course, the nice thing about short-term financing is that you keep getting those current datapoints over-and-over again. FRE’s deal on Monday will be interesting.
Hence the bailout of choice. War.
It is NOT excessive “subsidizing the accumulation of wasteful and unproductive housing capital” that is the root of the problem. Rather it is excessive securitization and leverage.
Furthermore, I object to the notion housing “has zippo effect on the productivity of labor.” This conjurs images of human cattle herded into unheated huts who work until they collapse dead. Is Mr. Roubini a fascist?
Great post from Rubini. If the US wants to go through the recesion with as little damage as possible, it must secure the health of the federal finances. President Franklin D. Roosevelt did exactly this when he assumed office, to make clear to everybody that the US would not fail in the middle of the gigantic crisis of that time.
“I object to the notion housing ‘has zippo effect on the productivity of labor.’ This conjurs images of human cattle herded into unheated huts who work until they collapse dead.”
Well, how much does your house contribute to your ability to be more productive in your job? Unless you are one of the few who are self-employed with a home office, I can’t exactly see how.
The house is merely a place of shelter when you are not at work. Perhaps it is an intangible asset that provides psychic income as a place of refuge from a day of slaughter at day-trading. But then again, if you are affected by the housing crisis, maybe it is more like a liability… Even in the most normal of times (non-bubble and non-recessional), housing is a depreciating asset.
Hmmm. Depreciating asset. There’s an oxymoron for you.
So S. and all, Brad Setser on his own blog has weighed in with a reconsideration of Roubini’s post. I strongly recommend that all interested read his perspective; loosely stated he evidently concurs with Roubini’s summary but demurs from his remedy. I’m with Setser, here.
The principal issue is that more than 20% of GSE bonds—appreciably more than $1T—are held by foreign central banks including in China, Russia, Japan, and Korea. The support of these central banks for the dollar and the US generally is a sine qua non for any recovery in the US financial system. Any repudiation of the GSE bonds in this context is unthinkable, in my view. I made a long comment to one of Yves’ posts on the GSEs yesterday which I won’t repeat here in total, but I’m much in favor of the public capital infusion approach being mooted, diluting out existing equity but retaining the institutions, their staffs, and their bonds intact. Yes, there are many problematic aspects of the ‘mortgage subsidy industry’ in the US, particularly the flat guarantee of GSE MBSs which I think should be capped. It might be a good idea once the GSEs are stabilized to spin off the existing guarantees into a separate enterprise where those guarantees may take a writedown so that the public till doesn’t have to guarantee bubble-top housing prices. But GSE _bonds_ are going to have to be repaid at par, so it seems better to keep the GSEs in business to do that, at the very least.
I would take issue with several of Roubini’s characterizations in his post, but there are too many points to really take this up but for one issue. I wouldn’t dispute as technically correct R.’s characterization of housing investment in the US as ‘unproductive’ from an investment standpoint—which, however, completely misses the point to such a degree as to call R.’s judgment into question. In the US, if I buy equity I’m a peon, and the company can dilute or go broke. If I buy bonds or an index fund, I can make money or lose it but I’m a flea in someone else’s game. If I buy a house, _I hold the title_, and the asset is mine, legally. This is a huge social difference. It is an issue deeply embedded in American history and society beyond anything Roubini remotely grasps given his cavalier dismissal of housing: Most of the initial immigrants who can to the US (and stole the land from the indigenes, but) came specifically to acquire clear title to real property as vested stakeholders. The entire American idea that they/we/you/ are not beholden to politicians, the rich, to industry, to creed, or to class is fundamentally pinned on the concept of smallholding property, modest but with clear title, enforced by law. The concept of ‘owning one’s home’ is a latter day derivative of owning one’s homestead. I’m not saying that we all should own a home; I don’t. The social history of this is non-neglibible.
Now, land speculation has a long, bad history in the US. Speculative property bubbles are supremely ‘unproductive’ as we see once again. And moneied sharps preying upon the social desire to own property are the odious campfollowers to ‘The American Dream’ through more than 400 years; Mozillo the Godzilla and the fixed income boys on the desks at Lehman’s and Bear are just the latest mob of carpetbaggers. (You can look this up.) To the extent that government support for homeowning promotes property speculation—a very considerable exten over the last twenty years—then yes, those government policies are by definition ‘unproductive.’ Roubini discusses all this as if the perspective of economists on money and property are the only ‘right and valid’ ones. I think he is mistaken, and that’s even before raising, yet again, the delusions of economists regarding the value of anything, begining with their advice.
Although that said I surely agree with Roubini that the US has needed and yet needs much, much more productive investment, and desperately so. We need to get the middle class saving again, and one way to do that is to direct their savings into productive investments outside of their own property, yes. Of course, a big focus for recent thieves in politicians’ clothing was to siphon off all of that ‘personal investing’ into Wall Street speculation on bad terms for the hoi poloi, so the concept comes tainted to the tongue. It isn’t, though, an either or, either own a home or invest personal savings ‘productively.’ One might well do both, and all the better as there would be diversity in one’s personal assets. What we need not to see are individuals speculating on the price appreciation of their primary residences: that is supremely unproductive and a fool’s gambit for most property owners. A few sell in time, but most can’t and simply take the bitter after the sweet.
Richard,
Your comments well taken, but I must differ with you a tad on a couple of points,
First, I note that even an economist that does not hew to radical views, namely James Hamilton, says that creditors should stare in the pain of restructuring Fannie and Freddie. Roubini admits his proposal will never be implemented, but it is a useful thought exercise.
Moreover, as one reader has taken to reminding me repeatedly, the securities (and presumably all offering documents) very clearly DISCLAIM being obligations of the government. They are not merely silent on this point. They affirmatively disavow it. That would give the US a tad stronger footing in any restructuing conversations (yes, I know this will never happen…..)
And more important, there is no free lunch for our friendly money sources. If the government takes on the obligation for the GSEs, Treasuries will go down , or rather have per this comment from Accrued Interest:
This is the first time in my career that I truly believe U.S. Treasury bonds sold off on credit concern. By this I mean, the credit of the U.S. Government. Long time readers know I’m not an alarmist type, and I’m sure not saying the United States is going belly up, but credit default swaps on the United States of America moved 11bps wider today (from 9bps to 20bps). The 10-year Treasury moved 15bps higher. All on a day when people are scared shitless and there should have been strong demand for “risk-free” assets.
I guarantee you will see even stronger purchases of gold (I’m annoyed that I can’t get over my goldbug prejudice and am now probably too late for that idea).
I think a modest restructuring could be pitched to GSE creditors as no worse than the alternative (provided the US does chip in as a gesture of good faith) of tarnishing Treasuries (although we’d probably have to pitch that measures would be taken to improve the creditworthiness of the GSEs, so that they could hope for a later partial recovery of the restructuring loss via ratings gains).
As for “housing as an investment” I think that very idea is what got us in the mess we are in, treating housing as an asset.
In the stone ages of my youth, the big reason for buying housing was personal risk reduction and better use of funds. The logic was you could pay rent and have nothing to show for it, or put some money down and maybe stretch on your monthly outlays, and have something to show for it.
Another big advantage was the increases you would face as an owner would be lower than as a tenant. The big number was the mortgage; those payments were fixed (at least in the pre-ARM days) and would fall over time in real terms thanks to inflation. So as an owner, you were at risk mainly of property tax increases and unexpected expenses (hopefully, the buyer budgeted for ongoing upkeep).
As a tenant, the landlord can raise the rent when your lease is up for renewal by however much he think he can extract, which could be a lot.
The forces savings/equity build up was a nice side bennie, but in the bad old days, many people planned to stay in the same house into their retirement years. Thus, the lifetime cash outlay would match their lifetime earnings profile: pay the mortgage off in your working years, enjoy much lower payments thereafter.
And I am not certain that home ownership makes much sense in a US with a much job instability as we have. Even if you can sell your home at a profit, transactions costs are very high relative to your equity (if you assume the historic 25% plus some appreciation). And if the market has traded down, it creates an impediment to relocating.
Yes, I know this posture is opposed to the idea of local communities, and I recognize and am saddened about the social costs. At the same time, this is the world we live in, and until things change, it behooves us to be realistic about it.
So Yves, I would love, love, love to see the US negotiate directly, and preferably more or less openly, with foreign central banks and sovereign capital institutions. If we can persuade them to take a write down in existing GSE bonds, all to the good; something will have to be given for that, but this could probably be achieved, in principal. Our present administration lacks credibility, but I must say that foreign public financial authorities have thus far acted with much more competence than our own over the last year, so that if invited they may see it in there interests to make concessions. That is all the world of difference from forcing an involuntary write down on our global financial counterparties. If there is one thing that I think I can guarantee as an outcome it is that further unilateral macrofinancial actions by the US public authorities will end badly.
Regarding the ‘home as an investment’ model, I like you am far from sanguine on this. We subsidize it too much, I agree. But what are the alternatives. if we had, as I suggest, the option to invest individually in long-term public debt as a store of personal asset accumulation, many might choose to rent and carry their capital in another form. I would love to see something like the Japanese Postal Bank with preferential rates for small depositor-investors. But we don’t have anything like this. Moreover, the social profile of owning property will not go away in ten lifetimes in our country. This is part of our cultural macrogestalt. The question is how to limit speculation and get people to invest in more sensible housing. I detest most of our housing stock now; that is one reason I’ve had little incentive to even attempt to buy in. Condos are ugly cracking wrecks which bring all the problems of neighbors with little of the benefits of community. We could build energy efficient, beautifully built, rammed earth dwellings which would last two hundred years with reasonable maintenance but instead we get ugly, inefficient, resource stupid, cardboard packing crates in Sprawlville which are uninhabitable in a generation. Let’st promote sustainable urban design and architecture, and then see what our investments look like. . . . I’m not going to live to see this, either, I’m afraid.
And re: those ‘not backed by government labels,’ that is language for lawyers, but everyone has always known that the government would back these notes, and the government has implicitly promoted the understanding that they would. I seriously doubt that anyone buying GSE debt in 1975 remotely considered that the government would permit a default on it. The labels are part of a domestic political game, but the use of the debt has been part of a public financial process. I think that we have to give up the coy lie and accept the wink-and-a-nod promise. But yes, if we can negotiate down from face by all means let’s do it.
Just noticed anonymous’s response (sort of) to my comment. First, I’m fully aware of their GSE status. Second, I didn’t say they would file bankruptcy, I was using BK procedures as an analogy to show how loony (i.e. politically driven) this process is. Third, the restructuring he refers to can not be done by legislative fiat; it will require either a massive write-down, effectively torpedoing the mortgage market, or a massive bailout, sending the national debt through the roof. Which was sort of my point.