So much for the notion that the not-quite-a-rescue-plan for Fannie and Freddie would calm troubled markets. Equities gave a raspberry yesterday and overnight, the TED spread widened 11 basis points to 133 basis points (a sign interbank funding trouble may be nigh) and today the currency markets, which initially seemed to take the news in stride, beat a path away from the dollar.
With this kind of reaction, and possibly worse in the offing (Friday is an options expiration day) are we really certain this bailout is the right move? I much prefer the idea of shared pain, that the taxpayers take some of the burden as a necessary gesture to our friendly foreign funding sources, but that creditors, who were told explicitly in all offering documents that Freddie and Fannie paper was not an obligation of the US government, take their lumps too.
More important, there has been not a word from the officialdom about how to manage the GSEs going forward. Of course, that’s because they are trying not to admit that nationalization of some form is the end game (and nationalism pretending to be something else is just about certain to be worse than the real deal). Indeed, a whistling-in-the-dark letter to Freddie employees envisions that the GSE can continue as before with a backstop in place.
Some ideas are being advanced. Accrued Interest suggested that GSEs should be broken up into “Macs” not too big to fail. Martin Hutchinson of BreakingViews($) goes even further, arguing that the GSEs be wound down (he sees divvying them as a less attractive alternative):
Fannie Mae and Freddie Mac, the US mortgage giants, distort the economy and one option now available is gradually to kill them off….
The government has now effectively taken full responsibility for the government-sponsored enterprises’ $5.2 trillion of obligations. It should recognise the fact by nationalising them…
….remove the GSEs from the market altogether over time. The government, as their owner, could force them to increase their fees in stages over several years. They currently charge 0.25% up-front for buying or guaranteeing mortgages extended to people with strong credit, plus about another 0.25% a year. The annual fee could, for example, be increased to 0.5% immediately, with further increases of 0.25% each year announced in advance.
Meanwhile, the GSEs, now in the public sector, could start cutting down their salary scales towards civil service levels. The higher fees and compensation savings would compensate taxpayers somewhat for the bailout costs…
Gradually, banks that have lost the habit of making and holding mortgage loans would find the business profitable again
As much as this idea is a political non-starter, excessive subsidies to the housing market played a major role in getting us into this mess in the first place. And the GSE’s major role in mortgage finance had the perverse effect of reducing the attractiveness of opportunities for banks in higher credit quality mortgages (the GSEs take their cut with the advantage of near-Treasury borrowing rates and far higher gearing, leaving a smaller part of the economic pie left for banks).
The increasingly distressed level of the dollar shows that our trading partners are ever-more nervous about our debt crisis, which includes the Federal deficit. It is a no-brainer that more fiscal stimulus, which means even bigger deficits, are in the offing. Yet shoring up housing, an effort doomed to fail (prices have to retreat to levels that borrower incomes can support) is not a very productive use of fiscal firepower. The biggest bang for the diminishing buck is putting cash in the hand of those with high propensities to spend.
Propping up the housing market seemed cheap to policy-makers: a so-called $300 billion housing bill would cost only $5 billion according to the Congressional Budget Office, thanks to low uptake (only 28% of the amount authorized was assumed to be utilized). That total could well be right for the wrong reasons (I suspect the loss assumptions are too low, but Adam Levitin argues that participation will be even lower). But how much tolerance will there be now for the government assuming more contingent liabilities with lots of zeros attached, even if the likely true cost, relatively speaking, is bupkis? The Fannie/Freddie debacle may have put an end to that game for now.
As Leigh Skene of Lombard Street Research notes in the Financial Times today:
A World Bank study in 2002 entitled Managing the Real & Fiscal Costs of Banking Crises studied 30 years of systemic banking crises across 94 countries. It shows bail-outs cost a lot of money but they neither solve problems nor alleviate the slowdowns the crises cause. The bail-out of Fannie and Freddie is no exception. This credit liquidation will continue for a lot longer than most people think regardless of what the authorities do.
From the Wall Street Journal:
The dollar sank to a new low against the euro Tuesday and declined against other major currencies as the Treasury rescue package for Freddie Mac and Fannie Mae failed to reassure financial investors about the state of the U.S. economy.
As the U.S. currency faltered, the pound was able to rally back over $2.00 for the first time since early this month. The euro, meanwhile, was testing a break over $1.60, which could prompt fresh talk of market intervention by central banks to support the dollar.
The latest dollar losses came as markets continued to look both for more bad news on the U.S. economy — especially as spending of tax rebate checks is completed in the next few weeks — and more bad news on U.S. banks.
The reduction in risk appetite was evident in a shift out of high-yielding currencies back into lower-yielding ones, such as the yen and the Swiss franc. The UBS Risk Aversion Index rose to 1.14 Tuesday from 1.03 Monday.
The dollar traded below $1.60 against the euro for the first time in almost three months on speculation Federal Reserve Chairman Ben S. Bernanke and U.S. Treasury Secretary Henry Paulson will tell lawmakers credit- market losses will weigh on U.S. economic growth.
The currency also declined to a 25-year low versus the Australian dollar on concern confidence in the debt of Fannie Mae and Freddie Mac will deteriorate even after the U.S. government pledged support for the two-largest buyers of home loans. The yen rose after the Bank of Japan kept interest rates at 0.5 percent today, the lowest among major economies.
“The markets are reacting negatively to the renewed credit crisis in the U.S. and that’s hurting the dollar across the board,” said Roberto Mialich, a Milan-based currency strategist at Unicredit Markets & Investment Banking, a unit of Italy’s largest lender…..
“Bernanke will avoid saying anything that could potentially weaken confidence in the dollar,” said Takuma Kurosawa, global markets treasurer in Tokyo at HSBC Bank, a unit of Europe’s biggest lender. “But the reality is the U.S. housing market and credit squeeze haven’t hit bottom yet. That’s discouraging investors from holding dollar assets.”