Vote of No Confidence: Dollar Tanks (And More on Fannie and Freddie)

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.

From Bloomberg:

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.”

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  1. Anonymous

    “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).”

    Several decades ago, local banks still underwrote and retained their own mortgages. They may not have had the depth of staffing expertise that Fannie and Freddie did. But they DID have an intimate knowledge of their local property markets, which Fannie and Freddie do not.

    Diversity is good; centralization of risk is bad. But the overriding tendency of the past several decades has been to downgrade locally-held assets, reserves and expertise, in favor of centalizing everything. The crippled condition of F&F may be an opportunity for banks — at least, those who have capital available, and don’t need to hoard it for anticipated write-offs.

    To no one’s surprise, it turns out that Asian private and public institutions are stuffed to the gills with agency debt. After all, where else were they going to recycle those huge trade surpluses? Uncle Ben has an eye-popping $2.35 trillion stuffed away in his “custody account” slush fund, of which a large chunk reportedly is agencies. The upshot is that the entire planet was subsidizing America’s housing Bubble. What a Fubar Snafu — thank you, Alan Greenspan!

    You know that on a morning like this — with futures way down, and Hank Paulson humiliated by the market’s Bronx cheer in response to his GSE bailout plan — Ben’s instinct would be to pop the market with a surprise rate cut. Oh, wait — the euro’s at a record high! Stalemate.

    So, uhhhh … what did you really mean by “unconventional measures,” Ben? Let’s have a go, before something perfectly awful happens.

  2. ndk

    It’s not really the Euro that he is worried about, nor should he worry about it; lowering the dollar will increase our competitiveness, ceteris paribus, and it’s a desperately needed part of any meaningful adjustment plan.

    The problem is oil. We’re pegged to the oil standard, and that one is much harder to break than the gold standard. It also has the real economy by the short hairs.

    Ben, for all his brilliance and humanity, is probably handcuffed.

  3. Anonymous

    “Lowering the dollar will increase our competitiveness, ceteris paribus, and it’s a desperately needed part of any meaningful adjustment plan.”

    Quite so. Letting the dollar slide is a form of ‘backdoor easing.’ With Fed Funds locked at 2% to ‘fight inflation’ (LOL), normally dollar devaluation would be the escape valve to counter market weakness.

    But with crude oil at record highs, every tick lower in the dollar produces another disturbing headline about crude oil. Double checkmate!

    Ben is not only handcuffed; he’s straitjacketed, shackled, locked inside a chest, and sinking (glub-glub-glub) to the bottom of the sea. If he surfaces, it will be a bloody miracle for all of us, I’m sure.

  4. Italian

    GSEs are to the USA treasury what the SIVs are to banks: just ways to hide off balance debt.

  5. a

    Hedgie Ackman (who has shorted the GSEs) has a proposal. Sounds like Roubini lite. Story on Bloomberg.

  6. Totally Perplexed

    Feel Like I’m in the “Matrix”
    For every move there’s a counter move or an unintended consequence.

    Being a novice (although old) seems to me that the only way out, is a full fledged “Katrina” type occurence and start over.

    Yves et al — can the system handle letting the housing market find it’s real bottom, mortgages/loans/etc be written to their real level, foreclosures occur, bank failures occur etc or are we to slowly sink into the sea for the next 5 to 10 years ala Japan?

    Keep up the great work

  7. Anonymous

    What are the practical effects of currency intervention, beyond just the coordination of governments to keep a currency above or below a certain point? Are there any reprecussions of that?

  8. Anonymous

    In the Bernanke hearing, Senator Bunning excoriated the Fed for Greenspan’s easy money and Bernanke’s easy money. He blasted the Fed for funding the buyout of Bear Stearns by JPM. He condemned the “socialistic” proposal to allow Treasury to purchase equity in Fannie & Freddie. “Where will it stop?” he demanded rhetorically. “Where will this socialism stop?”

    As he ended, there was silence in committee room, followed by nervous giggles. “Do you went to respond to that?”, the committee chair asked Bernanke. As Bernanke tried to compose his thoughts, the committee chair went on, “Senator Bunning doesn’t have any strong views on this matter. I wish he would be more clear next time.”

    The camera shifts to Bunning. He looks to one side, and to the other, and glares. HE DOESN’T GET THE JOKE.

    I am laughing so hard I fall on the floor. PRICELESS!

  9. S

    Thank you, Mr. Chairman. I know we have a lot of ground to cover today, but I want to say a few things on the topic of this hearing and of the next.

    First, on monetary policy, I am deeply concerned about what the Fed has done in the last year and in the last decade. Chairman Greenspan’s easy money the late nineties and then following the tech bust inflated the housing bubble and created the mess we are in today. Chairman Bernanke’s easy money in the last year has undermined the dollar and sent oil to new record highs every few days, and almost doubling since the rate cuts started. Inflation is here and it is hurting average Americans.

    Second, the Fed is asking for more power. But the Fed has proven they can not be trusted with the power they have. They get it wrong, do not use it, or stretch it further than it was ever supposed to go. As I said a moment ago, their monetary policy is a leading cause of the mess we are in. As regulators, it took them until yesterday to use power we gave them in 1994 to regulate all mortgage lenders. And they stretched their authority to buy 29 billion dollars of Bear Stearns assets so J.P. Morgan could buy Bear at a steep discount.

    Now the Fed wants to be the systemic risk regulator. But the Fed is the systemic risk. Giving the Fed more power is like giving the neighborhood kid who broke your window playing baseball in the street a bigger bat and thinking that will fix the problem. I am not going to go along with that and will use all my powers as a Senator to stop any new powers going to the Fed. Instead, we should give them less to do so they can do it right, either by taking away their monetary policy responsibility or by requiring them to focus only on inflation.

    Third and finally, since I expect we will try to get right to questions in the next hearing, let me say a few words about the G.S.E. bailout plan. When I picked up my newspaper yesterday, I thought I woke up in France. But no, it turns out socialism is alive and well in America. The Treasury Secretary is asking for a blank check to buy as much Fannie and Freddie debt or equity as he wants. The Fed’s purchase of Bear Stearns’ assets was amateur socialism compared to this.

    And for this unprecedented intervention in the markets what assurances do we get that it will not happen again? None. We are in the process of passing a stronger regulator for the G.S.E.s, and that is important, but it allows them to continue in the current form. If they really do fail, should we let them go back to what they were doing before?

    I will close with this question Mr. Chairman. Given what the Fed and Treasury did with Bear Stearns, and given what we are talking about here today, I have to wonder what the next government intervention in private enterprise will be. More importantly, where does it stop?

  10. Doc Holiday

    I am told relationships have beginnings as well as endings, e.g, Rome had a nice run and then time moved on — which is what needs to happen with the GSEs and QSPEs and The FASB, GAAP and all the accounting fraud spun off from this modern era of corruption.

  11. Scott

    Fiscal stimulus directed toward non-productive assets is exactly what Japan did for years following the breakdown of their bubble…the result was the lost decade.

    I agree with Hutchinson’s approach…or else repudiate the implied guarantee and let the company fail and the creditors take their haircut. The Chinese govt can absorb this, certainly.

  12. Anonymous

    It’s all about CONfidence, the only thing I’m confident about is the it’s going to come down like a ton of crap.

  13. malabar

    I’d like all the super duper experts to tell me why Bill Gross should not get a haircut on the Fannie and Freddie bonds he owns?

    After all he made that extra coupon all these years. He’s made billions personally. He’s got an army of PhDs modeling every scenario known to man. Why does this dude need my meager hard earned dollars to keep his bond investment whole?

  14. S

    Pump failure. market finsihes down after all the talk and the apparent SEC action to halt shorts on PD and GSEs. Lets see GSEs down 27% each today. money center banks down average 5%. Regionals down 2 to 7% across the board. PD with LEh the exception down 1-4%. The market took the vote to the floor today and it failed miserably. Bernpaul 0, Shortsells 1

  15. Anonymous

    Bailing-out/backstopping Fannie and Freddy is a mistake. It is the function of the GSE’s that is systemically too important to fail, not the organizations themselves. As Roubini suggests, the rescue should consist of temporarily nationalizing the GSE’s function, bond holders take a haircut, the shareholders should get wiped out, and where called for management should be prosecuted.

  16. Anonymous

    “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.”

    Yes! The buyers of this debt BOUGHT and ACCEPTED the risk of default. The taxpayer didn’t – they did.

  17. fimbo

    the GSEs are only the latest victims of predatory lending.

    People are talking about these GSEs without regard to the undelying market, same mistake we with oil when it was trading at around 10 dollars.

    The demand for homes will continue to grow – there is no way the next generation will settle for renting – while investment in new construction etc will be negative for the decade whatever happens to GSEs.

    Imagine what will happen to home prices!

  18. Yves Smith


    It was a big surprise to demographers that the US showed population growth in the 1990s. It had been forecasted to fall, as it has in most advanced economies.

    The reasons for the growth was immigration and comparatively high birthrates among Hispanics.

    Moves are afoot to restrict immigration. mainly illegal, but it may redound to legal as well. Birthrates tend to drop in weak economies. And the baby boomers tended to have their kids late, so we are hitting the end of the so-called echo boom.

    Long winded way of saying you can’t count on continued population growth.

  19. Independent Accountant

    I have favored something like Hutchinson’s proposal for years. I never thought Franklin Raines should have been paid over $150,000 a year.

  20. Lune

    There’s a troubling inconsistency between the Fed/Treasuries statements. On the one hand, whenever it talks about bailing out the GSEs, they say that the vast majority of the GSE’s assets are fundamentally sound, and thus, the govt would only be on the hook for 5-10% of the total assets, which is a relatively “small” amount of $500 billion. On other other hand, when people suggest that the GSEs be allowed to fail, everyone talks about how the world will end because there will be a $5 trillion hole in the world’s balance sheet.

    Well which one is it? If indeed the expected losses on GSE assets are only in the $500 billion range, then no intervention is necessary. The private markets have already taken $500 bil in losses and are still standing. If $500 bil is chump change for the U.S. govt and the Amerian taxpayer, then it’s surely chump change for the global economy. Why the need for bailouts?

    OTOH, if the losses are expected to be so staggeringly high that the global economy will come crashing down and we’ll all be bartering seashells and goats next year, well then, surely the losses are also too high for the U.S. govt to bear alone. In which case, we have no choice but to let the GSEs fail (and maybe start collecting seashells :-)

    Either way, people need to decide on the basic facts. Exactly what losses are the GSEs looking at? And how exactly is that amount too much for the global economy (including a multitude of central banks) to bear, while simultaneously being trivial for a single economy (and one central bank) to bear? That’s illogical.

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