A Page From Japan’s Playbook? Bernanke Proposes "Floor" Under MBS Market

One of the widely criticized features of Japan’s approach to its post-bubble crisis was that its regulators tried for some time to avoid the recognition of bank losses. In a deflationary environment, it was not clear how this would lead to a better ending, since with a flagging economy and no inflation to reduce the real (as opposed to nominal) value of the debt, there was no reason to expect the borrowers’ ability to pay to improve. Thus, these dud assets would remain dud assets until some banks (occasionally) made large writeoffs, forcing others to at least whittle away at their dud loans, and a worsening of the downturn in the late 1990s and some financial firm failures finally forced the government to recapitalize banks.

The latest proposal from Bernanke has Japan written all over it. Rather than let the housing market fall to its sustainable price level (in the long run, housing cannot trade far out of line to incomes) and address the damage to bank balance sheets directly, through consolidation and recapitalization, the Fed chair is instead suggesting to not merely continue to support the de facto guarantees to Freddie and Fannie debt, but to continue to provide some sort of prop to the MBS market.

Note that this runs counter (philosophically, at least) to what Paulson said in the conservatorship announcement. that Freddie and Fannie would expand their balance sheets in 2009 but start shrinking them in 2010. We said at the time we doubted that would happen and indeed, the script is already being revised.

The US over time needs to reduce its subsidies to the housing market. It may be quite a while until that can be done, and for political and practical reasons probably has to wait until we are past the downturn we are entering. But it is appalling that the authorities are already renouncing the few commitments to that goal that they have made.

And this of course misses another issue. The Fed, and ultimately the US taxpayer, cannot serve as the guarantor of the entire financial system, which appears to be the posture it is taking. The Fed has already moved to take on considerable risk not only through its alphabet soup of domestic programs, but now has considerable foreign exposure through dollar swap lines.

From Bloomberg:

Federal Reserve Chairman Ben S. Bernanke said the market for mortgage-backed bonds will require some form of government support through either guarantees or insurance programs to weather times of heightened stress.

The Fed chief also said Fannie Mae and Freddie Mac, the largest sources of money for U.S. home loans, should retain some form of government support and oversight even if the companies are transformed from their current federal conservatorship to become private companies…. Bernanke said the current crisis shows there wouldn’t be a mortgage securities market without some government backing.

“The U.S. government’s strong and effective guarantee of the obligations issued under the current government-sponsored enterprise structure must be maintained,” Bernanke said today in remarks to a conference in Berkeley, California. “If the GSEs were privatized, it would seem advisable to retain some means of providing government support to the mortgage securitization process during times of turmoil.”

The vagueness in this statement is deeply troubling. Bernanke wants the GSEs privatized, yet still wants government support to the MBS market. How is that supposed to work, exactly? A new Federal guarantee program, the son of Freddie and Fannie, to compete with the privatized Freddie and Fannie?

In fact, he considers that to be a completely reasonable idea:

One approach would be to create a government bond insurer which would allow issuers to obtain a government guarantee for their bonds for a fee, the Fed chief said.

“This new agency would offer, for a premium, government- backed insurance for any form of bond financing used to provide funding to mortgage markets,” Bernanke said. Mortgage securities “issued by the privatized GSEs as well as mortgage- backed bonds issued by banks would be eligible.”…

Bernanke also discussed the option of covered bonds, while noting that they might be less competitive with existing finance options. Covered bonds offer banks a way to raise money for new mortgages without either selling the loans or packaging them into securities. Instead, a bank issues bonds that are backed by a dedicated and regularly updated pool of loans, which stay on the bank’s balance sheet.

Another alternative for Fannie Mae and Freddie Mac would be a public-utility model, where the two remain as shareholder- owned corporations and are overseen by public boards, Bernanke said.

“Beyond simply monitoring safety and soundness, the regulator would also establish pricing and other rules consistent with a promised rate of return to shareholders,” he said.

The reason Freddie and Fannie were privatized, and were NOT fully taken over by the government (roughly 20% of the shares remain outstanding) is that the powers that be do NOT want to consolidate Freddie and Fannie debt on the Federal balance sheet. The same problem would occur with any new entity once it had been in operation a few years.

The efforts to get a covered bond market started here have produced underwhelming results. And the “utility model” sounds like largely reverting to status quo ante. We tried that before and it didn’t work, remember? If the GSEs are properly capitalized as private companies without Federal support, they would have to have balance sheets a great deal smaller than what they are now. Bernanke simply refused to acknowledge the elephant in the room.

But more troubling than the particulars is the philosophy:

….it would seem advisable to retain some means of providing government support to the mortgage securitization process during times of turmoil.

That goes WAY beyond merely continuing government support for mortgages already issued or guarnateed by the GSEs. This implies an ongoing commitment. How do you provide support during times of turmoil and not other times? This is either appallingly naive or patently dishonest. Take your pick.

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  1. Anonymous


    I interpert the utility model to be an approach not yet tested because there’s never been a GSE regulator that wasn’t either weak or weak and politicized (see 93 page IG report a few years ago). Incompetent regulation and unchecked GSE arrogance allowed shareholder greed to swamp the social mission, eveidenced by eventual yield chasing buying of Alt-A and some 100% LTV loans. A utility would increase capital, lower growth expectations (minimal capital appreciation) with a modest dividend to shareholders. That has never been attempted and is entirely feasible. It is the old model in the sense that a commission would be more likely to bring into proper balance the profit-mission hybrid. The “flawed” model was allowing shareholders/mgmt to pitch the company as a growth stck. The regulator should/could have put the kabash on that in the 1990’s. Also do not forget, the banks– even before Paulson– were giant GSEs themselves in the manner of deposit insurance and lemming-like behavior (group think and market share whoring). This reminder should temper the demonizing of the GSEs that’s fashionable these days.

  2. ruetheday

    “The Fed, and ultimately the US taxpayer, cannot serve as the guarantor of the entire financial system”

    Bingo. At some point, the Fed and the Treasury have to get past this nonsense about propping up asset prices. Protect the core banking system, keep the money supply from collapsing, and put a floor under consumer demand by not letting unemployment rise too high. But forget about propping up asset prices.

  3. doc holiday


    It is nice to hear you and to read your introduction here! I agree that to synthetically support losses at the casino and to substitute free market illiquidity with artificial government bailout cash is absurd. The Fed is hellbent on buying time as it panics week-to-week and in so doing, they are essentially using every page in Japan’s 13 year recession as fast as possible. Thirteen years of denial to ignore market corruption and to keep the powers that be, connected to the same casino is just a reenactment of the same code of criminal conduct that got us into this mess.

    It seems to me, that buying time has the same exact cost as accepting reality now, but for some reason the concept of the future provides the mechanism for both past and present denial. Reality is being exchanged for fantasy!

  4. Anonymous

    Everybody’s always warning about the USA following the Japanese model of what to do (not). But have we pondered that following the Japanese model may have actually become the goal here? Japan is a pretty decent place, the food is fantastic, and overall their supposed lost decade or two didn’t quite topple their society, did it?

  5. wintermute

    I am stunned at witnessing Bernanke’s incomprehension of the root cause of the credit crisis. A few weeks ago we were shocked when Bernanke revealed that he thought the Fed could control commodity prices.

    Now “shocked and stunned” can be conflated to a general condition: “Bernankeosis”

    Definition: An affliction of the mind characterised by thought processes overwelmed with self-delusion, grandeur, and pseudo-scientific logic.

    Example: vast amounts of cheap credit made housing prices go up – so vast amounts of cheap credit must be the solution to a housing crash.

  6. Yves Smith

    Anon of 5:30 PM,

    In theory, a utility could work better, but in practice, there is no reason to think so. First, Jim Lockhart at OFHEO was widely seen as toughminded and smart and resisted considerable political pressure to expand the GSE’s balance sheets until very late in the game. Lockhart also complained that OFHEO was too small to perform effective oversight. But Lockhart capitulated in the end.

    Second, as long as the GSEs or whatever incarnation follows them have an objective of “making housing more affordable” or otherwise helping buyers (which is the alleged point of this exercise, to help middle class buyers buy more housing, although sometimes pressure is applied for more generosity towards lower income cohorts), you will see pressure from interested parties (the housing industry and financial firms) to extend support. There are plenty of lobbies for more largess, no lobbies for restraint. And now that the Fed has clearly lost its independence, how can expect a new entity, with no tradition of independence, to stand for probity? The fundamental goals here are in conflict, and it is easy to see how they will be resolved over time, even if the slippage is incremental.

  7. Small l

    You know, at some point people are going to have to face up to one small fact. You need people with income to buy goods.

    Isn’t globalization wonderful. The jobs have been taken to china the consumption has been left in the USA. That would have all been OK if the consumers where left serving fries for reasonable wages.

    Didn’t happen. It just might be the case you need unions to protect capitalism from itself.

  8. doc holiday


    Yah, you do need people to buy goods and continue playing along with unlimited cash and debt is apparently to be forgiven.

    In addition to this consumer game, globalization continues to distort the complex division between consumer and producer. We have trade agreements and policies in place that support zones that produce finished good for American consumers, but then these goods which end up at Big Box stores are the product of slave-like labor which benefits our GDP. Our government helps grow businesses in a place like Jordan, where labor laws and tax treaties are warped into the illusion of growth and progress here and there — and then meanwhile, mindless financial chaos spins around the globe, wherein consumers want more and more for less, and the mega-scale casinos need more cash from more people — in order for wall street to grow the next Lehman, Bear Stearns, Countrywide and Enron and in the next country that has free labor.

    You really have to wonder how long this game can go on, because it spiked out of complexity into hyperchaos in just a matter of maybe 15 years and I swear to God, it’s out of control! So, how do you restore confidence before XMAS and wish away reality?

  9. luther

    doc: “Reality is being exchanged for fantasy!”

    and those aren’t the only opposites being exchanged.

    pretty cool huh?

    when’s the LHC scheduled to turn on again?

  10. luther

    “the food is fantastic”

    yeah, but their food was fantastic way before the recession.

    not so in the US…unless you live in a place that has fantastic japanese (among others) food.

    (sometimes globalization is wonderful indeed)

    otherwise, excellent point. japan in so many ways has become the usa’s future. the usa is still bound with them from our recent past. and there is still a day of reckoning awaiting between the two.

  11. Anonymous

    they will promise to backstop everything until the point the US dollar collapses, and they will probably continue there.

    What else can they do to stave off reality a bit longer?

  12. fresno dan

    You can amputate a leg with a stroke of an axe, or do it with a rusty spoon. If you have to do it, people will choose the axe. But the rub is that people will say that you don’t really need to do it. We will do the Japan thing cause its the easiest thing.

  13. Anonymous

    Of all the imports our globalization guys bought, Greenspan’s decision to import the Japanese depression was the best.

  14. Tom K

    There’s something fundamentally wrong with the Fed as chaired by Bernanke. The last time I checked one of Fed’s 2 top mission is to protect the value of the US dollar by controlling inflation. Clearly the Fed has failed miserably in this mission. Which is bad enough. But lately all I heard is the Fed bail this out and bail that out. Who the hell Bernanke thinks he is? He is not charged to bail anything out!! He does not run the darn economy. He does not work for Paulson. His only job is to manage money supply and short-term interest rates to the banks.

  15. ndk

    @ anon 5:57, I spent awhile living and working in the middle of Tokyo at a national lab. While it is indeed a wonderful place to visit and live in for awhile, deflation was definitely not part of creating the magic. Project managers and employees would turn ashen every time a new fiscal year approached, because it inevitably meant budget cuts — even if just in line with deflation. Not wishing to harm general morale through across-the-board pay reductions, that meant routine project cancellations and firings once a year.

    That’s when I learned to stop worrying and love a little inflation. It makes it vastly easier to take a little bit away from all employees in tough times instead of really screwing a few.

  16. john c. halasz

    The GSEs were privatized due to smoke-and-mirror budgetary operations during the Vietnam era, to disguise the guns-and-butter dilemma, the same sort of operation that added SSA to the “unified budget”, which later, without malice aforethought, allowed the SSA funds to be looted in favor of tax cuts for the wealthy. In other words, there never was any good economic reason to quasi-privatize FNMA. So rather than returning them to the status of a publicly regulated private utility, why not rather “de-privatize” them,- (yes, I know the jokes have already been made),- and convert them into publicly owned utilities, (a model that has often worked much better in the past)? There would still be problems of adequate regulatory oversight, but it would be much more explicitly in the public domain and, for both domestic and foreign interests/constituencies alike, much more disciplined by relevant constraints.

    A few weeks ago, I left at another site the following as a part of a longer comment:

    “One more comment. The concept of insurance for credit or other financial assets doesn’t make basic logical/economic sense. Insurance depends on investing risk-adjusted premiums in financial assets to reserve against contingent liabilities as they arise, which contingencies must not be correlated with those of financial investments. But, of course, financial investments are correlated through tightly coupled financial markets with other such assets investments, and when the “insurance” is most needed during a financial crisis,- (which is not a 1 in 1000 year occurrence, but, in varying degrees, more like a 1 in 12 year event),- correlatively depreciating various asset classes, those very assets must be sold by the insurer to pay-off default claims, further adding to the downward pressure on asset prices and triggering still more defaults, thus amplifying rather than insuring against the problem. On the other hand, the illusion of such insurance generates moral hazard in the exact, proper use of the term, encouraging financial “players” to take on higher levels of risk, since it has been ostensibly laid off on other parties. (This is slightly different than the point about CDS’s being not true swaps, like interest-rate or currency swaps, but actually, as everyone knows, unregulated insurance contracts thinly disguised as swaps, which, as everyone knows, is insanely dangerous).”

    My point was that there is no basic way to insure investments in financial assets, other than through an adequately diversified portfolio, and even that will be imperfect, since there is no investment without risk,- (and those risks ultimately derive from the uncertainties of real investment in the real economy, which the financial economy can, at best, imperfectly mirror and transmit). I seriously doubt that the whole “world” of derivatives, transferring and reallocating financial risks can allieviate that fact; to the contrary, they multiply (the assessment of) such risks, given the inevitable gap between the financial and the real productive economy,- (and the possibility of misallocations of investment due to that gap). In fact, they can simply serve to rationalize further underlying imbalances in the real economy, which only prolongs and increases the eventual pain. (I’m not denying that there can be some useful functions for some sorts of derivatives; it’s just that they need to be constrained and regulated, to prevent them from overflowing their actual functions and overshadowing the financial and real economies as a whole).

    At any rate, I received via e-mail a reply, which I didn’t notice till this week:

    “”The concept of insurance for credit or other financial assets doesn’t make basic logical/economic sense”
    very good point

    the proper system is to have mandatory risk premia
    and have it paid to uncle sam
    the only player that can make as many chips as necessary
    and claw back the losese
    in the next premium cycle

    okay so the phoney fraudster fuckers stay one cycle up
    that at least is containable and not forever

    the various notional funds for each distinct financial product’s risk pool say mbs
    would be just that all premia would go torwards servicing the public national debt “

    As far as I can make out the correspondent’s point, the only type of financial asset insurance that makes sense is in the manner of the FDIC and the PBGC, (which scandal is just about ready to dawn on the public). But that, of course, requires oversight and regulation with respect to “moral hazard”, hence would impose further constraints on fiscal and monetary policies, to prevent financial asset inflations/bubbles from getting out of hand in relation to the productive capacities and revenues of the real economy. Perhaps Gentle Ben, in attempting to figure out how to make/revive a market for MBS, is just beginning to realize that dilemma: that it can only be done through worsening the explicit fiscal situation, which requires guarantees/confidence in the sharpened operation of subsequent fiscal constraints.

  17. thomas j

    My vote is for patently dishonest.

    Bernanke’s proposal for a government backed MBS insurer, alongside privatized GSEs, is nothing more than another privatize the gains, socialize the losses scheme.

    The longer housing prices are artificially propped up the longer the core banking cartel can squeeze higher debt payments out of mortgage payers.

    Government insured mortgages insure that the issuers gets all their money back then when the defaulted mortgages are sold off to the future “private” GSEs for pennies on the dollar, the banking cartel makes out again.

    Ultimately every last penny of household income will go towards paying for ridiculously overpriced homes. Or for taxes to backstop bad mortgage loans issued by the banks. In the future, mortgages, since they will be backstopped by the federal government, will no longer even be dischargeable in bankruptcy.

    Somebody better tell the “homeowners” signing up for the modification programs being offered by JPM and BAC that they are also moving from non-recourse loans to recourse loans.

  18. S

    first order of business for new president should be to fire bernanke. HE is a typical academic best left to pondering on the grassy knolls of academia. PAulson should follow. And rubin and Geithner and Dimon. All of them are rotten to the core. GS should be left to implode. Isnt there something incredibly strange about Obama and the following from the monied crowd. Can’t be about change now since his proposed cabinet is a bunch of recycled hacks. Geitner for treas sec? this has to be a bad joke. This guy sat on a board with Lehman Fuld at NY Fed and was totally aware of what LEH was doing. He should be deposed and prosecuted for aiding and abetting the i banks by opening the window after bear. Geitner, rubin paulson and bernanke sadly are bad reminders of a time long since past.

  19. Anonymous

    ….Like this is a fixable event. No way. Our system likes to follow the markets in normal times. When they try to lead the markets is when trouble really starts. You can see how well manipulation is working.

    You don’t head up an entity, especially a public anything, yelling that the end is near and we are all going to die. It’s more like death by a thousand razor nicks.

    They never say what the real problem is just keep adding fixes, an endless stream of fixes. Foreign
    US debt holders present the most pressing complications.

    I say make a new Treasury bank. Issue new currency, preferably red in color, then isolated the bad debt on the Federal Reserves books. Stop compounding interest. Issue loans on a fee basis only and of course follow basic accounting.

    Only happens when all else fails or pitch forks and torches are at the door.

    Until then, an endless stream of fixes for a decaying body.

  20. Don

    I know this won’t be popular, but here goes:

    Chairman Bagehot’s Response

    Chairman Bernanke gave a speech on “The Future of Mortgage Finance in the United States”:

    “The financial crisis that began in August 2007 has entered its second year. Its proximate cause was the end of the U.S. housing boom, which revealed serious deficiencies in the underwriting and credit rating of some mortgages, particularly subprime mortgages with adjustable interest rates. As subsequent events demonstrated, however, the boom in subprime mortgage lending was only a part of a much broader credit boom characterized by an underpricing of risk, excessive leverage, and the creation of complex and opaque financial instruments that proved fragile under stress. The unwinding of these developments is the source of the severe financial strain and tight credit that now damp economic growth.”

    The financial crisis was caused by the end of the housing boom. This boom showed problems in mortgages:
    1) Poor underwriting ( True )
    2) Poor credit ratings ( True )
    3) Allowing subprime mortgages with variable interest ( True )

    A good start. 3 obvious principles that investors forswore at their own peril.

    However, the general problems are:
    1) underpricing risk ( What caused this? )
    2) excessive leverage ( True )
    3) complex investments ( ? )
    4) not transparent investments ( ? )

    Okay. I think 1 and 3 and 4 go together, but that’s me. Now he says this:

    “To address these issues, we must consider both the part played by securitization in the mortgage market and the role of the government and government-sponsored entities in facilitating securitization.”

    Here I don’t agree. I’ve already considered securitization with the help of Derivative Dribble.

    Here’s why they’re worthwhile:

    “The ability of financial intermediaries to sell the mortgages they originate into the broader capital market by means of the securitization process serves two important purposes: First, it provides originators much wider sources of funding than they could obtain through conventional sources, such as retail deposits; second, it substantially reduces the originator’s exposure to interest rate, credit, prepayment, and other risks associated with holding mortgages to maturity, thereby reducing the overall costs of providing mortgage credit.”

    Okay. They give:
    A: Originators more sources, e.g., retail deposits
    B: Originators risk decreased on:
    a: interest rates
    b: credit
    c: Prepayment
    d: Holding mortgages to maturity
    And these lower costs of providing mortgage credit.

    This sounds good. The only things needed for using securitization properly are:
    1) Ultimate investors invest in good quality mortgages and underwriters
    2) All investors in process must be able to manage risk
    3) Must be transparent, because hard to price

    Here’s the thing: These are all common sense and not complicated. I’m sorry, but this is investing 101.

    He gives a bunch of remedies, but, I’m sorry, it wasn’t the products. It was the investors. The question is why did these investors take these risks? So, all the remedies are last year’s news to me. Go ahead and fool around with regulating these things. Good luck.

    I believe that investments involving shifting risk to third parties or magnifying risk, often with complicated models, should be looked into or regulated, but the principles need to be broad to capture future innovations.

    In any case, we need better investors, and having government guarantees makes that impossible.

    Here’s Beranke’s conclusion:

    Regardless of the organizational form, we must strive to design a housing financing system that ensures the successful funding and securitization of mortgages during times of financial stress but that does not create institutions that pose systemic risks to our financial markets and the economy. Government likely has a role to play in supporting mortgage securitization, at least during periods of high financial stress. But once government guarantees are involved, the problems of systemic risks and contingent taxpayer involvement must be dealt with clearly and credibly. Achieving the appropriate balance among these design challenges will be difficult, but it nevertheless must be high on the policy agenda for financial reform.”

    I agree that government has a role to play. I just gave one area above.
    I agree that if government is guaranteeing these investments, they should be highly regulated and limited in risk in order to keep the risk to the taxpayer at small as possible.

    Is there any better plan?

    I believe that there is.
    First, I accept what I call Bagehot’s Principle: If the B of E exists, it will be the ultimate guarantor, and that must be taken into account. Given the Fed and our government, they are the ultimate guarantors and must be taken into account. And, following Bagehot, I would like to see the following:

    A: Real moral hazard for banks or financial entities far short of a crisis. No propping up.
    B: General supervision as I recommended above. Minimal, but effective.
    C: Serious penalties if these businesses need government help. I recommend effectively taking them away from them,i.e., nationalization, which is why I favored a Swedish type plan, that would divest these nationalized entities back into private concerns as soon as possible. But such conditions as TARP are not nearly onerous enough.

    These principles have been known since Bagehot, and, since him, we have known that a pure free market plan is not real, as long as certain financial and government entities exist. It’s time we follow his advice.

    Don the libertarian Democrat

  21. a

    Bernanke will never admit that he is wrong. He will just come out with another program. So either he wins, or it’s the end of the dollar/the U.S. financial system.

  22. a

    Bernanke is suffering from Greenspanitis, a brain disease which causes delusions, specifically the belief that a central bank can solve all or most of an economy’s problems. The disease is fatal – to the economy.

  23. Anonymous

    …..In summation, greed is causing pain that will extend the period of recovery spilling into the next couple of generations.

    Have a nice day.

  24. Anonymous


    thank you for your humanistic description of what happens to real people when government is committed to inflation vs employment such as our phony 6% unemployment goal, the only goal Greenspan ever saw that he liked.

    If government is to try to provide stability in the economy, government’s first obligation is to provide security for those willing to play by the employment rules.

    anything else is cruelty. These recent years of employment insecurity, the top able to earn enough in any given year to retire, the rest working at less than living wages, or inflated salaries, levels of commitment and hours worked living in fear of losing their jobs is, again, official cruelty …

  25. Anonymous

    Chairman Bernanke’s Federal Reserve is a rogue institution without Congressional oversight. The Fed papers over the credit problems by standing in the way of price discovery, not allowing the incompetent to be identified and flushed out of the system, and injecting government money prematurely so that help is not available at the cyclical bottom when government funds are most needed to boost the real economy. The Federal Reserve needs to be reorganized, from a semi-private institution controlled by and for private bankers, into to a solely government institution controlled by an elected official, such as a Chief National Accountant, who has the responsibility to warn us when we are acting foolishly.

  26. Anonymous

    I mostly try to analyze policy on this basic premise:

    If the incentive system is set up (whether through free or regulated markets) for people to make decisions that end up with everyone worse off, everyone will end up worse off.

  27. Anonymous

    I’m based in Japan and teach a lot of managers and engineers in west Tokyo. One senior engineer who supervises the installation of large factory style equipment reported that China sales account for 80% of business and that business is extremely bad. China simply doesn’t need any more factories right now. Many products produced in China are produced and priced for export markets and export tastes. Domestic consumption is rising, but not a rate to compensate for any severe drop in demand from abroad.

    As for the banks, this is an interesting problem. I’m loathe to disagree with my betters, however as I recall the key issue for the Ministry of Finance was to establish accurate valuations of bank assets and debt. Something like 300 small and regional banks were folded into larger institutions or dissolved. There’s a good policy paper on this on the net I can probably find.

    The US dollar is perhaps slightly higher than it should be, but if stabilizing the markets is the current desired goal, then the Japanese model seems solid. My own principal concern is the failure of the US to properly develop nuclear energy.


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