Can Policymakers Keep Credit Markets from Freezing Up?

This helps to highlight that while the Bush/Paulson plan to freeze the interest rate on some subprime loans may help some homeowners, subprime loan defaults are not the primary problem for the economy. The main worry is that banks and other lenders will pull back on loans of all type and cause a slowdown of investment and economic activity:

America's Grand Deleveraging, by David Wessel, WSJ: ...The ... market for credit, the lifeblood of a modern economy, isn't functioning well.

Just a few weeks ago, a lot of folks were arguing that the worst was behind us. Housing was still ailing. But after a big wallop, markets for credit seemed to be moving toward normalcy. The Federal Reserve ended its Oct. 31 meeting declaring that the "upside risks to inflation roughly balance the downside risks to growth." If Fed officials truly believed that then, they no longer do. They'll likely cut interest rates again... Only the most optimistic observers expect the U.S. economy to rebound quickly from its fourth-quarter slump. The argument now is between those forecasters who expect growth to be so slow in early 2008 that the unemployment rate climbs a little, and those who see a recession in which it climbs more.

In ordinary times, this would be unpleasant, but not so frightening. The Fed knows how to treat this condition: cut interest rates. ... But these aren't ordinary times.

For years, banks and investors lent freely. They took big risks for surprisingly little reward (known as "low risk premiums"...). Now, they're shunning risk. Big banks are reluctant to lend even to each other for more than a few days, and are hoarding cash. In a symptom that the financial fever hasn't broken, interest rates for one- and three-month loans among banks are up sharply. The Fed and the European Central Bank are now forced to consider the economic equivalent of alternative medicine. ...

The problem goes beyond mortgages. Rising delinquencies for credit cards and home-equity and auto loans are bound to make banks, credit-card issuers and other lenders wary. "Banks are having to eat into their capital base in order to reserve for growing losses," Mr. Mauldin says. "And that means they have less money to lend."

The Fed's weekly numbers show that bank lending is still increasing. But a lot of that is unwilling lending. Some banks are making loans under old promises to finance customers if they couldn't access financial markets. Others are taking on to their books loans made through complicated off-balance-sheet entities, and now have to set aside capital as a result. At a time when they'd rather reduce their portfolios of loans, that unwilling lending seems certain to lead them to pull back, if they haven't already, on lending to consumers and businesses. ...

Getting liquidity to the choke points, many of which are outside the traditional banking system, is a tough problem for the Fed to solve since most of its tools operate within the traditional banking system. It has been creative, e.g. changing collateral rules so that banks could act as intermediaries between mortgage lenders and the discount window, but there are limits to what it can do within the existing regulatory structure.

Comments

[ndd]

"Getting liquidity to the choke points, many of which are outside the traditional banking system, is a tough problem for the Fed to solve since most of its tools operate within the traditional banking system."

Prof. Thoma:
While it may make economic sense to "get liquidity" to these out-of-system chokepoints (leaving aside for the moment the bailout/moral hazard arguments), as a matter of political equity to the taxpayer, a tradeoff needs to be enforced: in return for Uncle Sam rescuing the non-bank players, those players first agree to submit to future regulation, and further if they received taxpayer money or credits, Uncle Sam gets an equity stake in the player, which Uncle Sam can sell at some date later on to pay the taxpayers back.

[Worker]

Shouldn't banks be pulling back on credits of all types given the ridiculously low lending standards that existed through June? This is a rationale and healthy response.
Just because a private equity bigwig can't fund deals at 8x cash-flow (almost twice prudent ratios) and anyone with a pulse can't get a 100% LTV mortgage doesn't mean that credit constraints are limiting long-term growth, though it is quite a shock from 6 months ago.

NDD, I like the idea that if the government is going to act as a moral hazard banker, at least act like a banker. Take some hefty fees and piece of the upside for borrowing that US credit rating.

I looked at the Chrysler "bailout" 10 years ago, so my memory is foggy. But the "bailout" terms, specifically warrants (options) that the government received made the proposition more attractive investment than many Private Equity deals Wall Street (over) funded recently. I think the government made a decent profit on the deal, which is why bailout was in quotes.

[fiskhusjim]

Oh, please!!

Every time there is a Bush in office there is a banking/credit/finance crisis. Remember Papa Bush's S&L cheat? You know, the one that put Billion$ in Neil Bush's back pocket?

No?

Short memories, Americans.

The Bush family has manipulated the markets this way every single chance they have been handed by the (ignorant) electorate. And it will keep happening.

The Bushes do not have America's interests at heart - they work for the British investors who lost their property and "treasure" as a result of the American Revolution (I know, I know - it IS hard to believe).

You see, first the Bush (and Walker) families tied themselve to Brown Brothers and the Harriman fortune by proving that they were willing to commit treason for profit.

Then, working closely with Tom Dewey, the Bush's were instrumental in bringing the Meyer Lansky money into the Republican Party.

And, finally, they have also been allied with many of the most despicable and detestable of the Merchants of Death - those "Captains of Industry" who are nothing more than murderous parasites on world culture and civilization.

[The Baron]

The biggest issue I see, is that with all of the concerns about liquidity drying up and a credit crunch, what type of message did the Administration just send to lenders?

When they are willing to say that they will forcefully overthrow several hundred years of contract law, and force lenders to reduce the terms on which they can collect their investment, this is perilously close to nationalization. If a bank or other investor now has to think that any investment they make can be arbitrarily canceled, and new amounts of profit assigned by Bush and friends, with no adjustment to the risk associated, why would anyone, foreign or domestic, be willing to loan money to any U.S. investment? No matter how good the terms of the contract, the risk of those terms being changed unilaterally against you are so high, it just doesn't make sense.

[anne]

"When they are willing to say that they will forcefully overthrow several hundred years of contract law, and force lenders to reduce the terms on which they can collect their investment, this is perilously close to nationalization."

I would suggest reading the agreement will show just how perilously absurd this comment is; perilously that is. The agree was tepid and protects lenders far more than warrented and mortgage holders far less than warranted. Duh.

[anne]

"The agreement was perilously tepid...."

http://www.nytimes.com/2007/12/06/washington/06debt.html?hp

December 6, 2007

Lenders Agree to Freeze Rates on Some Loans
By EDMUND L. ANDREWS and VIKAS BAJAJ

WASHINGTON — The Bush administration reached an agreement with the mortgage industry on Wednesday on a plan to freeze interest rates for up to five years for a portion of the two million homeowners who bought houses in the last few years with subprime loans.

The plan, hammered out after weeks of talks among Treasury Department officials, mortgage lenders and Wall Street firms, would allow distressed borrowers who are current on their payments to keep their low introductory rates and escape an increase of 30 percent or more in their monthly payments when the rates expire.

Democratic lawmakers and presidential contenders quickly criticized the plan as being too timid and promoted more ambitious proposals of their own.

The agreement, to be formally announced Thursday by President Bush, is expected to contain numerous limitations that would exclude many — if not most — subprime borrowers, according to industry executives who have seen it. It would exclude those who are delinquent on their payments — about 22 percent of all subprime borrowers, according to First American LoanPerformance, an industry research firm.

The plan is also expected to exclude any borrower whose introductory rate expires before Jan. 1. About $57 billion in subprime loans are scheduled to be reset at higher rates in the final three months of this year, according to estimates by First American LoanPerformance.

Mortgage companies could also exclude borrowers whom they conclude are making enough money to afford higher monthly payments. Barclays Capital — extrapolating from a similar program recently unveiled in California — estimates that only about 12 percent of all subprime borrowers, or 240,000 homeowners, would get relief.

"From what I've heard, I don't see anything that leads me to believe we will see an increase in loan modifications," said Eric Halperin, Washington director of the Center for Responsible Lending, a nonprofit group that has studied the subprime problem....

[anne]

Poor sweet perilously close to nationaliztion lenders:

"The risk is that you could be modifying loans for people who don't need it," said Sharon Greenberg, director of mortgage strategy at Barclay's. "There's only so much you can do without talking to the borrower. You're spending $60 a month on cable TV; can you get by with less? You're spending $200 a month on food for two people, but food costs in your area show that you should be able to get by with $100 a month. These are the kinds of conversations that loan-servicing companies have to have with borrowers." *

* http://www.nytimes.com/2007/12/03/business/03cnd-debt.html

[calmo]

fiskusjim, where have you been all my life?
So, I take it you're not in charge of the Military Records at the Pentagon the biography of the Bush familyDynasty.
Could boost media ratings to have a fiskusjim weekly show on details of this period, no? ...with initial 75% approval ratings...what are they waiting for?
You have my permission to treat us as the test market, fiskus.

[anne]

http://www.nytimes.com/2007/12/06/business/06hedge.html?hp

December 6, 2007

Wary of Risk, Bankers Sold Shaky Mortgage Debt
By JENNY ANDERSON and VIKAS BAJAJ

As the subprime loan crisis deepens, Wall Street firms are increasingly coming under scrutiny for their role in selling risky mortgage-related securities to investors.

Many of the home loans tied to these investments quickly defaulted, resulting in billions of dollars of losses for investors. At the same time, many of the companies that sold these securities, concerned about a looming meltdown in the housing market, protected themselves from losses.

One big bank that saw the trouble coming, Goldman Sachs, began reducing its inventory of mortgages and mortgage securities late last year. Even so, Goldman went on to package and sell more than $6 billion of new securities backed by subprime mortgages during the first nine months of this year.

Of the loans backing the Goldman deals for which data is available, nearly 15 percent are already delinquent by more than 60 days, are in foreclosure or have resulted in the repossession of a home, according to data compiled by Bloomberg. The average default rate for subprime loans packaged in 2007 is 11 percent.

"There is a maxim that comes to mind: 'If you work in the kitchen, you don't eat the food,'" said Josh Rosner, a managing director of Graham Fisher, an independent consulting firm in New York....

[hari]

The ginny is out of the bottle, not even anne can get it back into the bottle!

Let the chips fall where they may!
Since Paulson was one of them responsible for
subprime/SIVs, let the market decide their fate...

If you want a nanny state....ok!
Then think of the consequences....
Democrats will do exactly what they will
on the US Congress floor!
GWB will meander on with his faux deau

[fiskhusjim]

Of course, the real kicker here is that any program from any Bush will be designed to restore the previous status quo - which is how we got this mess to begin with.

Always remember: Bush has no interest in saving homes because that would prevent the land grab that is planned as the next step here.

This program is only intended to preserve the capital of FOBs.

[skeptonomist]

Isn't excess "liquidity" in certain areas a major part of the cause of the problem in the first place? I don't often see people warning about excess liquidity - is it always a good thing? Someone has to think about how we get off the roller coaster.

[fiskhusjim]

Look folks - All this hoopla is about setting the stage for a land grab to come - just like the S&L BS from Papa Bush.

Did anyone see the Chicago Sun-Times report on the geographic distribution of foreclosures and repossessions?

Right now, I live in an area that is experiencing 18 - 32 foreclosures per sq. mile - and that's just about the mean! In some areas is is double or more.

Now, look at these facts, but do it this way: if rich corporatists masquerading as "developers" had simply moved into these heavily fdorclosed areas there would have been a big stick about racism, gentrification, etc.

However, this way - Bushies and other rich exploiters of the most vulnerable citizens of our country can pretend to have offered a chance at the so-called"American Dream" to these folks but they just couldn't accept the "personal responsibility". I.e., they will be able to have their land and eat the closing fees and interest paid-to-date, too!

It's a simple win-win for the rich - and just more poverty for the already impoverished - and, in the GOP, who really cares about those losers anyway?

[ST]

"There are limits to what it can do within the existing regulatory structure."

To understand the limits the Fed does and does not face in lending to banks and non-banks this FEDS paper is a good reference. It states that under section 10B of the Federal Reserve Act a Federal Reserve Bank can lend to a depository against any collateral it deems acceptable. Under section 13(3) of the Act the Fed is authorized to discount virtually any written credit instrument in lending to a non-bank. The conditions on the latter are the following:

(i) circumstances must be "unusual and exigent"
(ii) the non-bank must not be able to secure credit from other banks, and
(iii) five members of the Federal Reserve Board must vote to activate this authority.

The fact that we are talking about "choke-points" means that conditions already meet conditions (i) and (ii) for Federal Reserve lending to non-banks. All that is lacking is authorization by five members of the Fed Board.

In other words, the issue is not what the Fed can do within the existing regulatory structure, it is what the Fed is willing to do.

On the other hand, ndd's point is important. Before opening Fed lending to non-banks the issue of regulating them should be considered. It seems to me, however, that the Fed can use the crisis to demand itemized financials from any non-bank that seek to borrow from it. If the power to lend to non-banks is used carefully, it may be an important step to introducing some sanity into the current financial system.

[Dave]

>"There's only so much you can do without talking to the
>borrower. You're spending $60 a month on cable TV; can
>you get by with less? You're spending $200 a month on
>food for two people, but food costs in your area show
>that you should be able to get by with $100 a month.
>These are the kinds of conversations that loan-servicing
>companies have to have with borrowers." *

I canceled my cable TV service months ago.
Nothing worth watching anyway.

I could use a bailout, but there's no way
I'm going to get one.

What I want to see is lots of these crooks
going to jail. Not the usual Bush administration
"Helluva job" and a pat on the back.

Jail. It's a small price to pay.