Paul Krugman: The Power of De

Debt deflation is bad news:

The Power of De, by Paul Krugman, Commentary, NY Times: ...The just-announced federal takeover of Fannie Mae and Freddie Mac ... was certainly the right thing to do — and it was done fairly well, too. The plan will sustain institutions that play a crucial role in the economy, while holding down taxpayer costs by more or less cleaning out the stockholders.

But Sunday’s action needs to be seen in a larger context..., the attempt by the Federal Reserve and the Treasury Department to contain the fallout from the ongoing financial crisis. And that’s a fight the feds seem to be losing. ...

[Since the housing bubble] popped two years ago home prices have fallen faster than they did during the Great Depression.

Falling home prices, in turn, have led to the much-feared phenomenon of “debt deflation.” ...[T]he prices of assets, which are what matter for balance sheets, are dropping fast.

As the economist Irving Fisher observed way back in 1933, when highly indebted individuals and businesses get into financial trouble, they usually sell assets and use the proceeds to pay down their debt. What Fisher pointed out, however, was that ... if everyone tries to sell assets at the same time, the resulting plunge in market prices undermines debtors’ financial positions faster than debt can be paid off. So deflation in asset prices can turn into a vicious circle. And one consequence ... is a severe economic slump.

That’s what’s happening now, with debt deflation made especially ugly by the fact that key financial players are highly leveraged — their assets were mainly bought with borrowed money. As Paul McCulley of Pimco ... put it..., just about every financial institution has been trying to reduce its leverage — but the plunge in asset values has nonetheless left these institutions with more debt relative to their assets than before.

And the numbers keep getting worse. ...

Which brings us to Fannie and Freddie. They’re the only big financial institutions that haven’t joined in the rush to deleverage, which is why they now account for about 70 percent of new mortgage loans. But their financial foundations have been undermined by debt deflation, even though their lending was more responsible than average. ...

So Fannie and Freddie had to be rescued — otherwise debt deflation would have gotten much worse. ...

But is it enough? I doubt it.

The current U.S. financial crisis bears a strong resemblance to the crisis that hit Japan at the end of the 1980s, and led to a decade-long slump... American economists ... wondered whether the same thing could take place here — and ... the Fed devised strategies that were supposed to prevent that from happening. Above all, the response ... was supposed to involve a very aggressive combination of interest-rate cuts and fiscal stimulus, designed to prevent the crisis from spilling over into a major slump in the real economy.

When the current crisis hit, Mr. Bernanke was indeed very aggressive about cutting interest rates and pushing funds into the private sector. But despite his cuts, credit became tighter, not easier. And the fiscal stimulus was both too small and poorly targeted, largely because the Bush administration refused to consider any measure that couldn’t be labeled a tax cut.

As a result,... the effort to contain the financial crisis seems to be failing. Asset prices are still falling, losses are still mounting, and the unemployment rate has just hit a five-year high. With each passing month, America is looking more and more Japanese.

So yes, the Fannie-Freddie rescue was a good thing. But it takes place in the context of a broader economic struggle — a struggle we seem to be losing.

Comments

[Bruce Wilder]

That was suitably blunt.

Krugman is dutifully endorsing Paulson/Bernanke, which is understandable in the immediate circumstances, but I wonder if it is wise, in the long run.

As a macroeconomist writing popular opinion, Krugman has only one minor fault, imho, and that is a tendency to see critical macroeconomic policy as essentially technical. He, certainly, sees the present question as technical, above all else. His primary concerns are to legitimize, in a measured way, the panic and the response to the panic.

But, ultimately, there are structural and income distribution questions at stake as well. How will the banking system be structured and regulated? How will the decline in American income be distributed?

For all the talk of this being a "change" election, no one seems to want to take the risk of suggesting too radical a set of changes is necessary. The policy environment is one, in which people seem to me, generally, wanting repair rather than reform and restructuring. They want a little stimulus to set everything back on the familiar path. And, yet, everywhere, there are profound pressures for structural change of a radical nature.

[Cyrille]

My take is that Krugman had very little time to write about the implication of how they will be rescued.
That they had to be, well, honestly, this is something we must live with.
The specifics are more worrying. It seems to just be a 'prop up for November' which will make things much, much worse in the future. But I guess that by the time he had to submit his paper (despite obviously getting extra time, in a normal schedule he would have to have submitted before the annoucement), he never had a chance to study the how.

Which of course will mean he does not comment on them.

[gordon]

I hope when the books on the crisis start coming out somebody writes a chapter on the fascinating tale of how, early in the crisis, everybody was keen to "protect the real economy". But now, people only talk about "containing the financial crisis", ie. saving the financial system. For my money, the key event was the collapse of Bear Stearns. Before that, there was a "real economy"; afterwards, there wasn't.

[a]

So it's the right thing to do - but it's not going to help anyway? Give me a break. Roubini has it right: this is a transfer of wealth from the U.S. taxpayer to asset holders, which means the wealthy and foreigners. The transfer will be on a scale far greater than the Bush tax cuts. All done under the fig leaf of saving the U.S. economy, which apparently Krugman doesn't think will happen anyway.

The most immediate effect of the bailout will be to increase the chances that John McCain is elected, as it may provide just enough stability to get us past the November elections without a crisis.

A sad day for average Americans, a sad day for America, and a sadder day still for the world.

[Linda]

a says: The most immediate effect of the bailout will be to increase the chances that John McCain is elected, as it may provide just enough stability to get us past the November elections without a crisis.

from Naked Capitalism:

"Paulson said he didn't want to "kick the can down the road" but settles on a plan that his team called a "timeout"."

So is that it? Is it set to help McCain, and, failing that, set up Obama?

[hari]

Finally...Paul is coming around to subscribe to Dr Dooms scenario of stagflation and more ....

The structural deficit is left out of his evaluation, and the country seems to be digging in for a bitter winter.

[save_the_rustbelt]

Interesting - no solutions are offered.

[Andrew Hartman]

Well, there are two good things about Krugman's article and
the responses: first, Krugman didn't brag about how he was
all over this in the mid-90's, and no one has used the word
plutocrat yet.

[Mark]

"Avoiding a decision on the issue [privatize or nationalize the GSEs] enhances the likelihood of congressional backing for the emergency steps, Democratic Senator Charles Schumer said."
http://www.bloomberg.com/apps/news?pid=20601087&sid=aRHL3uYQjJWM&refer=home

[otherguy]

Here' the best use for the taxpayer's money.

"Dan Mudd, the CEO of Fannie Mae, is getting $9.3 million of severance for destroying his company. Richard Syron, the CEO of Freddie Mac, is getting $14.1 million--in part because of a clause he added to his employment contract two months ago, when it was clear the company was headed for disaster."

[otherguy]

"So yes, the Fannie-Freddie rescue was a good thing."

Yep, now we have a public sewer in which the big banks can dump their financial asbestos and be made whole by the taxpayers. A good thing, indeed.

[Benflation]

I, Benflation Bernanke promise you as long as you will allow me to head your monetary manipulation committee (MMC), will NOT allow the dreaded DEFLATION to destroy the financial system of america.
I promise, with the approval by Hanky Panky, to monetize any and all assets and derivatives of said ass-ets including but not limited to arsets, buttlets, bootylets and derivatives
of derivatives including craplets and turdlets.

[Inconsistent]

Its funny how rising prices are seen as a natural market operation to direct more resources into a sector, but falling prices are seen as disaster. Be consistent. If falling prices are a disaster, then rising prices are also. If flexible prices are good on the way up, then they are good on the way down too. Resources must be redirected to alternative sectors when enough McMansions have been built for the well to do (the only types of abodes allowed to be built in many areas).

BTW, over zoned areas magnified the problem many fold. Super bubble prices only appeared in areas with inelastic supply. Jingle mail in these areas made an otherwise manageable problem intractable.

[dogfacegeorge]

"[The bailout] takes place in the context of a broader economic struggle — a struggle we seem to be losing."

Yeah, yeah, yeah, but did you hear the latest about that hot Alaskan governor?

[bakho]

Housing prices collapsed and credit card debt is next. Credit is overextended beyond the ability of too many to pay it back. As a result, the value of the debt to be paid back must sharply increase (inflation) or we need massive downward redistribution of wealth so the people that are in hock up to their eyeballs can make good on their debt. If not, those at the bottom will have too few resources to sustain the economy.

[paine]

this wasn't a choice
any more then hosing down
a roof on fire is a choice
the time for choices is past
now its a fight to save stuff
like global output growth
from the hi fi confligration
slow mo fire balling
around and around the planet
our national fire department is
faced with only one of about 200 national fires
ya its way the biggest and badest
but the fire brigades so far are not even containment capable
my guess a japaning of the global economy
is a 50 50 shot at this point
what with the euro zone
the nordic belt england etc etc
under mr potter's school of tight ass credit management

suffer the hapless north wagery will indeed

practical elite talk about fiscal action
is suggesting demand boosts magnitudes too low

i can only hope come january
the right o appoint sureme chief judge
swears in
the air pirate as our commander in chief
and his
fronteer fremont films
polar star
as vice president hockey mom
then we can watch
the babbits' for jesus wing
of repubs catch the hell

oh ya my new slogan:

arm the foetuses

they have a right at conception
to defend themselves
against any
potentially
hostile womb terrorist
that might happen to be their hostess

[paine]

on a lighter note
the evocation of irv fisher
circa the depths of the Great One
reminds us all:
one head can contain
both keen analytic insight
and absolutely wrong policy solutions
and
both at the same time

[paine]

bakho

"those at the bottom will have too few resources to sustain the economy"

and i'm sure u agree
those "at" the middle of the heap too....

you stagger
miraculously

--as if guided
by a higher powered
invisible hand--

past uncovered mind holes

to the right of u :
"the value of the debt to be paid back
must sharply increase.... "

and

to the left of u :
"we need massive downward redistribution of wealth "

and arrive at the correct destination:

the road thru shitsville could be
long and winding

bravo

apropos the wealth bit :

since
under present class power co-relations
wealth share --real wealth --
can't be moved "down"...much
in fact
---contrary to your implied "harden the dollar "
remedfy implied above
uncle can only attack the value of
private paper wealth in general
and that only by raising
the relative value
of life's real stuff --ie piling
macro policy induced product inflation
atop our spontaneous asset deflation---

but
that hurts
the toiling victim class
more even then it hurts
the thieving culprit class

so i suggest instead
nt a quixotic call for a massive
downward wealth transfer
but instead
a nice big broad bold and yet sustainable
disposable pay raise
thru
a macro policy of
hyper-full employment ....for ever

[anne]

http://krugman.blogs.nytimes.com/2008/09/08/deprivatization/

September 8, 2008

Deprivatization
By Paul Krugman

I wish people wouldn’t say that Fannie and Freddie have been “nationalized.” I mean, it’s basically accurate, but it conveys the wrong impression.

The fact is that Fannie Mae was originally a government agency; it was privatized in 1968, not for any good economic reason, but to move its debt off the federal balance sheet (and Freddie was created 2 years later as a competitor.) Private ownership of Fannie and Freddie never made any real sense, and was always a crisis waiting to happen.

So what we’re really seeing now is deprivatization. It’s not something like the UK government seizing the steel mills; it’s more like firing Blackwater and giving responsibility for diplomatic security back to the Marines.

[im1dc]

The following comment from Anatole Kaletsky's 9-8-08 Editorial in the TimesOnline London, UK entitled "Big intervention should assure America's recovery" applies equally well to Krugman's Editorial, imo:

"If government intervention was so helpfull as Anotole claims, the richest country on the planet would have been the USSR. It is more an act of despair than sound economic policies"

"Fred, Cambridge, UK"

[im1dc]

The following comment from Anatole Kaletsky's 9-8-08 Editorial in the TimesOnline London, UK entitled "Big intervention should assure America's recovery" applies equally well to Krugman's Editorial, imo:

"If government intervention was so helpfull as Anotole claims, the richest country on the planet would have been the USSR. It is more an act of despair than sound economic policies"

"Fred, Cambridge, UK"

[im1dc]

This is no longer the USA of our fathers.

(Oops, sorry for the double post above)

[paine]

"The structural deficit is left out of his evaluation"

structural deficit ????

hari please come to terms with
the near tragic
mind shackling
produced by your pre keynesian
paradigm

i take you for one
not addicted to
the warming solidarity
of widely shared ....and worshipped

conventional delusions

[Zipf]

Although I am sure this is elemenary - why will FRE and FNM stock price go to zero under this deal? The company won't dissolve. Yes there won't be any dividends, but lots of companies don't pay dividends, and are priced on the dividends they might pay in the future.

[Julio]

paine,

In fine form today!

"oh ya my new slogan:

arm the foetuses"

Second Amendment rights, of course, we just needed you to connect the dots, thanks!!

"a nice big broad bold and yet sustainable
disposable pay raise
thru
a macro policy of
hyper-full employment ....for ever"

Keep plugging at this, maybe eventually we the people will all hear.
Maybe we can keep the pols from turning it into the War on Unemployment.

[im1dc]

anne posts this 9-8-08 Paul Krugman comment "Private ownership of Fannie and Freddie never made any real sense, and was always a crisis waiting to happen."

Question to anne, doesn't this sort of bold absolute assertion coming AFTER THE FACT by Krugman and all the other pontificating talking heads give you pause to question the reliability and validity of the source?

After all claiming to clairvoyant after the fact is lame if not outright dishonest.

[anne]

Zipf:

Although I am sure this is elemenary - why will FRE and FNM stock price go to zero under this deal?

No; the question is well, well worth asking, especially since some of the supposedly smartest Wall Street investors had no understanding of the answer. While I have noted for several years that Warren Buffett sold billions of dollars of Freddie Mac stock after owning the stock almost from formation of the corporation, and an important hedge fund manager for several years invested against Freddie Mac and Fannie Mae, there were steady buyers.

The sellers understood that the problem was earning, earning, earning, while the buyers just didn't understand. The lack of value of stock of the corporations is due to there being no prospect of earnings that will no go to fund the government assistance for years to come. Corporations with no earning prospects are seldom proper investments, especially mature corporations where earnings are to be absorbed for government assistance.

Nonetheless, there were buyers to the end and hot shot buyers at that.

[paine]

im1dc quotes:

"If government intervention was so helpfull as Anotole claims, the richest country on the planet would have been the USSR "... yikes !!!!

the brothers free marketovich strike again

ps & nb
the comment so sliced from
by imilack-1
is signed

" Fred, Cambridge, UK "

hmmmmm
i smell a free slav here

should we try
something more like ...

i-b-free range zbugnik, west kiev (uk)raine

am i crazy ....i wonder ...

at any rate
even if in this case
the true identity of fred is to wildly to the contrary
the air is filthy with "zbugniki" and their ilk

which provokes this cri de heart strings :

stop anglo-american corporate press
stop
stop giving such lavish public
space and time
to the glib gibberings
of these moth eaten
disguised gosplan survivors
i guess just properly phrasing the plee
provides the answer ...don't it ??

" Nyet !!!!!"

alas i must trudge on ...

but geez
some of us north american
urecovered corporate market rubes
are starting to tire
of all this apish radio free europe
-uncle milty friedmanesque quip-ski ing

[anne]

http://krugman.blogs.nytimes.com/2008/09/08/deprivatization/

"Private ownership of Fannie and Freddie never made any real sense, and was always a crisis waiting to happen."

I am thinking, but I know for sure Warren Buffett and Charles Munger would disagree with Paul Krugman. Suppose though all are right? Suppose Buffett and Munger were right about Freddie Mac being properly, conservatively run for a generation but realized there was a problem developing. All this long before Krugman understood, and Krugman is awfully sharp. What went wrong?

I knew something was wrong by 2002, but have never know quite what was wrong.

Thinking.

[anne]

Buffett found a problem when everyone was raving about the value of Freddie Mac, and I know never ever ignore Buffett. Buffett never explains such specific a finding, but a number of investors began to pay close attention and evidently thought Buffett was right from the beginning. I thought that, but why and why not years earlier? What might Krugman know that Buffett could have missed in the early years?

Darn.

[yamada]

After considering all that Mr Krugman has mentioned on the article, I have been insisting on the following thesis.
So I would like to ask your favor to have a look:

Is there any reason, that the deficit of central bank should not be admitted, by providing original fund to the banks for write-offs, to save financial systems?
We must remember the way how bubble was made, and build up the system to cope with the bubble, accordingly.

Bubble is caused by peoples’ expectation that the price of asset(real estate) will soar in future, with pouring high-powered money to the asset side of economic units’ balance-sheet. So, to solve this problem, such asset bubble on economic units’ balance-sheet must get ridden of in order, by the new system as below. Though it may be seen contradictory, high-powered money enables to work this new system. Please remember, no one has ever invented the solution in history, which fact that entraps economic dispute into confusion nowadays.

1. Every economic unit’s(including banks) assets that caused the bubble(real estate or CDO et al) on balance sheet should be evaluated on mark to market basis by the authorization of a third party(maybe auditor), which brings about some insolvent(i.e. debt section surpasses asset section on balance sheet) economic units.
2. FRB decide to write off a certain amount of the loans to the banks, which amount distributed to each bank according to the amount of each banks’ insolvency, calculated on 1.
3. Every bank that gets profit from written off should next enforced to, by using the profit from written off as original fund, write off its loans to its each debtor, according to the amount of insolvency of each debtor. If the bank is unable to use all the written off profit it earned, the remainder is taxed all.
4. Other economic unit that gets profit from the written off by the bank should next enforced to, by using the profit from the written off as original fund, write off it’s loan(or trade claim) to its each debtor, according to the amount of insolvency of each debtor. If the economic unit is unable to use all profit it earned, the remainder is taxed all. These processes are to be repeated operationally.
5. In consequence, the bubble portion of the targeted asset is extracted from the economy, and is transformed to tax.
6. It’s up to the Government how they dispose of their above tax claims, considering the situation of economy, of each bank and of each economic unit. Talking about the latter two, as a option the Government should examine the possibility of the bank’s and economic units’ turnaround, together with the other creditors, remaining desirable debt to the bank’s and economic unit(empirically it's ten to fifteen times annual earnings before interest, taxes, depreciation and amortization, known as EBITDA, of the economic unit), writing off the rest debt, with taking into account the value of disposable collateral(that do not accrue earnings), of guarantor and of consolidated basis.
7. Every write off must be supervised and tracable by centralized function of the system. So every write off must be executed through this function. Every write off may be done through this function, which exist on internet for access.
8. For cross-border. For each non-residential economic unit, the amount of write off should also be calculated in the same way as 4. , on the only cause from specific asset depreciation in the resident country. Economic unit that will be written off should next write off in the same booked currency. In case profit of the written off exists on the non-residential economic units, it's taxed and absorbed by the foreign(=non-residential) government and handed over to the sovereign(=residential) government of the currency, based on treaty.
9. In case inflation expectation exists, the system enables FRB to on one hand raise benchmark rate to cope with inflation expectation, on the other hand restructuring the balance sheets of economic units.
10. FRB should carefully watch the rate of the number of insolvent economic units to the number of all economic units in the US, when deciding the amount of the loans(trade claim) written off on 2.
11. As a result, FRB may bankrupt because FRB paid for asset depreciation to save financial system, the new second FRB shall be established which take over the first FRB.

For further details, please see the blog as below:

http://reversewealtheffect.blogspot.com/

[paine]

"Private ownership of Fannie and Freddie never made any real sense, and was always a crisis waiting to happen"

change "Private ownership " here to
"arms length independent management"
and i totally dis-agree

for a moment
put aside the equity skin game

to see the core problematique

unlike the FED

THESE OUTFITS OUGHTA STAY CLEAR OF CONGRESS

that leaves the nub
bad management

what we have here
is a simple failure to perform as commanded

uncle "appoints his creatures "
ie the mangement team
sets them free in 68
"in market eden "
gives thenm a rival
and tells em both
to do as they please more or less
invest more or less
as they please
within the bounds of market eden
perpetuate themselves as they please
all and for ever
so long as they follow
one rule :
"thou shalt not drink too much red ink "
they transgress
they end up in nod
as has happened here
after a 40 year run
how many pri sec created
publically owned corporations
have a mangement run that long ???

so now the red ink must get absorbed
and
a new mangement team must step in
imposed from the outside

but this round
what outha get left out
when uncle re frees these gse credit shops ??

imo:
the thin living equity ring
around the ever thicker debt trunk

next time
replace that pseudo risk baring profiteers belt
that filthy rotten private scambo
with a publically exacted risk premium
assigned bundle by bundle
and paid in full
on the fly
out of operating margins
to uncle
any operating profits not paid out as incentives
by management to management *
get plowed back into
a risk premium reducing escrow account

*of course comp plans require confirmation
by a fig leaf public board
appointed as necessary
by an ad hoc citizen jury

[Bruce Wilder]

The destruction of Fannie and Freddie was always part of the plan, the plan to redistribute income and wealth upward, always upward. The same plan that destroyed the Savings and Loans. The same plan that repealed Glass-Steagall. The same plan that eliminated usury ceilings on credit cards. The same plan that enacted the last Bankruptcy Reform. The same plan that gave us the housing bubble, is now in the process of eliminating half of the middle class's home equity.

Liberals and progressives need to walk away from being responsible volunteer firemen, and get serious about destroying the arsonists.

[anne]

Paine:

"Private ownership of Fannie and Freddie never made any real sense, and was always a crisis waiting to happen"

change "Private ownership " here to
"arms length independent management"
and i totally dis-agree

[What are you trying to explain?]

[Andrew Hartrman]

Hey Bruce: Give me the name of somebody who cooked up
THE PLAN. Someone who was involved from the getgo, who never
suffered a loss or a reverse. There must be one name that will be obvious to us all, right? How can we confiscate assets and criminalize behavior if you won't tell us what
you know.

[Winslow R.]

Start with Phil Gramm.

http://en.wikipedia.org/wiki/Phil_Gramm

[Jay]

Someone tried to warn us 5 years ago...

http://www.house.gov/paul/congrec/congrec2003/cr091003.htm

[paine]

bruce

"Liberals and progressives need to walk away from being responsible volunteer firemen, and get serious about destroying the arsonists"

destroying or castrating ?????

anne
the gist ??

get wall street at least one step back
from uncle's houseing blood bank
ie remove the private equity play
at fan/fred

uncle's too big to fail pack mules
oughtn't allow private direct participation

risk accounting should be imposed thru an quarterly premium
and
the risk rating entity for the two
oughta have no stake direct or indirect in
the outcomes and no perverse avenue or byway of gain
from
playing it dumb and trusting
while the two
operate with blind abandon
recall the ultimate balloon here
house lot value
pure capitalized ground rent
no replacement cost check on what's proper prudent valuations
add the weird flux and flex or credit rationing
and you need ..well note my jury idea above
apply here too
and probably escrot management incentive
earnings too with a very slow pay out period
all the while still availible ask first line funds
against
operating loses

oh this gets tedious
its a burden being so sage like

[anne]

Paine:

"Private ownership of Fannie and Freddie never made any real sense, and was always a crisis waiting to happen"

change "Private ownership" here to
"arms length independent management"
and i totally dis-agree

[So the problem in time became management independence, which might explain what finally bothered Buffett enough to just sell and evidently not to try to influence management. Buffett has intervened with others managements before, but not in this case.]

[paine]

andrew hartman
why play flack shooter for wall street thieves
its a criminal process
any participant no matter how partial
deservs a keel haul

any debacle like this ...or iraq
has its dynamic means ..even objective modifying aspects

as to a single founder thru finisher
how silly a notion

the aggregate will of the profiteer class
-- their over soul so to speak---
emerges from the hord of greedyindividual heterogenious
partial aware players

what emerges as a purpose from their colective play
gets modified
by changing fads facts and fancy
why does this process need a single
homoculian core ???
or even a full spansion thread
a one player play line
reaching back to an orignal conspiracy
or forward from that dirty original deed
to the present dabacle
to turn highly redundent
the plan is a collectively emergent pattern
a conjnction of asocial micro plans
sharing a common self centered gain max goal
and self aware enough to feed back on itself
and take on intentional characteristics
even as each player only strives to gain max
his or her program
the conglomeration can have collective endemic sponateous
common intention driven behaviours eh ???

which one of us can't see the common intent of a street
full of shop looters
-- society's
highest form of catabolic progressive heros
to me btw ---

looters are not co ordinated by a hierarchy with a unitary plan and yet we an call their acts predictable in outline
given certain "conditions"
collectively intended even if improvised in detail

[ken]

This announcement was not what I was expecting. I have given it some thought and do not think it is good news for the credit markets and will, I believe, do more harm than good.

The most glaring mistakes are:

1) Wiping out the common and preferred shareholders and telling the world that the Treasury is going to do this on its own, ie taxpayer, dime.

Many investors were willing to add capital to shore up Fannie and Freddie but were just waiting for the Treasury to clarifiy their intentions. Now it is going to cost the Treasury far more than it would have otherwise had they brought investors into partnership with them.

The government is ready to put 100 billion into each GSE in exchange for a preferred issue that pays 10% dividend, 12% if deferred, and has warrents attached for up to 80% of the companies. What a sweet deal!!!! Institutional investors would have gobbled this up had they been allowed to participate. Many institutions have a vested interest in keeping Fannie and Freddie viable and returning them to good health.

In my opinion it was politics and not sound economic or business practices that led them to make the decision to freeze out investors.

Is the credit market going to have any more confidence in the US Treasury now than it did before? I don't think so. This only makes the US Treasury weaker by added to its debt burden. It does nothing to strengthen the GSEs beyond the backing of the Treasury, which they had all along anyway.

2) Putting GSEs into a conservatorship with the ultimate disposition of the companies to be determined some time in the future.

Paulson called it a 'time out'. This analogy, like his 'bazooka', is all empty talk and the 'time out' will not work. The credit markets do not take to time outs unless they are shut down, and the government has no jurisdiction over global credit markets.

Paulson has left investors just as uncertain as to what will happen to the GSE's long term as they were before he made his announcement. I see the potential for serious spread widening on GSE debt, the opposite of what Paulson wanted to accomplish. Paulson left the door wide open to completely severing the GSE's from the Treasury through total privatization With that remaining on the table are the global investors going to buy GSE bonds with that doom hanging over them?

3) First expanding and then mandatory shrinking of their portfolios, in luie of raising more private capital.

Think about this. Are you more willing now to buy a home knowing that in a few years time there will be no room for Fannie or Freddie to finance the sale of your home to another family? How does announcing to the world that the GSE will be shrinking their loan portfolio by letting loans run off and not buying any new ones, how does that help the real estate market today? Home purchasers are just as forward looking as are any other investor. Potential buyers can see what this means to the mortgage market. It means fewer cost loans in the future - which means lower future prices for the home you are thinking about buying today.

The Treasury itself will buy loans for the next fourteen months. After that it will stop buying loans and Fannie and Freddie will stop buying loans. How in the heck is that supposed to comfort us that the long term credit markets will remain healthy?

Where is the liquidity going to come from?

4) Roll of the dice.

This entire plan is a roll of the dice on the part of the current administration that they can kick the can down the road far enough that the next administration will have no choice but to chase after it. By the time they catch up the damage will have been so great that it may niegh well be impossible to put FNR and FRE back on sound footing.

I hope I am wrong on all of this but I have absolutely no conficence in what Paulson wants to do. It smacks of politics and compromise and leaves nothing important resolved. I think we are actually worse off because of this decision. Foreign investors don't care about our domestic political struggles between conservatives and liberals still battling over New Deal era programs. They want to see clear cut, no questions asked, permanent government commitmets as far out into the future as the eye can see. And so do I.

[anne]

No; the whole point of the move was for the sake of the credit markets, international bond markets, and there the move will be effective. The Treasury will in time even gain a decent return from the agency purchase. Whatever could have or should have been found several years ago, the Treasury action was proper now for bond holders and that counts as it did in actions taken through the Clinton years.

[paine]

"So the problem in time became management independence"

yes the original spin off design failure
was precisely the equity buffer scheme
versus a socially imosed premium
that itself becomes the buffer
it was obvious from jump street
top management would inevitably
lack independence
from wall street's will
so long as the two operations were tied
at least collectively
"to wall street interests"
thru each outfits private equity ownership pool

now as bruce suggests
that was the intention
make them
---even if creatures of uncle sam----
none the less
zombies of wall street's
many voooodooooo warlocks

[anne]

Like Rubin, Paulsen knows the bond market, and either would have moved similarly.

[Barkley Rosser]

anne,
The explanation for Buffett's warnings back in 2002 had to do with another matter, although it reflected the de facto attitude that indeed the Agencies had a de facto backing by the US Treasury, a de facto attitude shared by the Bank of China and others who have so eagerly bought Agency paper recently. The problem back in 02 was a scandal over bad accounting at Freddie Mac. That led to the removal of Franklin Raines as CEO and a supposed reform of its accounting system.

These more recent problems have had to do with the collapse of the housing bubble combined with the fact that starting in late 2005, the Agencies were pressured into supporting subprime mortgages due to the fact that all the private firms were doing so. All the pro-privatizers have long argued that they should imitate the private firms. That was what the 1968 privatization of Fannie Mae and the subsequent creation of Freddie Mac was supposedly about. Of course, when things blew up last year, all the private secondary mortgage firms basically shut down their shops, leaving the GSEs as the only games in town. Letting them go down the drain would indeed cause a lot of serious problems.

Krugman is basically right. Fannie Mae should never have been privatized back in 1968. Blame that on LBJ caving to various financial interests.

[anne]

http://krugman.blogs.nytimes.com/2008/09/08/deprivatization/

"Private ownership of Fannie and Freddie never made any real sense, and was always a crisis waiting to happen."

Krugman was right then, and Buffett may have even been slow to understand the underlying problem from such a perspective. I surely did not understand that there were no effective management checks, when we were being warned about the need for such checks and how how they could be to find as management in general came to be increasingly more important than ownership.

[paine]

anne
"the whole point of the move was for the sake of the credit markets, international bond markets, and there the move will be effective"

exactly
after 4 decades of tireless portage
the two --as private pack mules
for wall street --are useless now
for equity purposes
and will remain so
till uncle assumes
all ...all the waste removal costs
of trucking off the balance sheets
any and all ...any and all surfacing bad debt
truck it to where ???

where else
to the imperial dollars
endlessly shafted gold mine and financial yuka mountain
ie
uncles unmoved mover
the national credit card

ps barro finkery aside
tax payers need not beware
it will create its own rewards
in higher if irregularly distributed incomes

we need the effective demand stretch here
of putting a floor under house lot values
other wise
the far greater down slide of the wealth effect
will have additional nasty effects on household spending

[Bruce Wilder]

Here are some names, in no particular order:

Sanford Weill
Jake Garn
Phil Gramm
Angelo Mozilo
Harvey Pitt
Charles Grassley

I know this will surprise, no shock you, Andrew, but
1.) economic policy has predictable consequences;
2.) actual human beings enact economic policies, for government and for business corporations.

Literally, thousands of people are involved in political movements, in various roles. There are conspiracies involved, but they tend to be a very minor aspect of the social and political dynamics. It is complex, and sometimes, somewhat chaotic, but it is not impersonal, and it is not the weather.

[save_the_rustbelt]

Having done a lot of bankruptcy (mostly Chapter 11) work in my younger days, I often saw what we now call a "tipping point."

There was a point reached when conventional means would no longer work and the Chapter 11 filing made the most sense.

Never, ever a pleasant decision. Sometimes a necessary decision.

Was this conservatorship at the right time and the right move? I think we will have to wait until this becomes history.

If it was the right move, can it still be botched? Oh yeah.

[ken]

No Anne, Paulson is not Rubin and the Bush administration is not the Clinton administration. Paulson made his choice based upon idealogy and politics instead of upon sound economic or business principles.

How does it help the credit markets to have the UST issue an extra 200 billion dollars in debt over and beyond what they have to issue anyway?

The GSEs already had the backing of the UST. Private capital could have helped filled the hole in the balance sheets of the GSEs if given the same kind of 'deal' the Treasury took for itself. Besides, financial institutions have a vested interest in seeing the GSE's restored to good health. The Treasury could have easily garnered substantial private capital to match or even exceed whatever tax dollars they put in themselves.

And the UST backing of FNM and FRE is now put in doubt. Before there was never a real question about the permanence of the explicit guarentee of GSE debt. But now the 'official' position is that it is in doubt. The new official position is that they may very well be privatized which means losing their explicit UST gaurantees. With that hanging over FNM and FRE who is going to buy long dated debt (5+ yrs) without a substantial risk premium attached?

[Winslow R.]

The meat of Krugman's piece....

"Above all, the response to a Japan-type financial crisis was supposed to involve a very aggressive combination of interest-rate cuts and fiscal stimulus, designed to prevent the crisis from spilling over into a major slump in the real economy.

When the current crisis hit, Mr. Bernanke was indeed very aggressive about cutting interest rates and pushing funds into the private sector. But despite his cuts, credit became tighter, not easier. And the fiscal stimulus was both too small and poorly targeted, largely because the Bush administration refused to consider any measure that couldn’t be labeled a tax cut.

As a result, as I suggested, the effort to contain the financial crisis seems to be failing. Asset prices are still falling, losses are still mounting, and the unemployment rate has just hit a five-year high. With each passing month, America is looking more and more Japanese."

...and I ask Paul, Mark etc. is this where we want to go? Do we want the monetary tool to become ineffective while the fiscal tool gains total dominance? If not, what is the academic's plan? Why not make the monetary tool more egalitarian and save it at the same time?

Paul is very good at figuring out where the economy should head, but McCulley is better. We need a monetary tool redesign, time to start thinking, talking, and blogging.

[kthomas]

More Bushonomics at work: steal from the middle-class, give to the mega-rich.

Prof. Krugman's support for this folly leads me to believe he's getting too old. Too old, because he'll never live long enough as some of us who will long enough to pay this crap off.

[CFA]

"And the UST backing of FNM and FRE is now put in doubt. Before there was never a real question about the permanence of the explicit guarentee of GSE debt. But now the 'official' position is that it is in doubt."

Ken, that's not what the markets are saying today. I've been on conference calls with 3 of the largest fixed income shops today, all of them say the Treasury is now acting on the "implicit" guarantee, none of them perceive this as a temporary. From the conference calls i've participated on, they expect the Treasury won't even come close to needing half of the $100 billion per firm, they are thinking more like $30-50 billion. A number like $100 billion is to create liquidity in the markets and let investors feel its safe to go back into these agency MBS. The idea that the Treasury will go out and purchase mortgage is just another step in the same direction. All three firms I spoke with see MBS and Treasury securities converging in price now that there is an explicit guarantee on the MBS. The only difference between the two is optionality related to prepayment/extension risk. As of this afternoon, spreads have tightened on MBS securities and Treasuries have sold off, so it appears the credit markets like what is happening.

[Barkley Rosser]

ken,

No, there was no official backing of the GSEs by the US Treasury in recent years. That has now only become official (again) with this move. It had been assumed by the markets, including our foreign lenders. So, this move simply makes official what had long been unofficially assumed.

If somebody wants to get all worked up about the Fed and worrying about Japan, in fact this goes back to the early 2000s, when Greenspan was in charge and engineered the very low interest rates that helped goose the housing bubble, which is the real source of the current problem. While the cynics might aver that the low interest rate policy back then was designed to smooth the reelection of Bush in 2004, the publicly stated reasons, beyond holding the economy up in the aftermath of 9/11, was to avoid a Japanese-style deflationary spiral. After all, that possibility was what triggered the famous remarks by Bernanke about dropping money out of helicopters (drawing on an image originally due to Milton Friedman). If the economy was in danger of deflating, then we should offset that by doing the helicopter bit, which was what got him the nickname "Helicopter Ben." In any case, it could be argued that we are now in danger of a Japanese style problem due to our earlier efforts to avoid getting into a Japanese style problems.

[Winslow R.]

Tennis match at the Mellon Open.

Monetary policy takes the ball and drops the fed funds rate to 2%, not to zero as it is necessary for Ben to be perceived as still having some ammunition. Ben pulls out the TAF, TSLF, etc. racket but he is helpless and exhausted. Ben lobs the ball to the Treasury.

Fiscal policy takes the ball and sends out rebates just sufficient to keep the 'real' economy bumping along until after November's election. But wait, the 'financial' economy collapse comes out of 'nowhere', and Treasury starts funneling money into MBS at sufficient rate to avoid financial collapse until after the election but is unable to use sufficient fiscal policy to push the ball out of their side of the court, back to monetary policy. Instead the ball is placed just on top of the net.

Paulson avoids winning the Mellon II award. As Paulson walks off stage Bernanke, by default, looks to still be the only player left.

Meanwhile the academics stand silently on the sidelines.

[Blissex]

«Its funny how rising prices are seen as a natural market operation to direct more resources into a sector, but falling prices are seen as disaster. Be consistent. If falling prices are a disaster, then rising prices are also.»

Martin Feldstein has been arguing on the Financial Times that a proper function of government is to prevent real estate prices from falling below trend. I am not joking, he really said that asset prices should always be above their average:

http://www.ft.com/cms/s/0/29e69ebc-736f-11dd-8a66-0000779fd18c.html
«How to shore up America’s crumbling housing market»

«The current decline of house prices is the natural result of the bubble that by 2006 had raised house prices to 60 per cent above their long-term trend. The sharp decline since then means that today’s prices are about 15 per cent above the trend level. But while a further 15 per cent decline may be inevitable, there is nothing to stop prices declining even further. House prices that could overshoot by 60 per cent on the way up could also overshoot substantially on the way down. During the past 12 months, house prices across the nation fell by an average of 16 per cent. The large overhang of unsold homes continues to create pressure for further price declines.»

«A policy is needed that will permit the appropriate 15 per cent additional decline in house prices but end the risk of a further downward spiral.»

A Lake Wobegon "economist"! What kind of buffoonery one must read in these especially corrupt times!

[Blissex]

«Its funny how rising prices are seen as a natural market operation to direct more resources into a sector, but falling prices are seen as disaster. Be consistent. If falling prices are a disaster, then rising prices are also.»

Martin Feldstein has been arguing on the Financial Times that a proper function of government is to prevent real estate prices from falling below trend. I am not joking, he really said that asset prices should always be above their average:

http://www.ft.com/cms/s/0/29e69ebc-736f-11dd-8a66-0000779fd18c.html
«How to shore up America’s crumbling housing market»

«The current decline of house prices is the natural result of the bubble that by 2006 had raised house prices to 60 per cent above their long-term trend. The sharp decline since then means that today’s prices are about 15 per cent above the trend level. But while a further 15 per cent decline may be inevitable, there is nothing to stop prices declining even further. House prices that could overshoot by 60 per cent on the way up could also overshoot substantially on the way down. During the past 12 months, house prices across the nation fell by an average of 16 per cent. The large overhang of unsold homes continues to create pressure for further price declines.»

«A policy is needed that will permit the appropriate 15 per cent additional decline in house prices but end the risk of a further downward spiral.»

A Lake Wobegon "economist"! What kind of buffoonery one must read in these especially corrupt times!

[Blissex]

«Its funny how rising prices are seen as a natural market operation to direct more resources into a sector, but falling prices are seen as disaster. Be consistent. If falling prices are a disaster, then rising prices are also.» Martin Feldstein has been arguing on the Financial Times that a proper function of government is to prevent real estate prices from falling below trend. I am not joking, he really said that asset prices should always be above their average: http://www.ft.com/cms/s/0/29e69ebc-736f-11dd-8a66-0000779fd18c.html «How to shore up America’s crumbling housing market» «The current decline of house prices is the natural result of the bubble that by 2006 had raised house prices to 60 per cent above their long-term trend. The sharp decline since then means that today’s prices are about 15 per cent above the trend level. But while a further 15 per cent decline may be inevitable, there is nothing to stop prices declining even further. House prices that could overshoot by 60 per cent on the way up could also overshoot substantially on the way down. During the past 12 months, house prices across the nation fell by an average of 16 per cent. The large overhang of unsold homes continues to create pressure for further price declines.» «A policy is needed that will permit the appropriate 15 per cent additional decline in house prices but end the risk of a further downward spiral.» A Lake Wobegon "economist"! What kind of buffoonery one must read in these especially corrupt times!

[im1dc]

Real Meat not hyperbole:

From Today's online Forbes magazine:

"Terms Of The Deal
"Under the deal, Fannie and Freddie, so-called government-sponsored entities (GSEs), will shrink their portfolios of mortgage-backed securities over the course of the next decade. Right now, they have portfolios valued at around $800 billion each, government officials said. Under the terms of the conservatorship, these portfolios can grow up to $850 billion in value. Then, beginning in 2010, the firms will be required to "run off" their portfolios gradually at a rate of 10% per year, though they won't be required to reduce their portfolio values to below $250 billion."

Forbes did not to mention that 1 in 10 of Fannie and Freddie home loans are nonperforming and that number is growing.

Show of hands please: Who here believes the US Taxpayer will only be on the hook for the additional $100 Billion of new capital infusion to cover the next 15 months of Fannie and Freddie?

It is said that "Only fools rush in where wise men fear to tread" and we are about to learn why that is considered a universal truth.

It has been reported elsewhere previously over this weekend that the debt service due to Fannie/Freddie RE losses to the US Tax Payer will be closer to $500 Billion, i.e., half trillion US$, and that's if everything works in the best case scenario.

The excuse given by SoT Paulsen, the other FEDS and posters here that the world's monetary system faced a collapse from a crisis in confidence in the USA if the US Treasury did not bail out Fannie/Freddie has no proof to support it. It is scare mongering pure and simple, read LIES.

IMO, the more likely outcome must eventually be the dramatic fall of the value of the US$ from inflation due to the US Treasury running the dollar presses overtime printing a half trillion in worthless paper money to pay for the bailouts.
=================================================================

payne,

I cut and pasted today, and no, I'm not the "Fred in Cambridge" of the TimesOnline Kaletsky comment, if that is what you are implying.

[Bruce Wilder]

Barkley Rosser: "the real source of the current problem"

I'd be careful about oversimplifying the "real source", and especially about attributing our current problems to a past instance of (arguably) sensible monetary policy.

The right-wing theory that it was all loose money feeds a general agenda opposed to sensible and effective macroeconomic management and regulatory intervention. Echoing that propaganda is not doing any good.

[Blissex]

«More Bushonomics at work: steal from the middle-class, give to the mega-rich.

Prof. Krugman's support for this folly leads me to believe he's getting too old. Too old, because he'll never live long enough as some of us who will long enough to pay this crap off.»

The official honoring by the USA of its debts is not a folly, it is a *duty*.

The folly was to endorse the GSEs and let the bubble explode and all sort of campaign-donating crooks make a lot of money out of it and then use the GSEs to cleanup.

However there was never a serious doubt that the USA taxpayer full faith and credit stood behind GSE debt.

The endorsement by the USA of GSE debt is just a necessary formality, not a folly.

The source of the folly was that the majority of voters chose to close both their eyes and believe the glamorous promises of a gang of confidence men and boiler room operators against their better judgement.

The USA are getting exactly what USA voters chose or at least could not care about. The price of freedom is eternal vigilance.

Tell that to the 50% of voters that are eager to elect McCain because he continues to make all the same promises or the 50% that may vote Obama because he makes new promises.

[Blissex]

Please delete the repetitions of the comment above, strange browser trouble.

[Blissex]

«No, there was no official backing of the GSEs by the US Treasury in recent years. That has now only become official (again) with this move. It had been assumed by the markets, including our foreign lenders. So, this move simply makes official what had long been unofficially assumed.»

Of course there was no official backing, and even official denial -- because otherwise the off-balance-sheet trick could not work, and that was absolutely essential to various other purposes.

But everybody knew it was just an accounting trick to pretend all those loans were off-balance-sheet. The pricing of that debt was pretty clear indicatio
n.

[Winslow R.]

To save monetary policy it's time for Ben to grab the ball off the top of the net and open the Fed window for citizen access. Ben's got maybe 4 months to make the move just in time for the holiday season, a huge gift for the American people. December would be a good month as GWB would be a figure head and the new president would not be inaugurated until Jan.

Annouce on December 31st, and implement in January when America's shoppers are overhung and realize it is time to invest.

[ken]

"Ken, that's not what the markets are saying today. I've been on conference calls with 3 of the largest fixed income shops today, all of them say the Treasury is now acting on the "implicit" guarantee, none of them perceive this as a temporary."

CFA,

They ought to listen to what Paulson has actually said instead of what they wish to hear.

This conservatorship is a 'time out'. During his time out, Paulson says, the discussion will take place and the decision made as to the ultimate dispossion of the GSE's, ie, are they going to be completely privatized or are they going to retain their government gaurantees.

That is the official position. It is a new position, one the government has never before explicitly stated. The most conservative interpretation of this position is that the gaurantees are not really permanent gaurantees, not yet anyway.

It doesn't surprise me that that people you talked to today did not emphasise this. If they are aware of it at all it should scare the cr*p out them cause they have no way of dealing with it. It is easier just to ignore it, for now. But it will not be ignored forever.

Now Paulson, Bush, Obama, McCain and other government official can put this all to rest by a clear cut statement that whatever happens, be they nationalized or not, they will never be fully privatized. Until that happens the option remains to walk away from the guarantees simply by privatizing the companies completely.

If Paulson has made any statement subsequent to his press conference yesterday contra to this I have not heard it and would be most interested in learning what he said.

[Winslow R.]

Time for Ben to change the 'helicopter Ben' moniker to something else.

I'd recommend 'boostrapping Ben' but first he has to earn it.

"Main alternatives to venture capital
Because of the strict requirements venture capitalists have for potential investments, many entrepreneurs seek initial funding from angel investors, who may be more willing to invest in highly speculative opportunities, or may have a prior relationship with the entrepreneur.

Furthermore, many venture capital firms will only seriously evaluate an investment in a start-up otherwise unknown to them if the company can prove at least some of its claims about the technology and/or market potential for its product or services. To achieve this, or even just to avoid the dilutive effects of receiving funding before such claims are proven, many start-ups seek to self-finance until they reach a point where they can credibly approach outside capital providers such as venture capitalists or angel investors. This practice is called "bootstrapping".

http://en.wikipedia.org/wiki/Venture_capital

[im1dc]

From Barry Ritholtz's (Big Picture dot com)

"The bailout does not save the Housing market, which remains distressed -- but it stops an immediate further damage from the mortgage giants to the real estate market.

"Housing still has 4 problems:

"1. There is still way too much inventory for sale; (not counting the "Shadow Inventory")

"2. Houses remain too expensive, by either Median Income to Median Home Price, or by Rental prices to purchase expenses;

"3. Millions of home owners who cannot afford their homes have yet to short sell/walk away/foreclose;

"4. The Economy is entering a recession;"

Back to im1dc: Allow me to ask, if the above is accurate and going to happen anyway, why then the sudden need for SoT Paulsen to do the Fannie/Freddie takeover?

Paulsen's action seems to me to signal one of two scenarios.

#1) There is more pain, much more pain to come across the board to the US economy, not recession, more than recession.

#2) Bush ideologue Republican appointees are deliberately over-stressing financially the FedGovt. by adding a Trillion to US Debt obligations and another $5.4 Trillion to potential Debt Obligations to hamstring the next Administration so that no new major Federal actions can be taken except to stay the course set by the current Bush Administration?

Far fetched? Too out there? Too paranoid?

Well maybe so, but at least I have the IRAQ model to point to that indeed this may be what Bush is orchestrating.

You know, all of this, IRAQ, the Freddie/Fannie fiasco, Bush/Cheney and McCain/Palin remind me of the old Sunday POGO cartoon of Vietnam War days where he declares upon his return that he "meet the enemy, and the enemy is us."

SURE SEEMS THAT WAY TO ME.

[Inconsistent]

Blissex..."Martin Feldstein has been arguing on the Financial Times that a proper function of government is to prevent real estate prices from falling below trend."

Resources were loaned to people who couldn't pay them back, and never had any intention of paying them back. Now MF wants to loan even more resources to other people who won't pay them back, so the old people can flip their homes to the new people. IOW, never actually pay back the debt, just borrow ever more to continuously roll it over to new flippers at higher prices.

The problem with going back to the Y2K trend line is that it was already unsustainably high. In the 1960s, a perfectly adequate home could be purchased for the CPI equivalent of 60K. Now the same home, 40 years older, retails for many times that. Homes have an average life of about 75 years. There is no economic reason for a depreciating commodity to increase in value as it nears the end of its useful life. The Y2K trend line was already a small bubble itself, which became a monster by 2006.

Each succeeding generation has experienced a reduced standard of living because of this trend line.

[RW]

The Republican's problem is Dubya was the chief of their tribe and after years of ritually washing themselves in his urine they are now attempting to persuade themselves and onlookers that it was really rain.

Psychosis does not always arise internally, it can be induced.

[im1dc]

Pardon me one an all, I forgot, with Bush/Cheney its always been about POLITICS:

White House blames mortgage bailout on Congress

By Sam Youngman Posted: 09/08/08 03:09 PM [ET]

"The White House on Monday said the multibillion-dollar bailout of mortgage giants Fannie Mae and Freddie Mac could have been avoided if Congress had acted years ago when President Bush expressed concern about the way the two companies were set up."

http://thehill.com/leading-the-news/white-house-blames-mortgage-bailout-on-congress-2008-09-08.html

November 4th can't come too soon and January 20th, feels like a lifetime away today.

[Barkley Rosser]

Bruce Wilder,

You should have read my remarks more carefully. I did not say the low interest rates by the Fed were the cause of the housing bubble. I said that they "goosed" it, which is to say, made an already happening thing go further. I think that this is indisputable, and I am not one who is into covering up facts for political propaganda purposes or ideolgocial game playing.

As it is, there was indeed a case for somewhat easy monetary policy at that time, a case made in a speech that Greenspan made to the AEA that appeared as a paper in the AER Papers and Proceedings a few years ago. He invoked complexity and asymmetry problems in the financial-economic system as a genuine fear, with Japan the poster boy. I have little doubt that Bernanke, the old student of financial fragility, was the ultimate source of many of the very legitimate arguments in that paper.

Indeed, there are deeper problems in the US economy, and the housing bubble is simply a reflection of them. The policymakers never had an easy problem on their hands, and they do not now, as the continued effort to come up with ever new approaches by the Fed and the Treasury to deal with the matter show.

[anne]

Even though I knew through Warren Buffett that there were problems at Freddie Mac, I never thought the company might need to be limited in growth, so I can understand this being a case where complaints were dismissed as ideology or politics when there was a basis to the complaints. Of course, the point to the complaints was to allow relatively faster growth for wholly private mortgage companies but I can understand being too quick to dismiss the complaints all the same.

The guess I made at the time, was that Buffett thought Freddie Mac was smoothing quarterly profits and I did not think this important though I always credit Buffett on investing and continued to wonder. There was a lot of not knowing, who can tell how much politically motivated?

[im1dc]

Lifted from Brad DeLong's blog today:

"National Review Speaks!

"It says:

"The Editors on Fannie Mae & Freddie Mac on National Review Online: The plan is designed to help Fannie and Freddie ride out the current wave of falling housing prices and to preserve the companies in something like their current form. This is a necessary intervention...

"A friend writes:

"Can you imagine what National Review would be saying if a Democratic administration had just nationalized two of the largest businesses in America?"
+++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++

I hadn't given this aspect of the Freddie/Fannie takeover story a thought.

Where is the outrage? Where is the opposition to Bush/Cheney/Paulsen/Bernanke NeoUSA Socialism?

[Bruce Wilder]

Barkley Rosser: "You should have read my remarks more carefully."

Perhaps, you should have written them more carefully. I doubt that I am the only one, who failed to recognize "goosed" as a term of art.

Barkley Rosser: "Indeed, there are deeper problems in the US economy, and the housing bubble is simply a reflection of them."

So, now, it is not a matter of cleverly designating the "real source of the problem", it is a matter of seeing in housing a reflection of "deeper problems". That cleared it all up for me. Thanks so much.

[Don Quijote]

Hey Bruce: Give me the name of somebody who cooked up
THE PLAN.

Alan Greenspan.

[Andrew Hartman]

Bruce Wilder:

You and I don't have enough time or words to explain ourselves to each other. Suffice it to say: you seem like a smart guy who believes in the big conspiracy. I see it more
as an intellectual FAILURE TO LAUNCH: people with limitations
getting in big trouble when they leave their mental backyards.

You sound like a guy who has read his Marx. "All that is solid melts into air" is one of the great lines of all time.
It is also a short seller's credo. I hope you made some money
from all of this. I shorted Fannie and Freddie long ago. When
Chris Dodd says something has to grow, it's time to sell high.

This is a great time of year. Tomato sauce from scratch
is the way to to go.

[Barkley Rosser]

Bruce Wilder,

I am perfectly willing to plead guilty to being less clear than might have been desired.

The hard fact is that we are in deep doo doo, and that this has been a long time coming. Much deeper than the housing bubble, and one of the reasons we are having such a hassle dealing with the Agency paper problem, is the massive structural current account deficit the US has been running for a very long time, resulting in the US becoming by far the largest net foreign debtor in world history. Nobody has wanted to stop lending to us so that we could continue to buy their stuff, although everybody has known that this was a tiger that could not be ridden forever, even as nobody has wanted us to get off, much less known how to get us off without all kinds of nasty stuff happening.

As it is, part of those low interest rates, even when the Fed was being tighter, especially the longer term ones that drive mortgage rates, were due to all those foreigners so happily buying up all our debt instruments to keep us all on that running, but increasingly weary, tiger.

[Barkley Rosser]

Bruce Wilder,

I am perfectly willing to plead guilty to being less clear than might have been desired.

The hard fact is that we are in deep doo doo, and that this has been a long time coming. Much deeper than the housing bubble, and one of the reasons we are having such a hassle dealing with the Agency paper problem, is the massive structural current account deficit the US has been running for a very long time, resulting in the US becoming by far the largest net foreign debtor in world history. Nobody has wanted to stop lending to us so that we could continue to buy their stuff, although everybody has known that this was a tiger that could not be ridden forever, even as nobody has wanted us to get off, much less known how to get us off without all kinds of nasty stuff happening.

As it is, part of those low interest rates, even when the Fed was being tighter, especially the longer term ones that drive mortgage rates, were due to all those foreigners so happily buying up all our debt instruments to keep us all on that running, but increasingly weary, tiger.

[Barkley Rosser]

Bruce Wilder,

I am perfectly willing to plead guilty to being less clear than might have been desired.

The hard fact is that we are in deep doo doo, and that this has been a long time coming. Much deeper than the housing bubble, and one of the reasons we are having such a hassle dealing with the Agency paper problem, is the massive structural current account deficit the US has been running for a very long time, resulting in the US becoming by far the largest net foreign debtor in world history. Nobody has wanted to stop lending to us so that we could continue to buy their stuff, although everybody has known that this was a tiger that could not be ridden forever, even as nobody has wanted us to get off, much less known how to get us off without all kinds of nasty stuff happening.

As it is, part of those low interest rates, even when the Fed was being tighter, especially the longer term ones that drive mortgage rates, were due to all those foreigners so happily buying up all our debt instruments to keep us all on that running, but increasingly weary, tiger.

[Barkley Rosser]

Bruce W.,

You are probably right that I was too unclear. Among the deeper problems is the huge foreign indebtedness of the US, run by our chronic current account deficits, which foreigners have so far been willing to finance to keep us buying their stuff, even though their buying of our longer term government securities has helped keep long term interest rates down, and thus mortgage rates, thus helping to goose the housing bubble even when the Fed was trying to tighten.

[paine]

incon writes:

"There is no economic reason
for a depreciating commodity to increase in value as it nears the end of its useful life "

correct
but
house lots as locations
do not depreciate my friend
the inflate and deflate perhaps
but they never depreciate

confusing the replacement cost of a house
with the lot value f a location
is the road to self confoundation

[paine]

"never actually pay back the debt, just borrow ever more to continuously roll it over to new flippers at higher prices"
just as it must have a beginning
all personal house lot ownership must have an ending

the house lot market
has first time buyers and last time sellers
in a very fundemental sense
all sales in between are irrelevent
tab these two price trends
and the picture clarifies

[Patricia Shannon]

ken says...
Think about this. Are you more willing now to buy a home knowing that in a few years time there will be no room for Fannie or Freddie to finance the sale of your home to another family? How does announcing to the world that the GSE will be shrinking their loan portfolio by letting loans run off and not buying any new ones, how does that help the real estate market today? Home purchasers are just as forward looking as are any other investor. Potential buyers can see what this means to the mortgage market. It means fewer cost loans in the future - which means lower future prices for the home you are thinking about buying today.

I may be wrong, but I don't think most people who buy homes will think about this, or even understand it. If somebody tries to tell them, they will be sure it will all work out.

[paine]

andy hartman
you waltz in circles

"I see it more
as an intellectual FAILURE TO LAUNCH"

more the missile's nth stage failed to ignite

bso what about the pre nth stage short
by
some of the pokes in on the flight
maybe even plan makers ????

"people with limitations
getting in big trouble ..."

that's what pre positioned escape capsules are for

"..when they leave their mental backyards"

not sure any of us can do that well

[paine]

pat

ken perhaps confuses
the size of future mortgages
with the number of same

if the ratio of mortgage value
to borrower's income
needs a correction ..fine
i think we all agree once that is set right
the market can churn along quite nicely
but how do we get there from here
from todays over geared lot values to tomorrows
properly geared lot vaues
without a wave of loses ???

if we expand the f and f portfolio value just enough

the PEAK THE FAMILY ARK teeters on today
IS the result of the fed and treasury engineered
lot value balloon

people didn't buy too much house
just paid too much for their zone required lot

as simple home owners buyers and sellers
the outcome of this process was beyond our control
but not beyond the control of the fed and treasury
soooooo
those two fine federal instittions
have an obligation to prop in place
our value stranded arks
at least till
household incomes rise high enough
to refloat our homes
so we can slide along through the payment stream
easily
just on our earned income cash flows

long run sane ratios
can be re claimed... with a transition
and don't mean resale prices must fall

[paine]

"Among the deeper problems is the huge foreign indebtedness of the US"
bark is prolly gone

but i'd prefer to frame this as our trade imbalance problem

the pile up of dollar debt
by the dollars creator nation
is not a sin its
in the worse case scenario
a policy hazard

but our staved in production platform
and our chronic product trade gap
are crimes
against the job class

[paine]

"everybody has known that this was a tiger that could not be ridden forever"
but why must it be ???

we can move toward national balanced trade
without exporting recession
that is keynes' gift to all the nations
even the greatest and must debauched of them

[cm]

Patricia: "I may be wrong, but I don't think most people who buy homes will think about this, or even understand it."

How about the guy writing the loan? When the GSEs are in runoff mode (if that ever actually happens), will there be an MBS market to support a loan volume that will sustain house prices?

The overall limit to housing finance has never been buyer restraint, but what size of loans can be obtained.

Aside from what paine said.

[A home among the Gum trees]

Inconsistent said..."There is no economic reason for a depreciating commodity to increase in value as it nears the end of its useful life".

Lets not forget that houses are built on land which, being a somewhat scarce factor,does appreciate in value!

[im1dc]

I think ken, patricia and cm are onto something that has not been explored as thoroughly as needed.

I for one would like to read more on their competing ideas about what may happen going forward with RE in the longer term.

[Barkley Rosser]

Gum,

The famous line of the realtor selling an overvalued piece of land to the sucker buyer in a speculative bubble is: "Land, they ain't making no more of it!"

Of course it can go down in value, does, and has just done so in large parts of the country.

[Bruce Wilder]

Andrew Hartman: ". . . you seem like a smart guy who believes in the big conspiracy."

I actually don't believe in the great conspiracy. I am railing against those who don't take to heart Lesson One at the Psychoanalytic Institute: "Just because you think 'they' are all out to get you, doesn't mean no one is."

Andrew Hartman: "I hope you made some money
from all of this."

I actually did make some. But, that's unusual. I often don't see the money-making potential of my own insights, or I overestimate the intelligence of others. (I shorted Amazon in the tech bubble -- I was right about the value of the company, but being right when everyone else is wrong can be a big mistake.)

Andrew Hartman: ". . . people with limitations
getting in big trouble when they leave their mental backyards."

I actually see these things in much the same way. Bounded rationality, you could call it. People, with a certain attitude or worldview, persistently favoring, politically, institutional reforms of a particular character or consequential tendency. But, having only a rough "technical" idea of what they are doing. People driving a car, without understanding either the mechanics or the physics, but mostly surviving, and getting where they want to go -- though sometimes not having very good taste in the choice of destination or much sense in choosing a route.

To me, the chief benefit of Economics (capital 'e') in the public discourse ought to be to put pressure on the political system to police the fence around bounded rationality. The political system is always going to run on slogans and bumperstickers and a highly imperfect and limited understanding of the dynamics of political economy, but there's a real value in having the slogans correspond with reasonable and rational policy choices. A political slogan, like "fiscal responsibility", can be a good thing if it helps to motivate the political system to be more prone to adopting sensible and (the economists might say) "technically correct" policies regarding budgeting and taxation.

I think we ought to recognize that the economists are also subject to bounded rationality; when they are being serious and responsible, they may expand the bounds a significant bit. Keynes (and Hicks) did a great thing, when they broke the grip of the classical model, and the prosperity of millions were enhanced in the post-WWII period as a result of more sensible, rational macroeconomic policy.

My natural temperment leads me to see all sides of an issue. If I lean heavily in these pages to the Left, it is because I find it easier to get mad at the Right, which I don't think is playing fair, and which certainly doesn't need my help.

I don't think, for example, that there is some "technically right" answer to most public policy questions, or if there could conceivably be such an ideal answer, as a practical matter, I am not sure we are equipped to calculate it, or arrive at it, except as an approximation, with often unfortunately large error bounds. The political process is a way of arriving at answers to questions that have no good, "technical" solution (within our present state of knowledge). To the extent, that human knowledge advances, it is useful, of course, to manipulate the institutional context in such a way that questions that do have good technical solutions are, in fact, put into the hands of genuine experts and technocrats. But, that doesn't shrink the bounds of political decision-making all that much -- many of the really important questions remain partially imponderable.

There's no way to know or calculate, precisely, for example, what the ideal degree of progressivity would be for the tax system. It is not a question we could usefully assign to an expert or a philosopher-king. That doesn't mean that an honest economist cannot be useful in fencing the problem, in cutting off from consideration policy extremes and quixotic notions (e.g. flat tax), which are really, predictably, truly awful.

I think a lot of economists (or think-tankers and editorial writers pretending to be economists) entering the popular political discourse with considerable academic authority are not very honest at all. They promote irresponsible sloganeering, like the Laffer Curve idea that tax cuts will increase tax revenues, which then enable patently unwise national policy choices (e.g. Bush's enormous deficits and increase to the national debt). I think Mark Thoma intends his blog as a remedy for, or at least a protest against, such irresponsible foolishness. And, while I rant for my own pleasure and entertainment, I try to support his intention, as I am able.

Anyway, in the present state of our politics, I find it easier to get mad at the Right, and at Right-leaning, Republican economists, who abuse their academic authority to, in my view, mislead people as to the political policy choices faced by the country. That Greg Mankiw, Harvard economist, would have the temerity to assert that Economics (or a consensus quorum of economists) condemns the minimum wage is simply infuriating hackery to me: utterly dishonest, vicious hackery. So, I rail and rant against it.

If I lean Left, it is because I perceive a gale blowing from the Right. Also, frankly, I think the Left, generally, is pretty dumb. The ideological distribution of economists, even among the heavy-weights, skews so far Right, that Stiglitz and Krugman are barely Left, and already badly outnumbered. So, in addition to the problem of first-rate Right-leaning economists injecting shameless hackery into the public discourse, we have the problem of not having all that many first-rate Left-leaning economists willing to put an oar in. It is easier to kid myself that I might have something enlightening to say, when so many of the few, leading left-leaning economists can be mostly such lightweights.

Economics promotes equilibrium analysis -- a powerful way of thinking -- which, unfortunately, is often easier for someone with the complacent temperment of a Dr. Pangloss to master. Many economists compound the bias of temperment with a certain lazy tendency to pontificate from a perch astride the welfare ideal of a Walrasian equilibrium of perfect competition yielding a perfectly efficient allocation of resources in a world of complete information. It's utter nonsense to "generalize" from such an analytical ideal in this way, and it tends to exclude way too much of human economic experience, including the results of vast amounts of formal economic research.

To me, one of the most useful insights Economics can offer about politics, is that political disputes are mostly about the distribution of risk and income.

Government is in the insurance business, big-time, but libertarians, in their endless meditations on the proper functions of government, seldom mention the provision of insurance. (I mean "insurance" in a very broad, abstract sense, a sense that would, for example, characterize public education as policy implementing government provision of "insurance".)

In a market economy, the distribution of risk and income are intimately entwined, but in our political disputes, it is like only the Right half of the discussion knows what it is doing. The Right argues (as it should, imo) for less insurance. Much of the time, the Left stumbles around, apparently mostly blind to what the argument is about. The Right can throw down as transparent a distracting gambit as the assertion that the Right are arguing for "the principle of smaller government" and the Left falls for it. Utterly exasperating.

Thirty years of the Right winning the policy arguments has resulted in a vast decrease in the provision of insurance to the middle class, and a vast increase in income and wealth inequality, and the Left acts surprised. Morons, who know less about economics than a clerk at Best Buy, mumble piously about education and skills-biased technological change. So, I rant.

It is not that I think the Vast Right-wing Conspiracy has been plotting in secret to destroy the banking system -- I, in fact, think that they have been lobbying, mostly publicly, for more risk, as a means to increase the upward distribution of income and wealth, and they have met with little effective political opposition, and, also, very little responsible intervention from professional/academic economists, who might, at least, fence off the more outrageously foolish choices.

The Right should be pressing for more risk and less insurance. In a world of bounded rationality, there's no way of knowing the unique, ideal answer. And, the Right are people, who are always going to be arguing for lower tax progressivity, less social insurance and less public provision of goods to the poor and the middle classes, etc. Democracy requires the participation of people espousing such interests and points-of-view to function effectively.

If the Commies and Socialists were running things in bizarro Amerika without Richard Mellon Scaife to pay the cost of impeaching the most competent President in 40 years, I'm sure they could manage to run the country into a ditch on the left-side of the road. But, they don't exist, and we're driving the country out of the right-side ditch and into the field.

I fault Economics for not doing a better job of fencing in the Right, and not doing a better job of arming the Left to balance the Right out.

If you add enough uninsured, unattenuated risk to the economy, and distribute more of that risk to people, who do not have the financial capacity to bear it, one gets bad results. Economists, who ought to be subject to somewhat broader bounds on their rational appreciation of public policy choices, should be articulating more clearly the consequences of policy choices as they are being made. But, instead we get Hackery from Right-leaning economists. So, I rant.

I especially hate the economy-as-the-weather metaphor, which is often introduced, to obscure what is going on in the world in a fog of supposedly unintentional consequences, when the consequences are perfectly predictable, but the author not only wants to make it seem like we understand nothing about the economy or political policy, but also doesn't want to expose his own callous indifference to the suffering of others. Phil Gramm, with his disdain for a nation of whiners, is the rare exception: an economist, who is pleased with what he helped wrought. So, I rant.

OK, so I explained myself at the end of a dead thread and no one will read it. Oh, well. At least I understand me better.