Sunday, July 13, 2008

Party Time! Call Indy, then Fanny & Freddy

First Indy, then Fanny, then Freddie. Then go to the Bank Implode-o-Meter spot. Wanna learn a little Economics on the cheap? As E.J. Dionne reported in "Capitalism's Reality Check" on Friday, July 11, 2008:
The biggest political story of 2008 is getting little coverage. It involves the collapse of assumptions that have dominated our economic debate for three decades. Since the Reagan years, free-market cliches have passed for sophisticated economic analysis. But in the current crisis, these ideas are falling, one by one, as even conservatives recognize that capitalism is ailing. You know the talking points: Regulation is the problem and deregulation is the solution. The distribution of income and wealth doesn't matter. Providing incentives for the investors of capital to "grow the pie" is the only policy that counts. Free trade produces well-distributed economic growth, and any dissent from this orthodoxy is "protectionism." The old script is in rewrite. "We are in a worldwide crisis now because of excessive deregulation," Rep. Barney Frank (D-Mass.), the chairman of the House Financial Services Committee, said in an interview. He noted that in 1999 when Congress replaced the New Deal-era Glass-Steagall Act with a set of looser banking rules, "we let investment banks get into a much wider range of activities without regulation." This helped create the subprime mortgage mess and the cascading calamity in banking. While Frank is a liberal, the same cannot be said of Ben Bernanke, the chairman of the Federal Reserve. Yet in a speech on Tuesday, Bernanke sounded like a born-again New Dealer in calling for "a more robust framework for the prudential supervision of investment banks and other large securities dealers." Bernanke said the Fed needed more authority to get inside "the structure and workings of financial markets" because "recent experience has clearly illustrated the importance, for the purpose of promoting financial stability, of having detailed information about money markets and the activities of borrowers and lenders in those markets." Sure sounds like Big Government to me. This is the third time in 100 years that support for taken-for-granted economic ideas has crumbled. The Great Depression discredited the radical laissez-faire doctrines of the Coolidge era. Stagflation in the 1970s and early '80s undermined New Deal ideas and called forth a rebirth of radical free-market notions. What's becoming the Panic of 2008 will mean an end to the latest Capital Rules era. What's striking is that conservatives who revere capitalism are offering their own criticisms of the way the system is working. Irwin Stelzer, director of the Center for Economic Policy Studies at the Hudson Institute, says the subprime crisis arose in part because lenders quickly sold their mortgages to others and bore no risk if the loans went bad. "You have to have the person who's writing the risk bearing the risk," he says. "That means a whole host of regulations. There's no way around that." While some conservatives now worry about the social and economic impact of growing inequalities, Stelzer isn't one of them. But he is highly critical of "the process that produces inequality." "I don't like three of your friends on a board voting you a zillion dollars," Stelzer, who is also a business consultant, told me. "A cozy boardroom back-scratching operation offends me." He argues that "the preservation of the capitalist system" requires finding new ways of "linking compensation to performance." Frank takes a similar view, arguing that CEOs "benefit substantially if the risks they take pay off" but "pay no penalty" if their risks lead to losses or even catastrophe -- another sign that capitalism, in its current form, isn't living by its own rules. Frank also calls for new thinking on the impact of free trade. He argues it can no longer be denied that globalization "is a contributor to the stagnation of wages and it has produced large pools of highly mobile capital." Mobile capital and the threat of moving a plant abroad give employers a huge advantage in negotiations with employees. "If you're dealing with someone and you can pick up and leave and he can't, you have the advantage." "Free trade has increased wealth, but it's been monopolized by a very small number of people," Frank said. The coming debate will focus not on shutting globalization down but rather on managing its effects with an eye toward the interests of "the most vulnerable people in the country." (Read the rest of the article and weep anew.)
Or, as Al Yoon in The Guardian so subtly put it (and our old friend Franklin Raines (Clinton's Budget Director) gets a quick nod here):
Debt of Fannie Mae and Freddie Mac soared in their best one-day gain in history on Friday amid speculation that a government takeover of the housing giants would make the bonds more like ultra-safe U.S. Treasuries. The prospects, sparked by deep consternation over the ability of the companies to survive on their own and a New York Times report saying the government is mulling a takeover, caused investors to flee the companies' stock, which some analysts said could be left worthless. Investors were selling shares of the congressionally chartered companies and buying their debt, which if assumed by the government would be seen as safe as Treasury bonds, said Michael Kastner, head of fixed-income at Sterling Stamos Capital Management in New York. Yield spreads on the corporate "federal agency" debt of the companies tightened as much as 29 basis points for five-year issues, according to broker GovPX/Garban-ICAP. The gapping eased to about 20 basis points, to 0.8 percentage point above Treasury notes, marking "unbelievable" shifts in a market that typically sees 1 to 2 basis point daily moves, a trader at a top-five bond dealer said in an e-mail. It was the most extreme narrowing of yield spreads ever, UBS Securities said in a report. "There's a closer linkage today with Fannie, Freddie and the U.S. government than ever before," said Jim DeMasi, chief fixed income strategist at Stifel Nicolaus & Co. in Baltimore. "It's a credit-quality upgrade." But that also means a credit-quality downgrade for U.S. Treasury debt, which slumped, investors said. For Treasury bond report see: [ID:nN11353603]. The health of Fannie Mae and Freddie Mac is seen as synonymous with the U.S. housing market since they own or guarantee more than $5 trillion in mortgages. The companies hold charters from Congress to raise money from investors by purchasing home loans and pooling them into mortgage-backed securities. They also have massive investment portfolios of home loans and MBS. Speculation that mounting losses at Fannie Mae and Freddie Mac would require billions of dollars in additional capital have fueled a firestorm of criticism this week, sending stock investors fleeing. Fear spread across financial markets after the government offered no hint that it would step in to help the companies. The companies combined have about $1.6 trillion in debt outstanding, much of which is held by central banks around the world. They use the money to fund the portfolios and securities that lawmakers have increasingly relied on to support the ailing housing market. Mortgage-backed securities issued by the companies also gained relative to Treasuries. But MBS issued by Ginnie Mae sharply lagged in price since their relative advantage of full government support over Fannie Mae and Freddie Mac issues would be diminished in a takeover. Stocks of the companies dropped for a third day since investors do not expect a bailout would extend to shareholders. Both fell more than 40 percent when trading opened in New York on Friday, but clawed back after a key senator said the Federal Reserve may allow the companies to borrow directly from the central bank. Investors also drubbed preferred shares of the companies, casting doubts that they would be able to raise the capital they need to avoid insolvency. "The equity market and the preferred markets are telling you nobody wants any part of it," said Julian Mann, a mortgage and asset-backed bond manager at Los Angeles-based First Pacific Advisors. Putting taxpayers on the hook for U.S. mortgages would upend the "entire free markets system," Mann said. "It's very disturbing." After the 4 p.m. New York market close, Freddie Mac and Fannie Mae sought to dispel that they face capital shortfalls. . . . Agency debt already holds the highest ratings, but investors have demanded a nominal spread over Treasury debt for perceived credit risk. The spreads are less than for other publicly traded companies since investors see government ties representing an implicit guarantee. Fannie Mae and Freddie Mac often pitched their debt in the late 1990s as an alternative to Treasuries, which were shrinking in supply due to a U.S. budget surplus. It coincided with the dawn of the housing boom and rapid growth in the portfolios under former Chief Executive Officer Franklin Raines.
And today the AP reports:
Freddie Mac (FRE) attracted more bidders Monday for a highly anticipated auction of $3 billion in short-term securities than it had nearly all year, a day after the federal government provided support for the mortgage giant. "This was a good auction result," said independent banking consultant Bert Ely. There had been fears all weekend about investors shying away from participating in the auction until the government stepped in and pledged to support the struggling mortgage financier.
Is your hand in the air yet? Suzan ______________________

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