Tuesday, 9 September 2008

Sorry, Jim

I had a random thought about acronyms today. You know, how "ASAP" is pretty much a word all on its own. BHP is another one, though less well known. They serve 20 oz Knickerbocker bottles for like $2, and they did me the kind service of regularly letting me in while I was in college. You see, I didn't turn 21 until Thanksgiving break of my senior year. A real prodigy, this one. BHP, by the way, is Beacon Hill Pub.

This evening, I was personally trained. It came free with the gym membership. Never having lifted with any sort of direction, skill or vigor before, I didn't really know how to approach it. It worked. I learned. I hurt. I will do it again. My posture is absolutely abhorrent and my flexibility is a contradiction in terms.

It's been a while since I got on the economics soap box, but I'm jumping back on it with the stuff that's happened with Fannie and Freddie. I enjoy it and maybe people get excited about things and decide somehow to get involved. I certainly don't know all that there is to know about it - very far from it.

Anyhow, let's begin with the mechanics of it. Freddie Mac and Fannie Mae (almost acronyms in themselves - how do you like that, I just figured out one of the random dark hallways of my mind) are two quasi-governmental agencies (or GSE's - Government Sponsored Entities), which were originally begun, by Congress, to facilitate home ownership among Americans. How do you do that? By extending credit. So basically, they are mortgage banks that are supposed to keep lending when other credit facilities (banks, etc) are either unwilling or unable to give people mortgages. Simple enough. The government sponsorship comes in with the implicit guarantee that if Fannie or Freddie should have trouble repaying the bonds they issue in order to be able to extend the mortgages, your dear old Uncle Sam will stand behind the bonds.

The problems inherent in this, for a pure free marketer, are several. You are giving these two entities an unfair advantage over their competitors in that their bonds are supposedly guaranteed by the government. They can't default. Thus, they get money very cheaply and have an advantage over any other mortgage lender who must issue bonds without an implicit government backing. Also, if the market isn't willing to extend loans, maybe they shouldn't be extended? More on that in a bit.

So by now, people probably understand why we have a housing meltdown on our hands. Financial entities (banks, investment banks, hedge funds, etc) could make a lot of money by creating loans and then repackaging the debt of those loans into bonds, called CDOs (collateralized debt obligations) or mortgage backed securities. The process of selling that debt was very profitable. In order to keep that cash cow mooing, more and more debt needed to be created. Originating a mortgage is a wonderful way to create debt, so many many mortgages were originated. More availability of mortgages means that new people who probably shouldn't have gotten mortgages now got them. Since there was more money available to buy houses, prices went up. Since demand and prices were going up, production went up. Since prices went up and the people who probably should have had mortgages had them, people who probably shouldn't have had mortgages got them, only they were weird mortgages that got them started, but the fine print pretty much spelled doom. Read the fine print. All of this was great while prices were going up, but then the fine print caught up with some people and they couldn't repay. They went into foreclosure. This brought down the value of houses. People who bought more house than they could afford, thinking that prices were always going to go up, now saw the grim reaper milling about their front yards. Whoops. Once things start to spiral down, the whole thing just picks up steam.

Now the problem is not only that there are a lot of people in foreclosure, there are a lot of builders not building and laying people off. The mortgage backed securities are being defaulted on, so nobody wants to buy any mortgage backed securities anymore. None of the banks want to underwrite mortgages because the market is going down and no one has any confidence in housing anymore.

Cue Fannie and Freddie.

Fannie and Freddie, to a degree which may become better known as time goes by, issued a bunch of bonds to be able to continue financing mortgages. In some cases they were new loans, in some cases they were older loans. Why would people buy bonds from Fannie and Freddie, which after all was like a half step removed from buying mortgage backed securities? Because if those bonds went bad, the implication was, the government would step in and prevent a default. That implicit guarantee became essentially an explicit guarantee last month, when the Treasury said that they would indeed make a bunch of liquidity available to keep Fannie and Freddie operable (i.e. cover their payments if needed so that they could continue to sell their bonds and make their loans). That action instigated a degree of inquiry and oversight into Fannie and Freddie which had previously been lacking. That oversight turned up some pretty nasty skeletons in the closet. Fannie and Freddie, in serving dual purposes of trying to enrich their shareholders and executives, while also ensuring access to credit for American home buyers, were a little shady. A little funny with the books. Basically, this caused the Treasury to say "oh shit, this is worse than we thought. The only way we can even stem this bleeding is to take these two over completely."

Now, investment banks and hedge funds and all of these other places are having to write down billions of dollars of losses on home loans, to fatal extent in some cases and, I am sure, many more to come. What makes us think that Fannie and Freddie, and the government on their behalf, won't have to do the same? How does the government respond to this dilemma? How do they make good on the oaken promise that is the US Treasury's word? They fire up the printing press and print money. Who cares how much money you owe when you can print the stuff?

Where does that leave us, the innocent bystanders? Fucked. It leaves us fucked. We are on the hook for all of this. We are Bear Stearns, being fire sold. What happens when they run the printing press that hard? Well, no one wants to buy US government bonds, that's for sure (although, incomprehensibly, demand for these suckers was apparently through the roof today). Would you give someone a loan, when he could tell you how much he was going to pay back? That's essentially what the Treasury can do now. The longer they run the printing press, the less each dollar is worth. In school we spell what happens next I-N-F-L-A-T-I-O-N. Inflation. If inflation runs 7% and your 10 year Treasury yields 4%, how much are you making on it each year? That's right, Johnnie, you're taking it in the rear for a minus 3% yield every year. Do you think other countries are going to want to buy treasuries under this circumstance? Is anybody? Do you know how good inflation is for the world?

If there is indeed even a bigger picture than this, it is that the whole mess is fundamentally caused by the average American's inability to live within his means, to save money and to not be greedy. Everyone wanted to buy a mansion on a middle class budget. Everyone thought they were entitled. Hell, you were stupid if you didn't what with prices guaranteed to go up and all.

You might think that having started to talk about this mess in pretty much Wagnerian tones a year ago would make me feel pretty smug. In that, you would be correct. I just wish that there had been more outlets to game the system and profit from it, because at this point my team player to a fault ideology vis a vis the American system has met its fault. Rome is burning, but I'd at least like to have a nice view, a comfortable seat and a nice glass of wine while I listen to the fiddle play.

Jesus that was long. Sorry. Coppi this weekend. Hooray, Coppi. Good luck to all. Don't crash.

1 comment:

Jim said...

It's okay. Private profit, publicly subsidized risk. Moral hazard.

And Palin is getting slammed for saying Freddie and Fannie are too large and too expensive, and that the fed should pull out of the mortgage backing bidness. Yeaaaahhh.... um... right.

FWIW, it's profitable to look and see who the top recipients of campaign finance donation from those pseudo public corporations are. They happen to be the people in charge of "reforming" them. Not to say this game is rigged, but the NBA refs have nothing on the reformers.

My point before is it's worth mulling this over the way you'd mull over a chess move but politics is not worth shedding a tear over. A few people in that game are worth caring about; few are, and rarely are the ones we seem to care most about.