Commentaries

Nooooo…not Fannie and Freddie

I know that the government already leaked the plan, but seeing it actually launched I can’t help but feel a little despair that the Obama Administration continues to use Fannie and Freddie to implement new housing policy.  I wrote a column when the idea was first floated to help state and local housing agencies access financing.

Simply, all things Fannie and Freddie at this point – more than a year into the conservatorship – should be squarely focused on sorting out what exactly they’re suppose to be. It seems absurd that they continue to operate in limbo given their enormous role in the housing market and credit markets. Either nationalize them, privatize them or unwind them, but don’t give them new tasks to perform.

If housing agencies need financing, then give them a grant or backstop their municipal debt. It’s more honest and efficient than the mind bending program launched today.

From Reuters:

The Treasury said it will purchase securities issued by Fannie and Freddie that are backed by new mortgage revenue bonds from the housing state and local housing agencies (HFAs). Treasury said the bond program can support “several hundred thousand” new mortgages for first-time homebuyers in the coming year, as well as refinancing “at risk” borrowers into more affordable loans.

The plan also aims to help jumpstart the private lending market for the state and local agencies. Before using proceeds of new mortgage bonds under the program, the state and local housing agencies must sell debt to private investors equal to 40 percent of the total amount borrowed via Fannie, Freddie and the Treasury.

Treasury line of credit should be Bair’s last option

With the FDIC’s staring at an incredibly shrinking deposit insurance fund, it’s no wonder that Sheila Bair is out about talking about the regulators looking at options to replenish it. That includes tapping the $500 billion line of credit the agency has with the U.S. Treasury put in place for a rainy days.

Borrowing from Treasury should be avoided until it’s absolutely necessary since it is likely to give the banking lobby leverage to shirk higher fees now and in the future, as  Wrightson ICAP noted in a recent report earlier this month.

The banking lobby will argue that the FDIC should rely on funds from the Treasury rather than industry resources until market conditions improve.  Unfortunately, as the FDIC knows full well, there never seems to be a good time to hike deposit insurance premiums as far as the banking industry is concerned.  Setting the precedent of borrowing from the Treasury will stiffen resistance to contributions to the insurance fund across the board.  In addition, activating the Treasury credit line might encourage other regulatory agencies to view the DIF as a free resource for patching holes in the financial system….The FDIC doesn’t want to start flashing a platinum credit card in public as long as other agencies might want it to pick up the dinner tab.

And right on cue, at least one lawmaker is calling on the FDIC to head to Treasury rather than the banks, for more funds.

From the Wall Street Journal:

Sen. Carl Levin (D., Mich.) sent a letter to Federal Deposit Insurance Corp. Chairman Sheila Bair on Tuesday urging her to borrow money from the Treasury Department instead of hitting thousands of community banks with another special assessment to recapitalize the insurance fund that backstops deposits.

While it’s true that many small banks are suffering under the weight of souring loans, especially those made to the commercial real estate market, taxpayers shouldn’t have to be bearing the biggest share of the burden.

Carrying the dollar lower

There’s been lots of hand wringing over the fate of the dollar, with its recent slide giving rise to, in the words of blogger Macroman, the “dollar going down forever” crowd. Data released from the U.S. Treasury on foreign capital flows didn’t help matters. Seems in July foreign investors wanted to put their funds elsewhere.

Lots of ink has already been spilled on the well worn arguments that blame reckless borrowing by the US government and the growing movement toward establishing an alternative world currency as the drivers behind the dollar’s decline.

The latest theory gaining traction is the dollar is becoming the funding currency of choice. It’s a compelling case that the FT lays out nicely. It also fits snuggly into the “US. is becoming Japan” school of thought.

Analysts say negligible US interest rates, its quantitative easing measures and little sign that the country is set to withdraw from its ultra-loose monetary policy anytime soon leaves it in a similar position to Japan at the start of the decade.

“This puts the dollar in exactly the same position as the yen back in 2001 and makes it naturally attractive as a carry trade funding currency,” says Simon Derrick at Bank of New York Mellon. “The dollar is the new yen.”

The carry trade strategy, in which low-yielding currencies are sold to finance the purchase of riskier, higher-yielding assets, was widely used in the years prior to the eruption of the financial crisis.

But then again, it’s nearly impossible to prove how much this is driving the currency.

“It’s notoriously hard to find real data to determine the size of carry trades funded out of any currency, let alone the dollar. Hence, it has to remain the subject of conjecture,” he says. “Nonetheless, we feel that it is advisable to assume that this funding switch is happening.”

Macroman throws in his 2 cents here, and notes that the recent declines most likely have to do with foreign central banks cutting back on their dollar stocks that they built up over the last year. (China and Japan, however, added big to their US asset stock pile in July).

Cleaning up the mess that remains

At least the Obama administration isn’t saying “Mission Accomplished.”

In marking the anniversary of Lehman Brothers’ demise, the administration understandably focused on how far we’ve come since, and on the various exit strategies in the works.

Lehman Brothers has been at the center of the narrative of what went wrong last year, and that makes it much easier for the administration to tell a story of triumph rather than the more uncomfortable legacy of dysfunctional companies and hidden toxic assets.

Coinciding with President Barack Obama’s speech in New York, the Treasury released a paper today, titled “The Next Phase of Government Financial Stabilization and Rehabilitation Policies.”

Its summary reads like a check list of emergency programs that are no longer needed now that the worst of the crisis is past. The insurance program for money market funds and the federal guarantee of qualifying bank debt can be tied directly to the fallout from Lehman’s spectacular end.

But last year’s turmoil didn’t begin and end with Lehman. Change the anniversary’s focus to, say, the government’s seizure of Fannie Mae and Freddie Mac that occurred a week earlier, or to American International Group, just a day after, and it’s clear that some of the messier legacies of the credit crisis still haunt the current administration a year later.

The government arguably isn’t any closer to figuring out what to do with the two giant housing finance companies than the previous administration was on September 7, 2008, when it announced Fannie and Freddie would be put into conservatorship.

Recycle the TARP

The U.S. insurance fund for bank deposits is running out of money. At the same time, some of the big institutions that received federal bailouts last fall have repaid more than $70 billion to the Treasury Department, and more checks to the government may be in the mail soon.

Right hand, meet left hand.

Indeed, one way of dealing with this looming crisis at the Federal Deposit Insurance Corp would be to take all that repaid bailout money and simply inject it into the bank insurance fund. Such a move would instantly bolster the deposit insurance fund, which at the end of June had just $10.4 billion in the kitty.

Transferring the repaid bailout money to the insurance fund would permit bank regulators to move more aggressively in shutting down some of the 416 troubled lenders with $300 billion in assets on the agency’s watch list.

And the sooner the FDIC can dispose of the worst banks, the faster the nation’s financial system will be on the path to a real recovery.

Using money repaid to the Troubled Asset Relief Program would also save President Obama from the embarrassment of having to go to Congress to ask for another bailout if the FDIC exhausts a $100 billion line of credit from Treasury.

It’s far easier for Obama to get Congress to approve the reallocation of bailout money that’s already been appropriated than asking for a new round of government welfare for the nation’s banks.

To buy, or not to buy MBS

It looks like the lines are being drawn within the Fed regarding its massive $1.25 trillion MBS asset purchase plan that’s due to expire at the end of the year.

New York Fed President William Dudley told CNBC earlier Monday that it’s too early to think about pulling back on these programs, and points to market expectations as a big reason the Fed should proceed carefully. The market expects the Fed to buy the full amount and is currently trying to figure out whether there’s a possibility the Fed will extend the program into next year to make for a smoother transition.

These purchases, if completed, will account for roughly a quarter of the outstanding MBS market. Without the Fed’s support, risk premiums are expected to shoot higher (and with them mortgage rates) to lure back investors who have moved into other areas of the credit markets to find juicier yields.

Dudley’s remarks come after Richmond Fed President Jeffrey Lacker indicated that improving financial conditions mean the central bank may not need to purchase the full amount of MBS.

With the economy leveling out and beginning to grow again later this year, and with bank reserve demand ebbing as financial conditions improve, I will be evaluating carefully whether we need or want the additional stimulus that purchasing the full amount authorized under our agency mortgage-backed securities purchase program would provide.

Both Dudley and Lacker are voters on the policy-setting FOMC.

FOMC tripping over Treasury auctions

It’s an age old complaint from bond investors – FOMC meetings in the middle of quarterly refundings screw up the bid. After all, who wants to aggressively bid on new Treasurys on the auction block before they know what the Fed is going to say about interest rates – or in today’s world, what they’re going to with their Treasury purchases.

This week, Treasury will sell $75 billion new notes, starting with $37 billion 3-year notes on Tuesday and $23 billion on Wednesday. The auction deadline is 1pm, so primary dealers as well as institutional investors and central banks will have to put in their orders well before the outcome of the 2-day FOMC meeting (annoucement due around 2:15 on Wednesday) is known. That the Fed could signal the end of its $300 billion Treasury purchase program during this meeting makes it even more fun.

But even if the Fed wanted to, say, schedule it’s meeting around Treasury debt sales, it would have its work cut out for it. The sheer dump of new supply means, there’s little room on the calendar for the Fed to meet when Treasury isn’t issuing new debt. In just a few weeks, Treasury will be back with fresh 2-, 5- and 7-year sales and then in September with new 3-year notes and reopened offerings of the 10- and 30-year debt.

Still, for those who want to kvetch anyway, a flood of cash coming into the market may make the Fed effect moot. John Canavan at Stone & McCarthy points out that thanks to maturing debt and coupon payments, the total amount of cash expected to be reinvested in the market should be around $15.8 billion in excess of the refunding auction sizes.

And since no one expects the Fed to touch short-term interest rates at this meeting or for some time to come, demand for the notes could be surprisingly strong.

Freddie in the black, Treasury off the hook

Freddie Mac reports that it managed an actual net income gain in second quarter of $768 billion – a big turnaround from the $9.9 billion loss in the prior quarter. That means Treasury is off the hook, at least in this quarter, in terms of giving Freddie more money through its $200 bln equity line.

This contrasts with Fannie, which needed to take another gulp from the Treasury spigot. See more on the sinkhole here.

Freddie’s net worth got a big boost from an accounting change, one that also benefited Fannie.

Net worth at June 30, 2009 was $8.2 billion. As a result of the positive net worth, no additional funding from the U.S. Department of the Treasury was required under the terms of the Senior Preferred Stock Purchase Agreement for the second quarter. The positive net worth includes a $5.1 billion increase to total equity reflecting the April 1, 2009 adoption of FSP FAS 115-2 and FAS 124-2 relating to accounting for security impairments.

The GSE also noted that it got big boost from lower funding costs (thank you Federal Reserve for buying agency debt) and a $4.2 billion gain in its derivatives portfolio and guarantee asset (not sure what that’s referring to exactly), which were driven by mark-to-market gains due to long-term interest rates rising (sounds like swaps). But those pesky credit expenses proved to be a downer, coming in at $5.2 billion.

Stomachs of steel for U.S. debt

Bond market vigilantes — investors who punish profligate governments by pushing up their cost of borrowing — have been remarkably quiescent.

This week the U.S. government has broken all records for debt sales. Come Friday investors will have bought $115 billion of freshly minted Treasury paper, and given the huge scale of these auctions, investors have shown only modest signs of indigestion.

The Treasury might have had to pay more than it would have liked, but the yield on 10-year U.S. government bonds has risen only infinitesimally. So far there are few signs the surge in government borrowing is “crowding out” businesses coming to the market for cash.

Indeed the reason behind the willingness of investors to swallow huge amounts of Treasury debt at extremely low rates is not immediately apparent. It is also a little disappointing for political hacks anticipating the Schadenfreude of seeing the Obama administration being castigated by the markets.

A yearning for safety by anxious traders does not appear to be the answer. Despite a modest stock market retreat in recent days, there appears to be no shortage of risk takers in the market. Precautionary holdings of cash are at their lowest level since May 2007, according to a Reuters poll.

But there are plenty of other reasons why the bond vigilantes might feel on the back foot. While levels of government borrowing are alarming, the outlook for price stability is not. With wage increases almost vanishing, inflation still seems a distant threat.

More important still, the Federal Reserve has stacked the cards in favor of their friends at the Treasury.

PPIP is a pipsqueak

The Treasury Department is finally out with its final version of a plan for ridding the banks of toxic assets and you have wonder why the Obama administration even bothered.

Treasury will now fund the program with $30 billion in government money. Back in March, Treasury Secretary Tim Geithner was talking about kicking in between $75 billion and $100 billion into the program.

The reduced government commitment is a sign that Treasury couldn’t convince banks to go along with the idea of selling their toxic securities at a discount–something that would force another round of painful writedowns.

So the toxic assets, for the most part, will continue to sit on the balance sheets of the banks and we’ll continue to delude ourselves that the financial system is on the road to recovery.

Back in June I suggested half in gest that Geithner scrap the PPIP altogether and simply tinker with the tax laws to make it possible for banks to take hefty tax deductions on any CDOs that were contributed to charitable groups.  But after seeing this half-hearted government plan, I think my idea is better.

In my plan, a favorable tax deduction would ease the bite of any writedown a bank would take on a CDO donation. And charitable groups would be able to make some money by selling the ailing mortgage-backed securities if they ever recovered in value.

Compared to Geithner’s lousy plan, CDOs for Charity seems like a win-win.