Rolfe Winkler

Yesterday I commented on Robert Shiller’s recent op-ed in the Journal.  He argued that our stimulus and bailout plans need to be larger to rescue our “animal spirits,” whatever that means.  And though given 1200 words of space, he didn’t bother addressing the crucial question–How do we pay for any of this?

The other op-ed worth highlighting is Paul Krugman’s on health care.  Readers may recall a recent post in which I chastised Krugman for using the financial crisis as an excuse to expand government.  States shouldn’t be cutting budgets in our time of need!  Better to have the Federal government take responsibility for expenditures that state and local governments can no longer pay for.

Well Paul is pressing this argument, this time for health care:

The whole world is in recession. But the United States is the only wealthy country in which the economic catastrophe will also be a health care catastrophe — in which millions of people will lose their health insurance along with their jobs, and therefore lose access to essential care.

We don’t have universal health care, you see.

Why has the Obama administration been silent, at least so far, about one of President Obama’s key promises during last year’s campaign — the promise of guaranteed health care for all Americans?

…

First, some people are arguing that a major expansion of health care access would just be too expensive right now, given the vast sums we’re about to spend trying to rescue the economy.

What does Paul have to say to us dopes who think we’re already spending too much on health care?

But research sponsored by the Commonwealth Fund shows that achieving universal coverage with a plan similar to Mr. Obama’s campaign proposals would add “only” about $104 billion to federal spending in 2010 — not a small sum, of course, but not large compared with, say, the tax cuts in the Obama stimulus plan.

We’re supposed to believe that universal health care is going to cost so little?  Even Krugman distances himself from this…

It’s true that the cost of universal health care will be a continuing expense, reaching far into the future. But that has always been true, and Mr. Obama has always claimed that his health care plan was affordable. The temporary expenses of his stimulus plan shouldn’t change that calculation.

Where does one even start with this comment? The first sentence is key. He acknowledges that universal health care is going to be a “continuing expense reaching far into the future.” This is strongest rebuttal against universal health care because it’s not political, it’s mathematical.

Take a look at the debt clock to the right. The $57 trillion number is the net present value of the liabilities we ALREADY HAVE for medicare and social security. Net present value just means that to keep our future health care promises, that’s how much money we owe in today’s dollars. We can’t afford that, not even if we cut ALL discretionary spending out of the federal budget (national defense, education, etc.). If we can’t afford the promises we’ve already made, where do we get the money to pay for universal health care plan?

Paul can hardly rebut this argument so he ignores it: it “has always been true” that “universal health care will be a continuing expense reaching far into the future,” he tells us.  Yes, and it has also always been true that we could never afford it.

Krugman backhands this argument noting that Obama “has always claimed his health care plan was affordable.”  Note the language.  Krugman doesn’t have the sack to claim Obama’s health plan is “affordable.”  But he’s willing to take Obama’s word for it, and so should we.

His other arguments are equally absurd.  First, health care spending would be at least as effective as tax cuts when it comes to stimulating the economy.  Second, that the economic crisis gives Obama an ideal opportunity to push through all elements of his agenda.

His column’s conclusion is positively Marxist:

The bottom line, then, is that this is no time to let campaign promises of guaranteed health care be quietly forgotten. It is, instead, a time to put the push for universal care front and center. Health care now!

Workers of the world unite!

Folks, fiscal conservatism should not be about Republican or Democrat, big “C” Conservative or Liberal.  It’s just math.  And it doesn’t lie.  We can bankrupt ourselves making promises that we’ll never be able to keep anyway.  Or we can cut back and try to build a decent economic future for post-Boomer generations.

Sabotage averted at the mortgage giant. AP:

The Justice Department says it foiled a plot by a fired Fannie Mae contract worker in Maryland to destroy all the data on the mortgage giant’s 4,000 computer servers nationwide.The U.S. Attorney’s Office says 35-year-old Rajendrasinh Makwana, of Glen Allen, Va., is scheduled for arraignment Friday in U.S. District Court in Baltimore on one count of computer intrusion.

U.S. Attorney Rod Rosenstein says Makwana was fired Oct. 24.

Rosenstein says that on that day, Makwana programmed a computer with a malicious code that was set to spread throughout the Fannie Mae network and destroy all data this Saturday…

Economists in the U.S. are conveniently ignoring questions about how we’re actually going to pay for stimulus, bank bailouts, etc.  Non-Americans at Davos are not.

To demonstrate the utter bankruptcy of what currently passes for economic thought, as well as America’s collective myopia regarding paying for stimulus, I will devote a post each to two recent op-eds.  One in the WSJ, one in the NYT.  Then in a third post I will get to what Davos attendees are saying…

First, Yale economist Robert Shiller–of Case-Shiller home price index fame.  In a truly mind-boggling op-ed in the Journal, he used an odd economic construct to argue that already mammoth stimulus and bailout plans aren’t large enough:

President Obama is urging Congress to pass an $825 billion stimulus package as soon as possible. But even that may not be enough to stabilize the economy, since it fails to take into account the downward spiral of animal spirits that is underway and may continue to worsen.

“Animal spirits” is a technical term from Keynes, Shiller tells us:

The term “animal spirits”…is related to consumer or business confidence, but it means more than that. It refers also to the sense of trust we have in each other, our sense of fairness in economic dealings, and our sense of the extent of corruption and bad faith. When animal spirits are on ebb, consumers do not want to spend and businesses do not want to make capital expenditures or hire people.

To revive our “animal spirits,” and keep businesses/consumers spending, we need to increase “trust” and rebuild “public confidence.”  How to do this?  Silly me, I would have thought this would involve far-reaching reforms of credit markets.  Shiller’s solution is to spend more!

So what must we do to revive our animal spirits and economic growth? We must be certain that programs to solve the current financial and economic crisis are large enough, and targeted broadly enough, to impact public confidence. Not only do we need a fiscal stimulus significantly greater than the proposal that is currently on the table, government action is also needed to take the place of the credit markets that seemingly worked so well when animal spirits were high.

Besides more fiscal stimulus than is currently envisioned, the Fed should prop up credit markets so “those who would normally receive credit in times of full employment can once again find it easy to do so, at rates with realistic risk premiums.”  Is he kidding?  During our most recent period of full employment, anyone with a pulse was able to get credit.  That was precisely the problem: a debt bubble blown up by too much credit.

Shiller then offers more surreal arguments for more government intervention.  To prop up credit markets, one solution is this:

…far more than $250 billion of government money has been used to recapitalize banks. But just making the banks solvent is not enough. The banks, whose managers are suffering from the same flagging animal spirits as the rest of the economy, will not expand their credit much just because they are more solvent. The banks will only expand if they see profitable opportunities to grant loans and if their fear of failure is diminished. It will take much more than keeping the banks solvent to make them take on the disappeared credit flows.

LOL!!  Pity the poor bank managers whose “animal spirits” are “flagging.”  Folks, it could take $4 trillion worth of taxpayer cash to keep the banks solvent.  That’s a third of gross domestic product.  Shiller makes it clear that this “is not enough.”  Indeed, to top it all off he offers the following:

…[G]overnment-sponsored enterprises have replaced a significant portion of the mortgage markets. But the government should do much more here as well. For example, failed banks might be kept alive longer as bridge banks under government supervision with the purpose of making credit freely available.

Not only should we try to rescue banks teetering on the edge of insolvency, we should prop up banks that are already insolvent so that these can continue to make loans.  Funny, I thought the reason banks become insolvent in the first place is because they’re bad at making loans.  Nevermind that, we’ve got an emergency “animal spirits” deficit that can only be solved by bigger stimulus, more bailouts and more credit.

He concludes quite directly:

In due course our animal spirits will once again turn positive, but we would rather that happen this year or the next rather than five or 10 years from now. There is only one way to speed this process: greatly expand governmental support of credit markets and pass a much larger fiscal stimulus plan than is now proposed.

Nowhere in the article does he actually articulate HOW MUCH we need to “greatly expand” government support of credit markets.  And HOW MUCH “larger” should the fiscal stimulus plan be?

Missing from this entire discussion is how we are going to pay for any of this.  Nor is there any discussion of second-order consequences of so much borrowing.

All of this from one of our leading economists…

The data below demonstrates how this blog got its name.  WSJ:

Nearly $750 billion of option adjustable-rate mortgages, or option ARMs, were issued from 2004 to 2007, according to Inside Mortgage Finance, an industry publication. Rising delinquencies are creating fresh challenges for companies such as Bank of America Corp., J.P. Morgan Chase & Co. and Wells Fargo & Co. that acquired troubled option-ARM lenders…

Option ARMs, which have been largely abandoned, give borrowers multiple payment options, including a minimum payment that often was less than the monthly interest due. Borrowers who made the minimum payment on a regular basis often saw their loan balances grow, also known as “negative amortization.” And with home prices falling, more than 55% of borrowers with option ARMs owe more than their homes are valued at, according to J.P. Morgan Securities Inc…

As of December, 28% of option ARMs were delinquent or in foreclosure, according to LPS Applied Analytics, a data firm that analyzes mortgage performance. That compares with 23% in September. An additional 7% involve properties that have already been taken back by the lenders. By comparison, 6% of prime loans have problems. Problems with subprime are still the worst. Just over half of subprime loans were delinquent, in foreclosure, or related to bank-owned properties as of December. The nearly $750 billion of option ARMs issued from 2004 to 2007 compares with roughly $1.9 trillion each of subprime and jumbo mortgages in that period.

Nearly 61% of option ARMs originated in 2007 will eventually default, according to a recent analysis by Goldman Sachs, which assumed a further 10% decline in home prices. That compares with a 63% default rate for subprime loans originated in 2007. Goldman estimates more than half of all option ARMs outstanding will default.

The last highlighted comment is particularly interesting.  Option ARMs were mostly “prime” loans, yet they are expected to default at a rate similar to subprime.

Large option ARM lenders like BankUnited, Downey, FirstFed, and GoldenWest (acquired by Wachovia) have all dropped like flies over the past few months.  GoldenWest is likely to take down not just Wachovia, but also Wells Fargo, which, in a stupendously foolish move, acquired Wachovia without government support.  The wild card, of course, is government.  Will Obama establish a “Bad Bank” and if so how much toxic trash will it buy and at what price?

Charlie Gasparino said the above about 30 seconds ago on CNBC during an argument about Wall Street bonuses.  He said big banks are all “insolvent” and bankers bonuses should have been zero.  That we’re even asking how much Wall Streeters should have gotten in bonuses is a “stupid f***ing question.”

He’s sworn on-air before, but the F-bomb is new territory I believe. Congrats to him for articulating what most of the country is feeling, and on a network that caters to Wall Streeters.

Clusterstock has the clip:

Clusterstock: Gasparino’s F-Bomb from AlleyInsider on Vimeo.

The Congressional Oversight Panel established by the TARP legislation released its report today.  The recommendations for regulatory reform are fine, but a quick read of the thing suggests that, like the recent Group of 30 report, punches were pulled in order to achieve consensus among contributors.

The Panel has identified eight specific areas most urgently in need of reform:

1. Identify and regulate financial institutions that pose systemic risk.
2. Limit excessive leverage in American financial institutions.
3. Increase supervision of the shadow financial system.
4. Create a new system for federal and state regulation of mortgages and other consumer credit products.
5. Create executive pay structures that discourage excessive risk taking.
6. Reform the credit rating system.
7. Make establishing a global financial regulatory floor a U.S. diplomatic priority.
8. Plan for the next crisis

Done correctly, recommendation #2 would obviate the need for the other seven.  Unfortunately every policy response taken so far has been an effort to increase leverage.  Encouraging banks to “lend more” despite shrinking capital, borrowing trillions to fund guarantees or stimulus, lower interest rates and increased money-printing by the Fed.  More debt, all of it.

The American economy is collapsing under the weight of too much debt, we won’t rescue it by piling on more.

As for #8, planning for the next crisis, the report recommends the creation of a Financial Risk Council that should conduct wargames, strategic scenario analysis or “black swan” sensitivity analysis in order to identify looming financial threats.  Sounds nice, though what exactly would politicians do with this information?  They’ve proven totally feckless at reforming financial markets when in the midst of crisis, much less in advance of it.

They do skewer Greenspan for having argued that derivative markets should be totally unregulated.  I appreciated that.

Previously, Bloomberg has banned indoor smoking, trans fats in foods and required restaurant owners to post the calorie count of their menu items. Now he’s going after salt.  WCBS:

City officials said that people don’t realize the salt content of the things they buy in the supermarket. For example, potato chips you would think are the saltiest thing in the store but they have only 180 milligrams per serving. Turkey meatballs, on the other hand, have 660 milligrams per serving. Marble cake has 300 per serving and chicken noodle soup has nearly 1,400 milligrams of salt per serving.

The city’s plan is to get food manufacturers in the United States to agree to gradually start reducing salt content until it reaches a 50 percent cut in 10 years.

“Salt, when its high in the diet, increases the blood pressure and high blood pressure is a major factor for heart disease and stroke,” said Dr. Sonia Angell of NYC’s Cardiovascular Disease Prevention Program.

Before you criticize our mayor for nanny state measures like this consider that if nothing is done to control costs, New York state’s Medicaid budget will come in at $48 billion next fiscal year.  I’m fairly sure that’s the highest in the nation.  One guy’s reaction to the Mayor’s salt plan:

“We don’t need any more nanny state people can take care of themselves. We don’t need the government to take care of us,” said Patrick Keenan of Hell’s Kitchen.

I’m not sure of the exact number, but my bet is that a majority of New Yorkers are on Medicaid and/or Medicare, meaning they DO require the government, or more precisely taxpayers, to take care of them.

With this in mind, the mayor makes a strong case to ban salt/trans fats/smoking/etc., which all increase incidence of expensive medical conditions.  Should taxpayers be able to regulate what individuals put in their bodies?  What if the people rely on the state to take care of their bodies via a socialized health care system?

Should obese people have the right to eat unhealthy foods even if their likely to end up an expensive ward of the state when they come down with diabetes?

If the American people want their health care paid for by taxpayers, don’t taxpayers have some say in banning unhealthy (and thus expensive) habits?

I don’t know what I think about this issue.  The smoking ban makes plenty of sense since smokers aren’t only putting their own health at risk…

But when are taxpayers crossing the line in legislating healthy habits to controI medical costs?  I invite reader comments.

The NYT has the skinny on Wall Street’s 2008 bonuses:

…Despite crippling losses, multibillion-dollar bailouts and the passing of some of the most prominent names in the business, employees at financial companies in New York, the now-diminished world capital of capital, collected an estimated $18.4 billion in bonuses for the year.

That was the sixth-largest haul on record, according to a report released Wednesday by the New York State comptroller…

Granted, New York’s bankers and brokers are far poorer than they were in 2006, when record deals, and the record profits they generated, ushered in an era of Wall Street hyperwealth. All told, bonuses fell 44 percent last year, from $32.9 billion in 2007, the largest decline in dollar terms on record.

But the size of that downturn partly reflected the lofty heights to which bonuses had soared during the bull market. At many banks, those payouts were based on profits that turned out to be ephemeral. Throughout the financial industry, years of earnings have vanished in the flames of the credit crisis…

The state comptroller, Thomas P. DiNapoli, said it was unclear if banks had used taxpayer money for the bonuses, a possibility that strikes corporate governance experts, and indeed many ordinary Americans, as outrageous. He urged the Obama administration to examine the issue closely.

Um, the only reason Wall Street banks still have a pulse is courtesy of taxpayer cash and guarantees.  By definition, these bonuses were paid with taxpayer money.

Many corporate governance experts, investors and lawmakers question why financial companies that have accepted taxpayer money paid any bonuses at all.

Bankers will keep getting their bonuses, especially if a new Bad Bank rescues Wall Street from its losses on toxic assets.

To reduce expenses, the USPS may cut back deliveries to five days per week.  AP:

Massive deficits could force the post office to cut out one day of mail delivery, the postmaster general [John Potter] told Congress on Wednesday, in asking lawmakers to lift the requirement that the agency deliver mail six days a week.  If the change happens, that doesn’t necessarily mean an end to Saturday mail delivery. Previous post office studies have looked at the possibility of skipping some other day when mail flow is light, such as Tuesday.

Faced with dwindling mail volume and rising costs, the post office was $2.8 billion in the red last year. “If current trends continue, we could experience a net loss of $6 billion or more this fiscal year,” Potter said in testimony for a Senate Homeland Security and Governmental Affairs subcommittee.

Total mail volume was 202 billion items last year, over 9 billion less than the year before, the largest single volume drop in history.

And, despite annual rate increases, Potter said 2009 could be the first year since 1946 that the actual amount of money collected by the post office declines.

“It is possible that the cost of six-day delivery may simply prove to be unaffordable,” Potter said. “I reluctantly request that Congress remove the annual appropriation bill rider, first added in 1983, that requires the Postal Service to deliver mail six days each week.”

According to the article, this won’t happen right away, but the post office needs flexibility to cut costs, including large pension obligations:

Potter also asked that Congress ease the requirement that it make advance payments into a fund to cover future health benefits for retirees. Last year the post office was required to put $5.6 billion into the fund.

Pension obligations seem to be a bigger problem than a sixth day of delivery, which if eliminated will save about $2 billion annually.

As noted above, mail volumes are falling quickly.  According to Potter,

“A revolution in the way people communicate has structurally changed the way America uses the mail,” with a shift from first-class letters to the Internet for personal communications, billings, payments, statements and business correspondence.

To some extent that was made up for my growth in standard mail—largely advertising—but the economic meltdown has resulted in a drop there also.

Home prices are getting cheaper and junk mail volumes are down.  At least the economic meltdown has some fringe benefits!

… how much money the government can give to the banks.  Financials are flying high this morning on the news that the Obama administration will create a “bad bank” to buy toxic assets from the banks using taxpayer money.

To rescue the banking sector, financial investors now feel confident that Obama is going to overpay for toxic bank assets in order to restore “confidence” in the banking sector and bring back private capital.

Going back to our discussion of leverage, it’s easy to understand why this is a big giveaway to the banks.  Assets = Liabilities + Equity.

Bank asset values are cratering, while liabilities are remaining fixed.  This means bank equity had been virtually wiped out.  When bank equity falls below zero, then FDIC must step in and nationalize the banking sector.  Clearly this is a scary prospect as we don’t really want government to be running the banking system.  But that horse has already left the barn.  Unless…

Unless miraculously, bank asset values go higher.  How can this happen when there are no buyers for those assets?  Well, it appears there may be a new one: Sheila Bair at FDIC.  She’ll likely get $100 billion of TARP money, which she can lever up 10x in order to buy $1 trillion of bad assets from the banking system.

And bank stocks are jumping because she’s made clear that she’ll buy the assets at their “hold-to-maturity” price.  In other words, she’s planning to vastly overpay for these assets in order to recapitalize the banking system.

Take a look at my last post on BKUNA.  To keep that bank going, FDIC would literally have to buy billions worth of non-performing loans at their hold-to-maturity value, or close.  Take an example:

Flashback to 2006, BKUNA writes an option ARM loan on a condo in Miami.  The condo is valued at $1,000,000 at the time the loan is made.  The borrower puts down 10% and starts making minimum payments on the option ARM.

Flash forward to 2009, the condo is now worth $500,000 at best and the loan’s principal is now $975,000 or so.  (Remember, like with a credit card, option ARM borrowers that make minimum payments aren’t paying down even the interest they owe, which then gets added to the loan balance).

The “hold-to-maturity” value of this loan would be $975,000.  That is, after all, what the borrower owes if he stays current over the life of the loan.  Trouble is, he sees that the value of his property has fallen dramatically below his loan balance, so he has no incentive to pay back the loan.  The borrower defaults  and the loan ends up in the non-performing asset bucket.

The bank forecloses on the condo and sells it for what it can get, the current value of $500,000 on the market.  So in reality, the value of the bank’s asset, the loan, has fallen from the $975k the borrower owed, to the $500k the bank was actually able to recover.  A near 50% loss.

If losses are substantial enough throughout the bank’s portfolio of loans (i.e. the “asset” side of the equation above), then equity is wiped out and the bank fails.  The only way to rescue the bank is to write-UP the value of its assets back to their fictitious “hold-to-maturity” value, in the example above: $975k.

This is exactly what Sheila Bair is likely to do.  Have taxpayers absorb the losses on the big banks’ assets by overpaying for them.  So of course bank stocks are flying high on the news.

This is what was originally envisioned for TARP before economists and the UK went for equity injections instead.  But that wasn’t large enough to rescue the banks, the losses on their assets are just to steep.  So we’re back to the original plan, which is to buy “troubled assets” directly from banks.  I discussed the problems of such a plan in more detail here.

The losses on these purchased assets will run into the hundreds of billions most likely.*  Probably 3-5% of GDP.  We are going to transfer 3-5% of our gross national wealth to the banking sector so that it can survive.  Appalling.

Like I said at the top: never underestimate how much money the government can give to the banks.

——–

*(The other possibility is that Ben Bernanke can successfully re-inflate the housing bubble so that the Miami condo in our example above sees its price go back to the 2006 peak.  But then taxpayers lose anyway as inflation robs them of their purchasing power.)

Buried at the bottom of an SEC filing made tonight, BankUnited of Florida dropped another bombshell.  To get you caught up, in their last interim filing they offered a preliminary estimate of their fourth quarter loss: $327 million.  Well turns out they were a tad low on that estimate…

Additional review of the Company’s ALLL reserve indicates that the loss for the fourth quarter of fiscal 2008 will be approximately $607 million, resulting in a loss for 2008 of approximately $816 million.

To put that number in perspective, according to BKUNA’s filings, its net income between 1995 and 2007 totaled $368 million.  They lost nearly twice that amount in one quarter.  Oops.

As part of this revised ALLL analysis, they’ve determined that at Sept. 30th, non-performing assets totaled $1.4 billion.  That’s 10%(!) of their total assets listed as of June 30th.  A year ago, non-performing assets were $209 million; the year before that…$21 million.  So NPAs septupled this year after jumping an order of magnitude last year.

And these numbers are already four months out of date.  The economy has deteriorated substantially since Sept 30th, so figure the bank’s present condition is significantly worse than even these terrible numbers suggest.

Another fact to keep in mind: BKUNA’s loans were all “prime.”  They didn’t do FICOs below 700.  So the bank’s shitty numbers are yet more evidence that high credit scores are a bad indicator of loan performance, especially when borrowers are in a negative equity position.  BKUNA’s loan book was largely made up of option ARMs in Florida/California/Arizona on which borrowers were making minimum payments.  This means their loan balances have been growing even as house prices have cratered.  That’s a recipe for negative equity.

So with all these non-performing assets clogging up the balance sheet, what do BKUNA’s capital ratios look like?

Based upon a preliminary fourth quarter loss of $607 million, the Bank’s Tier I Core Capital ratio was 3.4% and total risk-Based Capital ratio was 7.1% as of September 30, 2008….

The bank’s regulator, the Office of Thrift Supervision, mandated that BKUNA get its capital ratios up to 7% and 14% respectively by the end of the year or face regulatory seizure.

The Company continues negotiations to raise capital and restructure its balance sheet to comply with the ratios [demanded by OTS]. We cannot assure you that these negotiations will be successful. If such negotiations are not successful, it is highly unlikely that we will be able to continue as a going concern. Additionally, since the Bank is not in compliance with the portion of the Order requiring certain capital ratios by December 31, 2008, bank regulators could take enforcement action, which could include placing the Bank into receivership.

[If you want to understand Tier 1 and risk-based capital ratios, check out this tutorial.]

In its last filing, BKUNA mentioned a “fund” they were in discussions with to provide new capital.  Said fund has, of course, forked over no rescue money.  BKUNA’s losses are just too massive to make the bank worth saving.

How BKUNA has survived this long, I just don’t know.

The tide went out and LOTS of people were swimming naked. CNBC:

I feel bad for the guy in the video, and anyone who falls victim to a Ponzi.  But trusting a friend’s recommendation does not qualify as due diligence.

Bloomberg has more on the story:

Cosmo operated a Ponzi scheme at least between October 2003 and December 2008 that raised more than $370 million from more than 1,500 individual investors and deposited that money into Agape World bank accounts, according to a 51-page affidavit by U.S. Postal Inspector Richard Cinnamo detailing the allegations against Cosmo.

Cosmo, arrested after he surrendered yesterday in Hicksville, New York, claimed he was putting investors’ money into bridge loans to businesses, according to the Cinnamo affidavit, which was unsealed today. Just $746,000 of the money was found in the bank accounts last week, Cinnamo said. Less than $10 million was loaned out, the alleged business of Agape World.

Instead, more than $100 million was invested in commodity futures trading accounts, with losses of about $80 million, according to Cinnamo.

The Case-Shiller data for November:

The Composite 20 Index (a composite index for the 20 cities listed above) has fallen 25% since the peak back in 2006.  It was down 18.2% versus November ’07 and off 2.2% compared to October.  CR has some nifty charts slicing/dicing this data that are worth checking out.

Deflation in action folks.  Bad news for home-owners, but good news for prospective home-buyers.

Fannie needs money:

Fannie Mae, the largest source of home-loan money in the U.S., said it will need to tap as much as $16 billion in emergency funds from the U.S. Treasury Department to stay afloat as deterioration in the housing market persists.

This will not be Fannie’s first trip to the well; they said last month that the $100 billion Treasury promised likely won’t be enough.

Freddie has already requested $48.5 billion.  The FHLBs won’t be far behind…

If enacted, these proposals would be a decent first step in the battle against moral hazard.  Bloomberg:

The Federal Deposit Insurance Corp., which is selling failed U.S. banks at the fastest pace in 17 years, probably will propose limits on interest rates paid by lenders with less than adequate regulatory capital, industry consultant Bert Ely said.

The FDIC at a meeting today will consider risk-based deposit insurance premiums on institutions that fall below regulatory requirements for adequate capital, a step to prevent banks from paying too much to boost revenue, Ely said yesterday. Banks also may be limited on higher-cost sources of funds, such as brokered deposits, if they miss regulatory targets, said Ely, chief executive officer of Ely & Co. in Alexandria, Virginia.

As banks get more desperate for funding—often because they are at risk of failing—they tend to offer higher interest rates.  See, for instance, GMAC offering 3.0% on CDs.  Like WaMu before it, GMAC can still attract deposits by offering above market interest rates despite its high risk of failure.  Depositors couldn’t care less if the bank is at risk of failing, since it has FDIC insurance, they are protected.  Might as well take advantage of those high interest rates while you can, right?

Classic moral hazard problem.  Quoting Wikipedia:

Moral hazard is the prospect that a party insulated from risk may behave differently from the way it would behave if it were fully exposed to the risk. Moral hazard arises because an individual or institution does not bear the full consequences of its actions, and therefore has a tendency to act less carefully than it otherwise would, leaving another party to bear some responsibility for the consequences of those actions.

Insulated from the risk of bank failures, depositors put money in risky banks when, in the absence of federal deposit insurance, they wouldn’t.  The other party left to pick up the pieces is the American taxpayer, who would fund FDIC insurance claims if FDIC runs out of money.  This is far more likely than most realize.

You’d think steps like these would have been instituted long ago.  Especially charging riskier banks higher premiums.  That’s what you’d see if deposit insurance was privatized and highly regulated like all other insurers.  Interest rates at banks would be lower (because insurance premiums would be higher), but the banking system would be far more sound.

Would it make sense to have nationalized car insurance, with 16 year-old males paying the same premiums as thirty-something mothers with babies on board?  No.

And FDIC isn’t the only example of a massively underfunded federal insurance company.  Federal pension insurance via PBGC is in similarly terrible condition.  And during the campaign, there was talk of creating a federal insurer to protect homeowners from hurricane damage.  The only reason to have it is private insurers want too much or aren’t willing to write policies on Florida’s coastal properties.  Rather than raise taxes on Floridians to adequately fund the state’s insurance pool, Republican governor Charlie Crist would prefer taxpayers nationwide subsidize insurance for his rich homeowners.  This is particularly obnoxious since Florida doesn’t even have a state income tax.  Obama supported the idea, by the way, while McCain refused (he secured Crist’s endorsement anyway).

When insurance prices are set by the government, instead of the market, they will tend to be too low as politicians pressure the agencies to underprice their product in order to benefit constituents.  This is not to say that laissez-faire is the correct way for the insurance biz to operate.  It should be private, but heavily regulated so that insurer capital is always sufficient to pay out claims.