Rolfe Winkler

Gretchen Morgenson’s column in tomorrow’s NYT is a decent discussion of the creative lending facilities to which the Fed has resorted to help out troubled banks.

SAVING the nation’s financial system from reckless banks and brokerage firms is an enormous job, heaven knows. But somebody’s got to do it, so the Federal Reserve Board, with its taxpayer-funded balance sheet, stepped in.

To grease the gears of the nation’s seized-up credit markets, the New York Fed in recent months created three new lending entities. Together, they allow banks and financial firms to swap up to $350 billion of securities they cannot sell for cash or United States Treasuries.

The entities will stay in business as long as the markets for mortgage securities and other orphaned “investments” are closed, the Fed said. This allows institutions to exchange their trash for cash that they can turn around and lend to corporations or individuals.

The nature of these new Fed lending facilities is not without risks, of course. One of those risks is that taxpayers may have to cover losses if a firm or bank fails to repay a loan.

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If Ben Bernanke keeps his present course, former Fed Chairman Paul Volcker warns we could repeat the 70s. “Core” inflation is still within the Fed’s “comfort zone,” but at a certain point, rising food and energy costs may pull other prices along with them. That’s the opposite of what the Fed is assuming will happen. The Fed appears to believe that food and energy costs will come back down as the economy slows.

But that may give the U.S. a lot more credit that it deserves for driving oil demand. What if demand growth outside the U.S. is enough to offset declines here at home, keeping oil prices high? It’s not far-fetched to believe that can happen:

Despite China’s fantastic growth, and very inefficient use of fossil fuels, the U.S. is still the largest consumer of oil worldwide. The stats at that link are from 2007, and China’s economy has probably grown another 10% since then. So figure we consume 21 million barrels of oil per day and China consumes 7.2 million. I confess I don’t know enough about the dynamics of the oil market to know the impact of, for instance, a 2% decline in U.S. GDP would do to oil demand. But for simplicity figure oil demand growth matches economic growth.

To offset a 2% decline in U.S. demand for oil, Chinese demand would merely have to rise 6%. They’re certainly on track to grow faster than that the next few years.

Herein lies the problem with the Fed’s plan I think, and the reason people ignore Paul Volcker at their own peril:

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Warren Buffett hosted the annual shareholders meeting in Omaha today. If the investing world has a rock star, Buffett is it:

31,000 people attended the meeting. Once upon a time (when I was in junior high) I wrote a letter to him, recommending a stock. [Cracker Barrel, ticker CBRL: seems I was enthralled with the synergy of selling tchotchkes in a restaurant.] And I got a letter back! Which I lost. He (=his ghost-writing secretary) wrote back that I had a good nose for stocks and included an invite to the annual meeting….I never made it.

Probably a mistake. As my nose for stocks wasn’t really that well developed:

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Rs and Ds in the Senate have agreed on the basic framework for a new housing bill, according to the NYT. The basic framework appears to include the follwing:

• $100 million to expand counseling for homeowners at risk of defaulting on their loans
• tax-exempt bonds to let local housing agencies refinance subprime mortgages
• $4 billion in grants for local governments to buy foreclosed properties
• several tax provisions, including a credit of $7000 for purchasers of foreclosed properties that have been sitting vacant, and a break for struggling home-builders, allowing them to claim current losses against taxes paid in earlier, more profitable years
• a cap on mortgages insured by the Federal Housing Administration at $550,000 in the most expensive real estate markets. The cap had been $363k before Congress “temporarily” raised it to $730k as part of the Stimulus package passed in February.

So far, so good. No behemoth bailouts above. But there are two more contentious provisions being pitched by Democrats that are likely to be introduced as amendments:

• Connecticut Senator Chris Dodd wants the federal government to insure $400 billion in new loans for homeowners. Scary.
• Illinois Senator Dick Durbin wants to give bankruptcy judges the power to alter the terms of certain mortgages. Also very scary. This would raise the cost of mortgages for everyone else as lenders boost interest rates to compensate for future risk that loans could be written down by judicial fiat…..

I disagree completely with this video’s conclusions. I will explain why in my next post. Still, it’s pretty darn creative and worthy of posting here.