Regulating Fannie and Freddie

[Crazed Rabbit]

We should have let the institutions fall and their investors become penniless. Ideally, it would have let investors know we won't bail out idiocy and so be more careful about investing in the future.

CR

[Xiahou]

We should have let the institutions fall and their investors become penniless. Ideally, it would have let investors know we won't bail out idiocy and so be more careful about investing in the future.

CR

Ideally, this is what I'd prefer too. The trouble is that government meddling has allowed the problem to grow so much bigger than it would have if it had just kept its hands off. Right now, if Fannie and Freddie folded, it would be catastrophic to not just the US economy, but the global economy. It's gone well beyond the idiots who made the loans taking the fall- sadly, the idiots in government never take it on the chin, we do.

[drone]

Apparently Lehman Bros. is having trouble raising capital, and lost half their market value today. If they crash and burn, are they considered "too big to fail" and get the bailout, ala Bear Stearns, or will we finally close the taxpayers' charity fund?

[rory_20_uk]

Nationalisation is going to cost private investors a fortune: since the state has control, probably no more dividends, and since the share price went down by about 98%, they've all but lost all their money.

[drone]

Apparently Lehman Bros. is having trouble raising capital, and lost half their market value today. If they crash and burn, are they considered "too big to fail" and get the bailout, ala Bear Stearns, or will we finally close the taxpayers' charity fund?

And we will soon have our answer:
http://www.washingtonpost.com/wp-dyn...l?hpid=topnews

Spoiler Alert, click show to read: 

The Treasury Department and the Federal Reserve are helping Lehman Brothers put itself up for sale. The details are not finalized, but sources familiar with the matter say the purchase is expected to be completed and announced this weekend before Asian markets open Monday morning.

The Fed and Treasury are talking to a wide range of firms and examining multiple scenarios for the sale of the venerable investment brokerage.

Lehman Brothers, which had been anxious to show it could weather the credit crisis that contributed to the firm's $3.9 billion third-quarter loss, said Wednesday that it would sell a majority stake in its investment-management division, slash its dividend and spin off about $30 billion of real estate assets.

The announcement did little to calm investors' concerns that Lehman, the smallest of the four major Wall Street investment banks, might suffer the same fate as former rival Bear Stearns, which was acquired by J.P. Morgan Chase in a deal regulators brokered in March after a bank run that shook the securities industry.

Lehman's share price fell nearly 40 percent to $4.22 at the end of trading today, continuing a precipitous fall from more than $60 a share as of February.

[ICantSpellDawg]

Is WaMu next to fall? That would be crazy.

http://www.iht.com/articles/2008/09/...s/15lehman.php

[TinCow]

The one I am the most conerned about at the moment is AIG, both for financial and personal reasons. I have read indications that it is nearing collapse as well unless it gets some capitalization to cover its losses. AIG is the world's largest insurance company, and if it tanks it will have massive repercussions at all levels. I also worked there for two summers during law school and have a lot of friends who have careers there. It's bad news all around if AIG doesn't get shored up quickly.

[Sasaki Kojiro]

I recommend that you all withdraw your savings from whatever bank you have them in, I know I already have.

Spoiler Alert, click show to read: 

[drone]

I recommend that you all withdraw your savings from whatever bank you have them in, I know I already have.

Spoiler Alert, click show to read: 

Under the mattress is the safest place!

Bank of America got Merrill Lynch for a good price. I suppose at some point they will stick a capital 'T' "The" in front of their name after this. BoA looked at Lehman, but decided they were a lost cause without government backing and jumped on Merrill who was healthier. At the end of this mess BoA is going to be a juggernaut. I think I need to start complaining about the interest rate I'm getting on my checking account...

AIG does not look to be in a good position. Don't know who is willing to take on that risk.


I've been wondering when Ford/GM will ask for a bailout. They are both bleeding cash, and will eventually go through their reserves. Then I saw this on over the weekend:
http://www.washingtonpost.com/wp-dyn...091203341.html
Sounds to me like a "we bet everything on gas-guzzlers, can you please loan us money cheap while we retool our factories for small fuel-efficient vehicles that the Japanese have a 20 year head start on" whine.

[Ironside]

I'm curious, exactly who did really benfit on this bubble?

Obviously getting caught with the poor loans , making you bankrupt or getting the state to bail you out isn't profitable.

[Papewaio]

Ah the sweet sweet smell of corporate welfare wafting through the economy from baked books and over leveraged assets. When will the fun stop?

Oh look the private sector does it so much better then government, why burden the private sector with rules and regulations. But if anything goes wrong to the private investments, lets bail it out with public sector money.

=][=

I think the underlying structural issues need to be addressed. The US economy is looking suspicously too much like the 90's Japanese economy were the big banks and insurers weren't structured for the modern economy.

Has there been no learning from the likes of Arthur Anderson, the Energy Trading and WorldCom?

=][=

At the end of the day transparency and accountability have to rise up. And if the private sector expects handouts, it should expect substantial strings attached. Not just to those who get it, but the entire sector so that the mistakes are not repeated.

=][=

PS How is Warren Buffet and Co. doing? If it is a bear market, he must be in getting some bargins.

[seireikhaan]

Under the mattress is the safest place!

Bank of America got Merrill Lynch for a good price. I suppose at some point they will stick a capital 'T' "The" in front of their name after this. BoA looked at Lehman, but decided they were a lost cause without government backing and jumped on Merrill who was healthier. At the end of this mess BoA is going to be a juggernaut. I think I need to start complaining about the interest rate I'm getting on my checking account...

AIG does not look to be in a good position. Don't know who is willing to take on that risk.


I've been wondering when Ford/GM will ask for a bailout. They are both bleeding cash, and will eventually go through their reserves. Then I saw this on over the weekend:
http://www.washingtonpost.com/wp-dyn...091203341.html
Sounds to me like a "we bet everything on gas-guzzlers, can you please loan us money cheap while we retool our factories for small fuel-efficient vehicles that the Japanese have a 20 year head start on" whine.

So what happens when Bank of America pulls the same that all these other numnutzes have done?

[drone]

So what happens when Bank of America pulls the same that all these other numnutzes have done?

I haven't seen the balance sheets, but I believe Bank of America is fairly isolated from the mortgage crisis. They avoided sub-prime lending and investing, and they have a huge amount of capital. They had tried earlier to start an investment banking arm, but it never really took off, so taking over Merrill Lynch gets their foot in the door and shores up Merrill's investments. What sank Lehman is not debt, but the inability (or the appearance of) to raise capital to cover that debt. Banks like Wachovia, Washington Mutual, etc, are in trouble, best to avoid those, once the blood is in the water it's only a matter of time. There are a few big banks that kept away from the mortgage wheeling and dealing, those will be the best bets for survival. As far as where your money goes, look up the rules of FDIC insurance. If you have more than $100K with any one bank under one name, start up an account elsewhere and transfer.

[seireikhaan]

I haven't seen the balance sheets, but I believe Bank of America is fairly isolated from the mortgage crisis. They avoided sub-prime lending and investing, and they have a huge amount of capital. They had tried earlier to start an investment banking arm, but it never really took off, so taking over Merrill Lynch gets their foot in the door and shores up Merrill's investments. What sank Lehman is not debt, but the inability (or the appearance of) to raise capital to cover that debt. Banks like Wachovia, Washington Mutual, etc, are in trouble, best to avoid those, once the blood is in the water it's only a matter of time. There are a few big banks that kept away from the mortgage wheeling and dealing, those will be the best bets for survival. As far as where your money goes, look up the rules of FDIC insurance. If you have more than $100K with any one bank under one name, start up an account elsewhere and transfer.

Drone, I'm not talking about in the next year or two. I'm talking about 15 or 20 years down the line, when they inevitably succumb to the same sort of stuff that Fannie, Freddy, and Lehman have. What then, when we've got an even bigger crisis our hands? BoA will be so gigantic that the government will inevitably have to bail them out too. Honestly, I can't believe I'm saying this, but with so much of the world economy at stake, the heads of these super banks should be getting the death penalty for this. SOMETHING to get it through their heads that they can't just do whatever they want and get an 8 million dollar buyout offer so they can go retire in comfort to Miami or Panama City.

[Big_John]

I'm talking about 15 or 20 years down the line

wut lol? get your head out of the clouds, brotha. anything further ahead than 5 years from now ain't worth worrying about. bush 08!

[Adrian II]

At the end of the day transparency and accountability have to rise up. And if the private sector expects handouts, it should expect substantial strings attached. Not just to those who get it, but the entire sector so that the mistakes are not repeated.

Alright, alright. But what sort of accountability? That's the issue I've been trying to raise.

Fannie and Freddie were accountable. So were Enron or WOL. It didn't work because

1. they got preferential treatment, and
2. the oversight was lax/incompetent/corrupt

It is obvious that markets do not sufficiently regulate themselves voluntarily and that the State is usually a bad supervisor. So, how do we make the State a better supervisor without killing the benefits of private business?

[Vladimir]

Something from Stratfor. Sorry, don't have a link:

Spoiler Alert, click show to read: 

China: Making Due With U.S. Assets
September 12, 2008 | 2036 GMT

PAUL J. RICHARDS/AFP/Getty Images
Freddie Mac headquarters in McLean, Va.Summary China International Capital Corp., an investment bank, estimated Sept. 12 that China’s holdings in U.S. mortgage giants Fannie Mae and Freddie Mac account for a fifth of China’s foreign currency reserves, at approximately $400 billion, according to China Daily on Sept. 12 which cited China International Capital Corp. The immense size of this investment, combined with China’s holdings of other U.S. assets, reveals the persistent lack of diversity in China’s foreign reserve policy. While the Chinese would like to put some of their money in other places, their economic dependence on American consumption means they are essentially stuck making middling returns on U.S. debt.

Analysis
RELATED SPECIAL TOPIC PAGE
U.S.-China Economic Relations
China’s holdings in U.S. debt through mortgage giants Fannie Mae and Freddie Mac amounts to about $400 billion, or one-fifth of China’s total foreign currency reserves, according to a Sept. 12 China Daily report quoting the major investment bank, China International Capital Corp. (CICC). Though estimates differ and the precise value of the Chinese holdings is in constant flux, the roughly 20 percent chunk is proof enough that China stands to suffer big losses from the Fannie and Freddie debacle despite the U.S. Treasury bailout.

After decades of rapid economic growth driven in great part by exports of manufactured goods to American consumers, China has built up the world’s largest foreign currency reserves at approximately $1.8 trillion. The CICC believes that 60 percent of this massive sum, or $1.08 trillion, consists of US dollar assets, though some economists say it is closer to 70 percent — the rest lies mostly in euros and Japanese yen. The $1.08 trillion in dollar assets can be further divided into 50 percent (or about $540 billion) in US treasury bills and 40 percent (about $432 billion) in US agency bonds. The remaining ten percent of China’s state holdings of US securities comprise U.S. corporate debt and equities. The roughly $400 billion that China holds in Fannie and Freddie represents a fall from CICC’s previous estimate of $447 billion in June. But the precise measurement is in continual flux as the relative value of U.S. securities fluctuate, and in the current global economic situation fluctuation can be rather dramatic.

The disproportional presence of American assets in China’s reserves reveals the country’s inability or unwillingness to diversify the range of financial investments it uses to sock away its extra cash — despite the warning signs ahead of the subprime mortgage crisis and credit crunch, commodity inflation and the various other economic woes China now faces.

Beijing has not diversified its reserve holdings away from the dollar because doing so would be incredibly risky. Beijing sees its dollar assets as so numerous that any attempt to offload them in bulk would be dangerous to the country’s financial — and ultimately social and political — stability. Not only would it have trouble selling, say, $100 billion of securities on the spot, but flooding the market would drive the value of its remaining assets down. Moreover, American securities remain Beijing’s best option, despite the currency risk and low returns, because China’s domestic consumption is not developed enough to merit investing at home.

So rather than devalue its own dollar-denominated assets, China will for the most part hang onto them, knowing that only the United States provides a pool of debt big enough to handle the massive reserves that the Chinese continue to accrue through their trade surplus. (Most other serious contenders — Russia, Brazil, Australia, Germany — are running surpluses and do not need to borrow from China.) Furthermore, America is a secure place for China’s money, unlike some of the secondary options.

China can begin to break its dependence on U.S. habits of consumption and debt accumulation and reduce the proportion of U.S. assets in its foreign reserves by buying up non-dollar assets instead. But it will have to do so slowly in order to reduce the negative impact on China’s remaining dollar-denominated assets. Ultimately, until China can generate enough domestic demand to soak up its surplus funds at home, it will have to accept the middling returns of American securities.

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Looks like China is in the same mess we are. Kinda supports my theory that we're cutting off our nose (devaluing the dollar) to spite our face (China).

[Mangudai]

It is obvious that markets do not sufficiently regulate themselves voluntarily and that the State is usually a bad supervisor. So, how do we make the State a better supervisor without killing the benefits of private business?

Anti-trust laws should be enforced. There is no way companies like Fannie and Freddie should be permitted to hold 70% of US mortgages. Forcing overblown companies to split into many pieces is a viable solution.

[Mangudai]

I'm going to try to express a very big idea. I hope I can do it justice.

Nassim Taleb coined the term "ludic fallacy". Ludic is the latin word for games. Probability theory and game theory are sufficiently advanced to predict economic returns for gambling casinos. However, the economy as a whole is a different animal.

Probability theory and game theory are fashionable on Wal-Street. Quants (analysts) force their data to fit the Gaussian models, and express their uncertainty in standard deviations. Based on these models many people thought they understood how much risk they were taking. We all know outcome when they are wrong. The real world, and subsets like the financial markets, are not like games. The rules are not well defined, and rare events can turn the whole systems upside down.

We don't have any logically sound way of making decisions under uncertainty. Gaussian models are helpful most of the time, but sometimes they are woefully wrong. There are other mathematical models, but they are not logically sound either. We need to acknowledge deep uncertainty. In the words of Donald Rumsfeld, "there are unknown unknowns".




This idea also informs my view of regulation going forward. Many people are calling for the government to regulate the procedures used by credit rating agencies. This is a horrible idea because the regulators have no logically sound procedure. If the government did oversee credit rating procedures, this would lead to an even more dangerous level of misplaced trust in flawed models.

[Adrian II]

This idea also informs my view of regulation going forward. Many people are calling for the government to regulate the procedures used by credit rating agencies. This is a horrible idea because the regulators have no logically sound procedure. If the government did oversee credit rating procedures, this would lead to an even more dangerous level of misplaced trust in flawed models.

Besides Banquo's Ghost proposition that we abolish incorporation, this is another highly original contribution to the thread. It is an approach (or rather, an issue) which never even occurred to me.

Question for you. Gaussian prediction is mostly used when we don't know the mechanism underlying a distribution, right? If we would know the mechanism, we might take better samples and reach more sound conclusions with regard to markets. This points to inadequacies in economic theory rather than statistical analysis.

Or am I being blond here?

[Oleander Ardens]

Mangudai brought up what brought down "Long Term Investment" roughly 15 years ago, and now so many big names. When you roll the dice each new roll has the same probability. Rolling 66 times a 6 is very very improbable.

But in our real social world a session of 4 sixes in a row can highly increase the chance of a six in the next roll, because people may expect this exit. In our highly interconnected world, especially in the financial one everything influences everything with a varying degree. Some seemingly unconnected events can shape the peception and create in the mind of the majority a very strong correlation between events.

This in turn can morph into a self-fullfilling prophecy like the famous bear or bank run. Many think Lehmann will fail, many sell, more see this as a sign of Lehmann failing more sell. While usually there are enough different opinions to moderate a stocks movement in highly volatile and nervous markets a rumour can bring down a titan. Something which is quite unthinkable in pure statistical analysis. But something which happens now.

P.S: LT Investment thought they could only loose 5 millions a day at most, and they had two Nobels in their ranks and other highly esteemed mathematicians making this calculations. Then they lost it at a rate of over 50 millions a day.

[Mangudai]

Besides Banquo's Ghost proposition that we abolish incorporation, this is another highly original contribution to the thread. It is an approach (or rather, an issue) which never even occurred to me.

Question for you. Gaussian prediction is mostly used when we don't know the mechanism underlying a distribution, right? If we would know the mechanism, we might take better samples and reach more sound conclusions with regard to markets. This points to inadequacies in economic theory rather than statistical analysis.

Or am I being blond here?

Here are two quick examples one is Gaussian the other isn't.

Line up 100 people and measure their height. The distribution is Gaussian.
Line up 100 authors and measure how many books they sold, one of the people is JK Rowling author of Harry Potter. Her score is thousands of times greater than everybody else in the line put together. Not Gaussian.

Automobile insurance is well modeled by Gaussian methods.
Home owners insurance breaks the Gaussian model when there is a hurricane or tsunami. (Companies like All State barely remained solvent after Katrina.)
AIG wrote insurance on financial derivates. At the start of the crisis the CEO said "Our balance sheet is bullet-proof". He was relying on Gaussian models.


Economic theory is inadequate and may always be so. Oleander pointed toward one reason why. Perception and what we think other people are going to do is central in markets. Right now the best bull market are stable earners like packaged food, toothpaste, toilet paper, etc. I'm up 8% on that part of my portfolio in the past few weeks. The sector will probably go up another 8% as everybody rushes in hoping not to be last. Then when it appears that everybody is in who wants in, the stock prices will suddenly drop back to their normal levels.

Sales of toothpaste are Gaussian. Sales of the toy most requested this Christmas are not.

[Crazed Rabbit]

A opinion article on how Fannie and Freddie became so top heavy they toppled:
http://www.bloomberg.com/apps/news?p...d=aSKSoiNbnQY0

Back in 2005, Fannie and Freddie were, after years of dominating Washington, on the ropes. They were enmeshed in accounting scandals that led to turnover at the top. At one telling moment in late 2004, captured in an article by my American Enterprise Institute colleague Peter Wallison, the Securities and Exchange Comiission's chief accountant told disgraced Fannie Mae chief Franklin Raines that Fannie's position on the relevant accounting issue was not even ``on the page'' of allowable interpretations.

Then legislative momentum emerged for an attempt to create a ``world-class regulator'' that would oversee the pair more like banks, imposing strict requirements on their ability to take excessive risks. Politicians who previously had associated themselves proudly with the two accounting miscreants were less eager to be associated with them. The time was ripe.
...
What happened next was extraordinary. For the first time in history, a serious Fannie and Freddie reform bill was passed by the Senate Banking Committee. The bill gave a regulator power to crack down, and would have required the companies to eliminate their investments in risky assets.

Different World

If that bill had become law, then the world today would be different. In 2005, 2006 and 2007, a blizzard of terrible mortgage paper fluttered out of the Fannie and Freddie clouds, burying many of our oldest and most venerable institutions. Without their checkbooks keeping the market liquid and buying up excess supply, the market would likely have not existed.

But the bill didn't become law, for a simple reason: Democrats opposed it on a party-line vote in the committee, signaling that this would be a partisan issue. Republicans, tied in knots by the tight Democratic opposition, couldn't even get the Senate to vote on the matter.

That such a reckless political stand could have been taken by the Democrats was obscene even then. Wallison wrote at the time: ``It is a classic case of socializing the risk while privatizing the profit. The Democrats and the few Republicans who oppose portfolio limitations could not possibly do so if their constituents understood what they were doing.''

Democrats love regulations, except when it's on the government. Pape made a good analogy about the football team.

CR