Problems at Fanny Mae
Problems at Fanny MaeMy research into banking failures over the last 300 years in the United States has reviled to me some important facts about how our government handles bank failures. Fanny Mae may be a mortgage lending business, but it is really a bank by pseudo definition.
Most, if not all banking crisis since paper money was first used in the US starting in 1691 has resulted in one undeniable fact. Creditors lose property rights in favor of borrowers.
In terms of banking failures this means that the bank or banking system in distress is allowed to continue doing business while suspending payments to creditors. Contrary to popular belief banks tend to be the biggest debtors of all since they produce debt using a fractional reserve system of banking.
Therefore the government will in fact step in and inflate. If you study the origins of The Federal Reserve, you can clearly see the argument made by Jacob H. Schiff in his speech in January of 1906. In the book the A History of Money and Banking in the United States Murray Rothbard writes
“The campaign for a central bank was kicked off by a fateful speech in January 1906 by the powerful Jacob H. Schiff, head of the Wall Street investment bank of Kuhn, Loeb and Company, before the New York Chamber of Commerce. Schiff complained that in the autumn of 1905, when “the country needed money,” the Treasury, instead of working to expand the money supply, reduced government deposits in the national banks, thereby precipitating a financial crisis, a “disgrace” in which the New York clearinghouse banks had been forced to contract their loans drastically, sending interest rates sky-high.
An “elastic currency” for the nation was therefore imperative, and Schiff urged the New York chamber’s committee on finance to draw up a comprehensive plan for a modern banking system to provide for an elastic currency. A colleague who had already been agitating for a central bank behind the scenes was Schiff’s partner, Paul Moritz Warburg, who had suggested the plan to Schiff as early as 1903.
Warburg had emigrated from the German investment firm of M.M. Warburg and Company in 1897, and before long his major function at Kuhn, Loeb was to agitate to bring the blessings of European central banking to the United States”
In the case of mortgage lenders banks during the S&L Crisis of the 1980’s used several tactics in order to remain operational during a meltdown. The first attempt to save the S&L’s was in September of 1981 when the Federal Home Loan Bank Board permitted the Federal Savings and Loan Insurance Corporation (FSLIC) to buy Income Capital Certificates from insolvent S&L’s. This allows the S&L’s to appear solvent on their balance sheets when they are in fact insolvent.
GAAP requirement are dropped and replaced with Regulatory Accounting Principles (RAP) in January of 1982. This effetely avoids accounting which would indicate that the S&L’s are insolvent and liberalizes financial accounting.
So, during a crisis you could expect the US to keep on lending money for mortgages, it can do this because when all else fails, it can just print money. Not only can they keep on lending, but they can peg mortgage interest rates to be artificially low.
Remember, mortgage interest rates are normally set by interest rates of the MBS bonds, however, the government doesn’t have to sell the mortgages. Therefore they can technically set any level of interest they desire for mortgages or subsidize them. And don’t think they wouldn’t either. This is not an uncommon tactic for a country facing a contracting monetary system.
Chromatic Dispersion
Most, if not all banking crisis since paper money was first used in the US starting in 1691 has resulted in one undeniable fact. Creditors lose property rights in favor of borrowers.
In terms of banking failures this means that the bank or banking system in distress is allowed to continue doing business while suspending payments to creditors. Contrary to popular belief banks tend to be the biggest debtors of all since they produce debt using a fractional reserve system of banking.
Therefore the government will in fact step in and inflate. If you study the origins of The Federal Reserve, you can clearly see the argument made by Jacob H. Schiff in his speech in January of 1906. In the book the A History of Money and Banking in the United States Murray Rothbard writes
“The campaign for a central bank was kicked off by a fateful speech in January 1906 by the powerful Jacob H. Schiff, head of the Wall Street investment bank of Kuhn, Loeb and Company, before the New York Chamber of Commerce. Schiff complained that in the autumn of 1905, when “the country needed money,” the Treasury, instead of working to expand the money supply, reduced government deposits in the national banks, thereby precipitating a financial crisis, a “disgrace” in which the New York clearinghouse banks had been forced to contract their loans drastically, sending interest rates sky-high.
An “elastic currency” for the nation was therefore imperative, and Schiff urged the New York chamber’s committee on finance to draw up a comprehensive plan for a modern banking system to provide for an elastic currency. A colleague who had already been agitating for a central bank behind the scenes was Schiff’s partner, Paul Moritz Warburg, who had suggested the plan to Schiff as early as 1903.
Warburg had emigrated from the German investment firm of M.M. Warburg and Company in 1897, and before long his major function at Kuhn, Loeb was to agitate to bring the blessings of European central banking to the United States”
In the case of mortgage lenders banks during the S&L Crisis of the 1980’s used several tactics in order to remain operational during a meltdown. The first attempt to save the S&L’s was in September of 1981 when the Federal Home Loan Bank Board permitted the Federal Savings and Loan Insurance Corporation (FSLIC) to buy Income Capital Certificates from insolvent S&L’s. This allows the S&L’s to appear solvent on their balance sheets when they are in fact insolvent.
GAAP requirement are dropped and replaced with Regulatory Accounting Principles (RAP) in January of 1982. This effetely avoids accounting which would indicate that the S&L’s are insolvent and liberalizes financial accounting.
So, during a crisis you could expect the US to keep on lending money for mortgages, it can do this because when all else fails, it can just print money. Not only can they keep on lending, but they can peg mortgage interest rates to be artificially low.
Remember, mortgage interest rates are normally set by interest rates of the MBS bonds, however, the government doesn’t have to sell the mortgages. Therefore they can technically set any level of interest they desire for mortgages or subsidize them. And don’t think they wouldn’t either. This is not an uncommon tactic for a country facing a contracting monetary system.
Chromatic Dispersion
posted by Chromatic Dispersion at 9/28/2005 09:03:00 PM
7 Comments:
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If we compare the current crisis with the S&L crisis, I believe that we are in the accounting fraud stage. Fannie and Freddie have not been required to release accurate financials in over 2 years. There is little ability to actually monitor their solvency or insolvency and as you imply - for all intents and purposes it probably doesn't matter, so long as the implied Government backing and Greenspan PUT are present.
The part of your post that I don't understand - is the idea that the government could set interest rates - including long term interest rates. My understanding - is that under our current system at least - the long rates are determined not so much by what the MBS market can bite off, but more by what the fixed income markets overall can handle.
Not just mortgage rates are low - interest rates of all kinds, corporate, municipal, etc. - are at historic lows. If we look back over the past 10 years the answer that the Government would give - is that the system has been very stable with incredibly low inflation. As a result if a bond was yielding 5% - it was offering a real return of 3% plus because the inflation rate was under 2%.
Due to the oil shock things are changing before our eyes as inflationry expectations change and *rational* investors should demand higher risk premiums and interest rates as Greenspan argues. I think you have some ideas that coordinate with this in regard to the currency. If I understand your posts correctly - you argue that if the dollar depreciates 30% against the other world currencies - we may very well still be paying 5% interest on mortgages here - but we also would have just experienced a huge decline in the purchasing power of our currency??
Sorry man - I obivously don't understand your points completely - so maybe you can help out. Nonetheless - I belive we are on the cusp of something big here and am expecting something huge this October. What that would be...... I am not sure - but I think it is coming.
Regards,
Ben Green
Ben Green,
When I state that government can set mortgage interest rates this means that in a pinch or economic crisis the government can just use its power to set mortgage rates for mortgages that the government issues to home owners. This would not really affect mortgages outside of the governments prevue except to take away this business and force private lenders away.
This would be one example of additional property rights given to the borrower at the expense of the lender. For if a borrower couldn’t pay their mortgage at the current interest rate, and then they could obtain a government mortgage at a lower interest rate, thereby gaining an advantage that the free market would not produce on its own. Basically this is the government socializing the mortgage market.
Chromatic Dispersion
Would you say that a good comparison to this is the current student loan market where for graduate school (eg. law student) can obtain the federal stafford loans with advantages such as interest deferral and artificially low interest rates (re: less than 2%).
You think a similar program could be setup for troubled home owners, etc.? I actually see this as possible, but I feel like it is many years away. I guess it is all contingent on how fast things unravel.
Do you have any opinion as to timing or do you just prefer to study the main factors at work?
-BG
Ben,
I would agree with your analogy between a government fixed rate interest rate subsidy and student loans. I am a little ignorant how student loans are actually structured, but I believe the interest rate of the loan is subsidized.
The last time something like this was tried at a national scale was during the Great Depression. In 1933 President Roosevelt set up the Home Owners Loan Corporation to buy up distressed mortgages and to refinance them. This is what you might call the birth of Freddie Mac. Approx. one million mortgages were serviced under HOLC for a total cost for $3.1 billion.
This is not to say that mortgages were not liquidated, they were, however it reduced the burden on some homeowners enough so that they could keep their homes. Almost 200,000 mortgages were liquidated during the Depression.
Therefore I would reason that the government shall always be able to lend money to purchase housing, even if Fannie Mae goes bankrupt. If Fannie Mae goes bankrupt, this does not mean that the MBS they have sold will not be paid, that is dependent upon the borrowers ability to service their debt.
I would suspect that we shall see something like a HOLC when bankruptcies and foreclosures start to really accelerate. So it took 5 years in the Depression, this may go faster due to derivatives accelerating the velocity of money.
I have no idea when thing will break down, I just know that when lending for housing decreases and then becomes negative through foreclosures, then the end is very near.
As a final thought I would like to point out that under HOLC mortgages were increased from 5 to 30 years. With interest only loans, meaning an infinite length mortgage for payoff purposes, which can not effetely increase this rate, so the effect may be much more limited. Interest only loans also existed during the Depression as well, but most loans were from 5 to 7 years in length
Chromatic Dispersion
Hello Chrom ic Dispersion ,Als je bij een bank niet slaagt voor geldleningen heb je dan nog kans op geldleningen bij bijvoorbeeld postkrediet?
Hello Chrom ic Dispersion ,Als je bij een bank niet slaagt voor financiering heb je dan nog kans op een financiering bij bijvoorbeeld postkrediet?
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