“Stinker,” A Tutorial on Misusing Systemic Risk

Before earning great acclaim as a prominent anti-smoking and health care advocate, Joe Califano not only was President Jimmy Carter’s Secretary of Health, Education and Welfare--before the agency was renamed “HHS,” for you kids out there--but he was also a very capable assistant to President Lyndon Johnson and played a significant role in privatizing Fannie Mae.

Califano told me about his responsibilities in 1968 when, in the midst of the Vietnam War and domestic spending challenges, Lyndon Johnson did not want to be the first American President to send the Congress a $100 billion spending budget. The President tasked Califano to make the budget come in below LBJ’s perceived “political third rail” budget figure.

The aide repeatedly went over the draft federal budget and finally identified some 30 domestic items and functions which—if he could get the Congress to end or remove them as government obligations—would allow the Johnson budget to fall under the magic number. One of these proposals was selling Fannie Mae to private investors. Since the Roosevelt days, Fannie Mae--part of the Department of Housing and Urban Development--had acted as a secondary mortgage market for government backed mortgage loans.

Califano said that he intentionally chose the Fannie Mae idea as a “lightning rod.” Knowing it was such a congressional favorite, he assumed Congress never would allow the agency to be jettisoned. It was a “stinker,” something that stood out by design and which Califano included it in the package, believing that later he would acquiesce to congressional pressure and “reluctantly” take Fannie back keeping it in government.

That was Califano’s plan. He really was hoping that Congress would rage over Fannie and that it would draw all of the congressional fire, while he managed to preserve the balance of the cuts so that he could meet President Johnson’s budget goal.

To Califano’s surprise, the Congress bought all of the proposed changes. Congress restructured Fannie Mae as a private company—with authority to purchase and securitize conventional, i, e, non-federally insured or guaranteed mortgages—and in 1970, the new privately owned and managed company first was traded on the New York Stock exchange under the symbol FNM.

GSE Systemic Risk Stinks or Is It a Stinker?

What brought Califano’s political strategy to mind is the noise now coming out of various Administration spokespersons, bleating about the “systemic risk” language, taken from the House passed GSE regulatory reform bill, when Financial Services Committee members Melissa Bean (D-Ill) and Randy Neugebauer (R-Texas) convinced 381 of their Democrat and Republican colleagues to vote for a floor amendment removing the White House required boilerplate.

The original Administration language, which Bean, Neugebauer, and their House stalwarts wisely quashed, 383-36, had no parallel in other financial services regulatory regimes. It would have allowed the new GSE regulator to employ “systemic risk”--a very subjective term hatched and husbanded by the Greenspan anti-housers--to legitimize any actions a GSE regulator chooses to take against the companies.

The now excised provision would have given the GSE regulator broad latitude to apply regulatory sanctions, employing a rationale which might have nothing to do with Fannie Mae’s or Freddie Mac’s business operations, but merely was the regulator’s perception of broader amorphous threats somewhere in the financial services world.

Could today’s “systemic risk” be masquerading as Califano’s forty year old “stinker?”

Are Paulson, Steel, Lockhart, Bernanke (yes, he has finally earned his “Junior Bushman GSE Badge”), and others--who insist on return of that language—talking for real or are they just engaging in a feint designed to position themselves for more extreme demand later, in the inevitable compromise when/if the Senate passes a GSE bill and a conference occurs?

Maybe they are, but then again, maybe not.

“Systemic risk concern” employed by this White House crew sounds a little like them defining pornography, “Um, trust us. Lockie’s successor will know what systemic risk is when he sees it. KnowhatImean?”

This speech excerpt is a pretty fair description of some recent and real systemic risks.

Shortly after the August FOMC meeting, however, financial market conditions deteriorated considerably further, following events that shook investor confidence, particularly in complex structured credit products. The disruptions to nonprime mortgage markets became more severe and problems even extended to high-quality loans, as rates for prime jumbo mortgages jumped after the secondary markets for them shut down. Importantly, the disruptions also spread beyond the mortgage markets. Most notably, investors' concerns about exposures to subprime mortgage credit risk caused them to shun commercial paper that might be backed by such assets, in both Europe and the United States. This aversion, in turn, meant that commercial banks that had written backup liquidity lines for commercial paper programs or had other connections with these programs might have to make good on their actual or implied support by extending credit. With leveraged buyout credit and some mortgage originations also possibly staying on the balance sheet unexpectedly, the banks faced substantial, but uncertain, calls on their liquidity and capital. All this uncertainty led the banks and other short-term lenders to turn very cautious; interest rates on bank deposits and other sources of credit beyond just a few days rose steeply, funding in money markets became concentrated in the very short term, and concerned and uncertain lenders generally became much less willing to extend the credit needed for liquid and efficient financial markets.

Those words were part of a talk delivered last Friday, Oct. 5, to the Philadelphia Chamber of Commerce, by Fed Vice Chairman Don Kohn. To his credit, Mr. Kohn did not try and blame the housing GSEs for these broader systemic challenges in the wake of subprime mortgage problems.

Garage Sales in McLean and at 3900

For years, the Bush Administration and their conservative think tank and media friends have labeled Fannie Mae and Freddie Mac as “systemic risks,” wrongly in my oft stated view.

If the current OFHEO had additional intervention authority, based solely on the Director’s systemic risk allegations, there is little doubt in my mind that the two companies boards now would be presiding over giant “garage sales”--in McLean ,Virginia and Northwest DC--hawking the GSEs furniture, drapes, pcs and cafeteria supplies at deep discounts. That is the level of disdain and political animus that the Bush appointees and their allies have for Fannie Mae and Freddie Mac.

The GSE opponents have tried very hard to make that case employing every communications and political trick at their disposal. I wonder if it ever has occurred to them that the reason they have failed so far is that they are wrong. Despite all of the mud, slurs, allegations, and heavy handed mugging, the two companies are well capitalized for the risks they take and operate soundly in their secondary market niche. They add value, plain and simple and most reasonable people seem to agree.

It also is why the Congress--primarily the Democrat leadership of the House Financial Services Committee and the Senate Banking Committee--can’t get fooled by the White House’s histrionics over what it “insists” must be in any bill which Congress passes. The last time I checked “W’s” party didn’t win the midterm elections and should get no grander seat at the table than the Democrats were given when the President was riding high and his party controlled the Hill.

In its arrogance, this White House would have the Congress ignore 383 votes in the “people’s house” against using systemic risk as a regulatory justification, plus years of the Senate’s own political wisdom. The Administration instead wants to tell us how “close” Congress is to producing a good GSE bill, if only it would “add this or put back that.”

It’s a “mug’s game.”

The anti-Fannie/Freddie financial crowd sits like jackals, hungering for the remains of a successful Administration hit on the GSEs, desperately wanting the new regulator to have some new power to add greater capital burdens to the companies or allow more interference in the product choices or initiatives. They'll take whatever GSE grief they can hustle.

This GSE fight always has been about money and which mortgage players will finance and hold the lion’s share of American home mortgages. The White House spins scary tall tales and hopes more mortgage financing and investing gets done by their Wall Street cronies and much less by the GSEs and their lender partners.

The Congress should never forget that the White House favorites in this conflict are the same unreliable mortgage interests who brought you the subprime and “jumbo illiquidity” messes, when they skittered and skulked away from the broader mortgage market as their subprime chickens first started coming home to roost.

Here is where that “stinker” comes into play. Either the “systemic risk” issue is a “stinker,” a phony issue stalking for something else they really want or it’s an ideologue's fondest dream, which the bad guys refuse to give up and the good guys can’t give them, in any way shape or form.

Remember, They Excel at Deceiving

Let me suggest one small note of political caution to the Democrats.

The WH will tease and offer carrots forever: “If the GSEs just did this to their books or did that to their securities, we will consider taking off their handcuffs.”

Don’t buy it. On these matters, they are not honest brokers nor have they ever been.

Just as they are talking with the Hill over elements of a GSE bill, the Treasury tries a sneak attack to hamstring the GSEs debt raising activities suggesting additional hurdles to efficient market access. That's "good faith?"

Responsible parties enter the debt markets when rates and conditions are optimal--and the timing for that changes hourly or more often--not when some Treasury GS 13 responds to a GSE debt request, following his/her morning latte break!

“Tomorrow is promised to nobody,” especially public officials. Even if the Democrat congressional majority thinks that the 2008 White House race already is in the “Blue bag,” its way too soon to act on it, even if they are correct.

Congress should not write comprehensive GSE legislation, now, contemplating that a more thoughtful, progressive, pro-housing regulator might oversee the companies two years from now. It is better to write legislation as if “Freddy Kreuger” is going to be the new GSE regulator—you know, someone like Lockie needing a manicure—rather than a housing soul mate to Mother Theresa.

“Stuff” happens!

The Congress can’t make it easy for the Bush Administration, thinking it won’t be around for long. Even a new GSE regulator needs a leash.

Offer Them What They Deserve

Consider giving the WH a “thin bill” now and, if the Democrats prevail in the 2008 elections and return as the majority, the Congress can complement any work done now or complete the job in 2009 with “a technical corrections package.”

Or, don’t give the Administration anything. Wait it out. Let Lockie whine to the appropriators and justify his budget and agency activities, until the White House/Treasury/OFHEO stop inviting you to shoot craps with their loaded dice.

In the meantime, expect the anti-GSE pack to continue their wearisome howling and guerrilla campaign against Fannie Mae and Freddie Mac.

Why shouldn’t they, most of them already own a home or two?

Maloni 10-8-07