Monday, February 8, 2010

The Volcker Rule

Ho-hum, there they go again. Former Fed Chairman and current Obama financial advisor Paul Volcker has proposed a limitation on banks financially speculating, creating conflicts with their federally insured deposit responsibilities.

The inevitable “Why now, why us, what’s the problem?” crowd comes out and opposes it. Retiring Senate Banking Chair Chris Dodd (D-Conn) has some doubts about the idea and, naturally, Sen. Dick Shelby (R-Ala) has concerns, and the big banks have their constant doubts about codifying in law what Volcker wants.

They tweet and twitter, “Maybe give the regulators that authority, but don’t put it in statute.”

In 1992, Fannie Mae and Freddie Mac insisted that the new GSE risk-based-capital rule—which had no precedent in US financial laws--be put in statute and made very explicitly. We did not want our inexperienced regulator interpreting vague legislative directives, making a tough new law even tougher. We wanted the law clear for all to read and see, including the regulator, so if the regulator decided to take out some anger in an extreme implementing reg, the world would have easy access to the facts.

You seldom get that kind of certainty, if a statute is vague and represents just a general call to the regulator to put something in place.

Most business interests seldom want statute, seeking regulations instead, because while the risk is there for tougher regulatory treatment, regs are not laws and regulators often can be lied to, cajoled, or even threatened, out of their regulatory intent. (“If you issue that reg, we will lose our market for widgets and 10,000 Ohio workers will lose their jobs and benefits and go to bed hungry.”)

The two biggest untruths the financial regulators hear now from their regulated entities are, “We need to grow. If we can’t grow to be the biggest in the world, we won’t be able to compete with foreign financial services companies” and, “We need to pay our senior employees top dollar or we will lose them to other employers!”
Bull pucky! Haven’t we seen this show before?

Whether it is the “Volcker Rule” or any related reform, Congress should listen carefully to every commercial banker, investment banker, and financial spokesperson and then do exactly of the opposite of what they advocate.

It’s simple, no bank exec or trade association official ever will endorse anything that might limit their money making ability. Risk reduction is one of those things. Remember the Wall Street bylaw: “The greater the risk, the greater the reward.”
The path is clear, if Congress wants to do anything on the “Volcker Rule,” just head for where the banks—and their congressional apologists--say don’t go.

How much BS does it take before Congress understands that and then just does right thing?

Voters to the Congress: “Scott Brown, Scott Brown, boogah, boogah! The public is tired of you kowtowing to the banks.”

Hank Paulson, the GSEs and his book “On the Brink”

After reading Hank Paulson’s account of the takeover of Fannie and Freddie, in his new book, I didn’t come away with many insights. Maybe he’s saving them for a sequel.

At the time of the takeover, many of us thought the action re Fannie was premature and that the DC Company was in much better shape and better managed than Freddie Mac.

Paulson seems to share those views in his book, but that relative “financial strength” was meaningless, since he felt that he had to treat both companies the same and at the same time. (Son, yes you’re sick, but your sister has only a slight fever, so I am going to chop off both your heads. Goodbye.”)

His description of Fannie CEO Dan Mudd being upset and somewhat angry when he heard Paulson’s plans and a laconic somewhat relieved Freddie CEO Dick Syron, when he got the same news, comports with the differences that many of us saw at the two GSEs.
Simply stated, the Fannie board and management always was far more involved with what the company did and more dedicated to the company’s congressional housing mission. The Freddie counterparts were less so.

Before the public takeover announcement, Paulson writes of his surprise conversations with the Democratic presidential and vice-presidential candidates. First, Barack Obama called Paulson to discuss the GSE issues, and a day later when Paulson called Joe Biden. Paulson’s suggests that the two public officials were knowledgeable ,thoughtful, and incisive in their comments and questions, and offered support for what was a daunting financial and economic action.

Paulson seemed not to gain the same confidence in his conversations with Senator John McCain and Sarah Palin, who still were enjoying the positive buzz of the Palin VP announcement which on that day was barely 24 hours old.

Paulson, who very much establishes himself as the Administration’s “driver” on the takeover confirms how weak was the GSEs’ regulator, the Federal Housing Finance Agency (FHFA,) formerly the Office of Financial Housing Enterprise Oversight (OFHEO).
FHFA had just spend years, every three months, announcing how well capitalized each company was and Paulson was taking them over because—in his opinion—Fannie and Freddie lacked sufficient capital.


OFHEO/FHFA was a basket case from Day 1 and never improved. Conservatives argued that the GSEs hamstrung the agencies and fought them over their budgets on the Hill. Nothing was further from the truth. I was there and I know, At Fannie, OFHEO’s budget and oversight specifically were “off limits” and we were told not to lobby the Congress on them, just to respond to congressional inquiries if asked.

IMO, the GSE regulator used its budget funds, poorly, never bringing in enough examiners and financial talent; instead they hired and kept on board a number of Fannie/Freddie foes who for years conducted a guerilla political campaign against the GSEs rather than overseeing them.

For every quality employee OFHEO/FHFA brought in, it seemed to me that they matched him or her with two slugs and a hack and it showed and still shows.

The best evidence I can offer to substantiate that the GSEs didn’t interfere with the regulatory budget (funds, BTW, which came from the companies themselves) is to note that, in every budget sent to the Hill by the Office of Management and Budget--under Democrat and Republican Administrations-- OFHEO/FHFA got exactly what the OMB sought for them, suggesting no lobbying the appropriations process and the staffing levels they supported.

We didn’t like OFHEO and their political agendas and were open about that, but we never challenged their spending requests.

The one thing Paulson mentions –beyond his personal certitude about doing in the GSEs—is how much he worried about Fannie’s (most notably) and Freddie’s political clout and their ability, at least outside the courts, to stop the Treasury action.
What a misread that was.

In 2008, by the time Paulson got the congressional authority to act (four years after I retired), Fannie--at the direction of its new CEO Dan Mudd, named in 2004—was into its third year cutting back substantially its entire external affairs team, dropping dozens of political consultants, cutting internal PR staff and in house lobbyists, and dumping major field staff who worked on grassroots efforts. Fannie long before Paulson moved was politically weaponless. Mudd wanted to change the muscular/pugnacious culture, which he felt preceded him.

The battering that the GSEs took from their business opponents, the Right, and the Bush Administration weakened the companies substantially and they could fight back if they chose to, except in court, which they never did.

That made it easy for Paulson to do what the GOP Right demanded, as well as what Russian investors wanted, the latter according to the book.

One major hole in the Paulson takeover drama—which for me raises questions about his motives--is the fact that the Obama Administration (as I suspect a McCain Administration would have found necessary) continues to utilize and rely on Fannie and Freddie.

Now that Chairman Barney Frank (D-Mass) has announced March hearings to produce a new national mortgage finance system, the public should get some insight as to why the GSEs still are required to be there, because it seems—even in their weakened and abused state—they remain the best secondary mortgage market option for the public as well as those institutions still making first mortgage loans.

So, Hank gassed them, but Fannie and Freddie still remain necessary.

The large commercial banks and other financial services behemoths, which many think can replace Fannie and Freddie, haven’t bothered to fill the void or even hint at their interest.

When a pair of institutions, being poorly run by government overseers, still cuts the mustard better than all of the faux private sector lenders (which non-Fannie and Freddie financial institutions have no tap on Uncle Sam?), those who aspire to be smart policy makers should take note.

Congress, careful what you discard with the bath water after you bathe this baby.

Maloni, 2-8-2010

(For those of you not living in the DC area, let me assure that this past weekend’s snow was the absolute heaviest/worst I’ve seen in the 40 years we’ve lived here. School closings, event cancellations, and digging out will go on for days. And we may get more snow on Tuesday and Wednesday.)


Anonymous said...

Interesting points on Paulson's book "On the Brink”. What do you think was the Russian leadership's motive to convince their chinese counterpart in selling their Fannie Mae's paper? The Russians had already sold theirs few years before, Paulson's logic seems out of sequence.
The Fed has given the GSE's a short period of grace to "recognize" assets off the books, and reserve capital against potential losses. Do you think Fannie's reserve of $57 billion is adequate for a max exposure of $2.4 trillion?
-Blue Agent

Bill Maloni said...

A couple of answers to matters for which I don't have the exact details.

In the context of reading about the Pualson book and his GSEs comments--before writing the last two blogs--someone noted that the Russians unloaded @$70 Billion of GSE securities shortly after failing to get the Chinese cooperation in their actions, which in turn were designed to force a US takeover, i.e. what Paulson did.

Who knows who sold what to whom, since the debt owners and their trades are not public. It is interesting to me that Paulson mentions his discussions re the GSE action, post facto, with Chinese business friends.

The short answer on the capital to asset ratio is "not now," but with a caveat.

The numbers you mention are not far off from the roughly 40-1 capital ratio which both Fannie and Freddie operated with in their prime.

Everything changed--and should have--with the 2007-2008 financial debacle.

But, if you gradually increased the GSEs capital; worked on removing from their books the self-inflicted Alt A and PLS securities; and
made some alterations in the "housing goals" (the severity of have been underestimated by commentators), then I believe the two--or certainly one of them--could return to crucial market role they had. But, you also would need a far better and thoughtful regualtor, or just better people at FHFA.

IMO, whatever steps are required in the preceding paragraphs--save the need for many politicians, in both parties, to swallow their words--are far less daunting than Barney Frank's "abolishing them" and designing an entire new mortgage fiannce system for the nation.

The Chairman is a very smart guy but he's is taking on a Herculean task, Gordian knot, Aegeam stables, childhood obesity, Wall Street greed, and more here, in a congressional election year.

I've been amazed at how easily people, who should know better, jumped on the demonization of the GSEs and our secondary mortgage market system.

You don't have to be a F&F apologist to see that you had two weak CEOs, Mudd and Syron--making bad decisions(PLS subprime)--and 15 years of lame/conflicted regulation, which got usd to where we are today.

Longer than you wanted, but that's what I think, ergo my congressional "baby and bath water" warning in yesterday's blog.

Norsky said...

Love your blog, Bill. Best info on what is going on in GSE land! I wonder though, if there is more to it than meets the eye regarding next month's restructuring hearings. Also, don't you think our former Treasury Secretary showed great foresight in giving priority to the Chinese gov't claims on F&F over the shareholders, should he resume his Wall Street career?

Anonymous said...

After attending the Amercian Securitization Conf, it's hard to imagine reform that isn't a version of a mortgage utility. The current GSE infrastructure is enormously complex. Most panelists saw no private label sponsorship anytime soon. And all agreed mtg rates would be over 150 bps higher w/o govt sponsorship.

And nobody saw housing prices posting gains for years to come-- most debated when prices would stabilize. Further, the FHA only recently stopped making stupid loans that are not likely to be repaid, as evidenced by their loss rates ON LOANS SINCE 2008 ! What Republican will sign up for a GNMA like govt ownership with that recent record? Congress can't "abolish' the GSEs with those risks. They may change the names but the heavily regulated utility model looks most likely to me. Regarding a portfolio (where I worked for many years), Congress will have to test whether the banks/insurers will keep fixed rate loans/MBS on their books without a much higher yield premium (FAS167 and the long duration doesn't make that very likely!). This issue is harder to quantify and therefore predict, so a reconstituted GSE is unlikely to have much of a portfolio, especially given right wing demonizing over the years. Funny, the balance sheet portfolios were not what created the vast majority of losses, yet over the years the right was targeted them but never said 'boo' about the MBS-- credit book. What do you think.

Bill Maloni said...

Wow, those two questions and comments give me a lot of groubnd to cover. So, here goes:


He clearly did--just a few weeks after hearing about the Russian overture to the Chionese--take over Fannie and Freddie, which is what the Russians sought.

One question is did the Russians, as Bloomberg reported, dump $70 Billion of GSE securities (presumably bonds) before the Secretary acted or not? It sounds like the Chinese didn't.

That is an intriguing question which the two Banking Committees might want to investigate.

Giving the Russians the greatest benefit of the doubt--despite my mother's family warnings--it may be that they saw an inevitability of takeover that others couldn't divine and wanted to accelerate it. But, I am probabaly being too fair to the bastards.

The shape of the future mortgage market...I suspect that there are not 10 people on Capitol Hill--including Senators, Members, and their staffs--who can relate/understand the issues raised by the "American Securitization Conference, as documented by "Anoymous."

That's not a putdown, that's the reality of Congress, which is one reasons why I've been trying to implore thsoe folks to learn and understand what's at stake.

I am almost certain that if you could honestly survery the House Banking Committee 75% of them or more would have negative things to say about the former GSEs, but not be able to give you cogent fact-based reasons for their views.

I believe a very chastened F&F, with their new managements, if told by the Treasury/Administration,"Get back to business;" charge what you need to charge; limit your portfolio growth; make sure that 40% of your business serves the "targeted audiences," and and get the US real estate market working, a real estate financing reversal and market revival would be accomplished in a matter fo months.
certainly by the end of 2010.

But, too many people and interests seem to want abuse the dead awhile longer, then try and gerrymander some new system which would take years to set up--and still may not work--after months of preening for re-election.

All of this rather than a simple remake of that which we have and which worked.

New isn't necessarily better than old.

Look at the system's shortcomings and fix those. It isn't a mystery.

Keep the mortgage structure/function you have and produce better regulation and better managers (which may already be in place) and limit months of ditehring and political hot air.

Anonymous said...

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Bill Maloni said...

"College assignment??"

Wait, I thought that ended for me when the last of my sons graduated in 2009.

"Anonymous," If you are writing about the large comemrcial banks, make sure you spell "scumsucker" correctly!

(Send me an "Anonymous" copy of your paper.)