Sunday, October 23, 2011

Cato Challenges 10 Year Old GSE Support

Stiglitz & Fannie Mae, continued…

Last week I expressed some disappointment that while Nobel prize winner Joseph Stiglitz now raises the issue of “privatized gains and socialized losses” in our financial system, he made very different claims about Fannie Mae some years ago. In a NPR piece back in July, Professor Stiglitz offers his response to this charge. You should read it and decide for yourself. To the Professor’s credit, he does admit that we have a problem with Fannie (and Freddie). Such an admission would have been more helpful a few years ago. But better late than never.

For the sake of brevity I will address one of the many claims now, and address the others later this week. Stiglitz argues that “our big banks get finance at lower rates of interest than do others, because of the belief, in part, that should they have a problem, they will be bailed out.” His implication is that had Fannie not existed the risk would have just flowed to the big banks, which had to be bailed out too. Now I’ve questioned elsewhere just how much of a problem “too big to fail” banks were before the crisis, but one critical point bears remembering, even the most higher leveraged and reckless of the big banks still had to hold multiples of the capital that Fannie and Freddie held. In the extreme the GSEs only were required to hold .45 percentage points of capital against their MBS guarantees. Had a bank held that same risk on portfolio, it would have been required to hold 4.0 percentage points. That’s correct, a bank would have held almost 9 times the capital for the same risk as did Fannie. Even if Fannie held that risk on balance sheet, banks would still be required to hold 160% more capital. The simple fact is that had Fannie/Freddie not existed and banks had instead held that risk, there would have been over a $100 billion more capital in our financial system.

Professor Stiglitz was far from alone, and far from the worst, in terms of academics writing work to provide cover for Fannie Mae. Current economic advisor to Mitt Romney and former Bush official Glenn Hubbard also produced work defending Fannie Mae. Fannie and Freddie were also some of the largest supporters of the various real estate finance academic organizations, like the American Real Estate and Urban Economics Association. This is less about picking on Stiglitz (or Hubbard) than exposing Fannie’s ability to corrupt academia for its own purposes.

Mark A. Calabria October 17, 2011 @ 1:49 pm
Filed under: Finance, Banking & Monetary Policy

Stiglitz and Hubbard are Innocent

By the time you read this, Cato Institute’s Mark Calabria, likely, will have turned to stone for his prevarications, just in the above article alone. He also might have a Pinocchio moment and find his nose several inches longer.

My teasing Calabria is based on something he wrote a week ago—which I’ve posted above--criticizing Fannie Mae, Nobel Prize in economics winner (2001) Joseph Stiglitz, and Glenn Hubbard, a Mitt Romney economic advisor.

About 10 years ago, both Stiglitz and Hubbard penned papers saying positive things about Fannie Mae, Freddie Mac, and the secondary mortgage market. The papers appeared in a Fannie compendium titled “Housing Matters.”

In attacking the two academics, now, Mr. Calabria uses standard right wing anti-GSE arguments to go after Stiglitz (and to a lesser extent Hubbard).

But what he really does—in using these tired themes—is to expose his own ignorance of how Fannie Mae truly operated and why “the pre-2004 Fannie Mae wasn’t the post-2004 Fannie Mae.”

(BTW, before writing this piece, I called Mr. Calabria—whom I didn’t know--to give him a heads up re my disagreements.)

This Mae Ain’t That Mae

The Right refuses to look at pre-2004 Fannie Mae in its pre-subprime role and compare/contrast it with the post-2004 company which made foolish purchases of Alt-A mortgages and subprime securities originated, marketed, and sold by Wall Street firms (a huge Fannie mistake, but one also committed by financial service firms all over the globe).

The pre-2004 Fannie Mae, before Dan Mudd was named Chairman and CEO in 2005, never engaged in that risky type of mortgage investing, as has been attested to in recent months by the SEC, Federal Reserve, Fannie’s regulator—the Federal Housing Finance Agency (FHFA), the President’s Financial Inquiry Commission and any number of economists and financial writers.

The original paper that Mr. Calabria uses to assail Mr. Stiglitz (ditto Hubbard)—where JS offered his opinions of Fannie Mae’s operations and capital—was produced in late 2001, when Fannie Mae was quite successful meeting its charter and producing solid earnings. It was written long before a future Fannie heavily buy private label subprime loans, chasing lost market share and profits.

There was no way, 10 years ago, for Messrs. Stiglitz and Hubbard to see subprime coming or understand how it would rock most of the world’s major financial serice companies and systems.

Privatized Gains and Socialized Losses

I also challenge Mr. Calabria to put some meat (and proof) on the phony—but cute sounding--allegation he parrots that Fannie “privatized its losses and socialized its losses.”

This is an attack line that some congressional know-nothings employ to disparage Fannie and Freddie, because it makes good sound bites but few of them can define or defend.

I worked at Fannie from 1983 through 2004 and every year the company had losses of one type or another, but fortunately, had far greater gains. The losses were deducted from profits and the net number was reported to the company’s investors and later the SEC. Nobody tried to stick the federal government with the company's losses.

It wasn’t until 2008—following the Hank Paulson/GOP takeover of Fannie and Freddie-- that the federal government put its first dime into Fannie Mae (and Freddie), which is another fact that the Right likes to forget.

The Pre-2004 Fannie Wasn’t a Major Risk Taker

The traditional and, indeed, conventional way Fannie operated before Mr. Mudd took control is evidence that huge risk taking wasn’t the GSE leadership MO of previous chairmen David Maxwell, Jim Johnson, and Frank Raines, who preceded Mudd.

During those eras, the “franchise” and “housing mission” were Fannie’s most valuable corporate possessions. None of my colleagues was willing to risk them. I remember telling any variety of outside groups and Congress that as long as the company responsibly met its congressionally mandated housing mission (goals), Fannie should enjoy congressional support.

I believe history proved me right.

Starting in 2004-2005, as soon as acquiring subprime securities--and aggressively seeking market share temporarily lost to the private-label security issuers--became the corporate priority, Fannie’s wheels fell off.

By 2008, Fannie (and Freddie) became wards of the Treasury; their shareholders got wiped out, most of their senior officers left voluntarily or were asked to leave, and their surviving workers lost years of savings they had in company stock.

(Let me note at this point, Fannie Mae’s dalliance with subprime investing should have been caught and stopped by its regulator. Instead the aberrant purchase activity was virtually regulator-blessed.)

GSE Versus Bank Capital

Calabria makes some generic comments about the GSEs smaller capital vis-Ă -vis commercial bank capital.

The Cato official conveniently forgets to mention two things about commercial bank capital requirements.

Banks had higher capital requirement than the GSEs because the banks could invest in any asset their management chose, including domestic loans of all kinds, foreign commercial and sovereign debt securities (think Greek bonds), while Fannie and Freddie were lower risk mono-line companies, with only mortgage loans and securities as permissible investments.

The GSE’s statutory “minimum” 45 basis points capital (.45%) against credit business was more than enough to protect that entire book of business in all of the years the risk based capital standard was in place--from 1992 on--before the failed subprime acquisitions produced the Paulson/Bush takeover.

Federal Regulators “Turtled” for the Big Banks

In offering the banks his protective journalistic shield, Calabria ignores the favored regulatory treatment big banks enjoyed.

Unlike the mortgage giants, bank executives and shareholders were protected from the consequences of their excessive risk-taking. The Fed lowered interest rates to "reliquify" them and then “lent” to them to prevent deposit runs, while the Treasury gave them capital (TARP funds).

First the Bush White House and then the Obama Administration did this—as I’ve noted ruefully—without demanding from the banks any sort of reciprocal lending (for small and large business or for mortgage borrowers), which could have ameliorated some of the nation’s unemployment problems.

How the Cato (and AEI) crowds can continue to use the "private gain public loss" label with Fannie/Freddie, but not, at a minimum, to apply the same to the banks—for which they toady--is beyond me.

I’d also ask Mr. Calabria to detail his charge that Fannie and Freddie borrowed at lower costs than the commercial banks.

FDIC Deposits Are Cheaper than GSE Debt Costs

The primary source of bank working capital (money they lend to customers, back in the day when banks did lend and not just arbitrage) is federally insured deposits.

There are about $3 Trillion of insured deposits in America’s depository institutions.

The cost of that is simple for the reader to figure, because it is what the banks pay you on your checking and savings accounts, roughly 1% give or take 25 basis points.

I can almost guarantee you that Fannie pays two or three times that amount for its working capital, slightly more than the US Treasury but slightly less than other large investors, when the latter borrow in the international debt markets.

I think Mr. Calabria perpetuates a myth when he continues to claim that Fannie pays/paid less for working capital than the banks and that banks are rugged private institutions.

Da Dum De Dum

(And finally, Congrats to DG and FDR, you two irrepressible and crazy kids!!)

Maloni, 10-23-2011

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