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Hussman Follow-Up On The Great $1.5 Trillion Unlegislated GSE Bail Out
Another convincing piece by John Hussman, elaborating on his previous perspectives on the "unlegislated" $1.5 trillion bail out of the GSEs. When reading this piece, keep in mind that during the Q&A of Hoenig's speech reference earlier, the Kansas Fed president said "Our primary goal is the exit strategy. We need to remove the assets from our balance sheet. And we need to get out of this as early as we can." Of course, Ben Bernanke will never actually do this, and the "calendar" is so vague it could be referencing 3000AD. As Dow Jones noted earlier, "In outlining the likely path the Fed will take to tighten credit once the economy is strong enough, Chairman Ben Bernanke last week said he expects the central bank's balance sheet to shrink over time. However, Bernanke said he didn't anticipate the Fed would sell any of its holdings of long-term U.S. Treasuries or mortgage-backed securities "in the near term." It is against this backdrop that the sinister bail out described by Hussman is taking place.
From The Federal Reserve's Exit Strategy: Unlegislated Bailout of Fannie and Freddie by John Hussman
Let's put two and two together here. Fannie Mae
and Freddie Mac are already insolvent, and face "significant negative
impact" on their net worth resulting from the required consolidation of
"off balance sheet" loans into their financial reporting, which will
take effect in financial statements for periods beginning January 1,
2010. Over 60% of the U.S. foreclosure market now falls under the
umbrella of these two entities.
Under the
Housing and Economic Recovery Act of 2008 (HERA), Congress authorized
the Treasury to provide sufficient funding to insure up to $300 billion
dollars of original principal. Yet in a
move that was clearly no part of Congressional intent, the Treasury has
announced that it will allow this commitment to "increase as necessary
to accommodate any cumulative reduction in net worth over the next
three years." Coincident with this, the Federal Reserve has accumulated
nearly $1.5 trillion of Fannie Mae and Freddie Mac securities (MBS and
agency debt), which is has no plan to liquidate other than lip service.
Rather, it is allowing these securities to run off through maturity and
pre-payment. Of course, the funds to pay off those maturing securities
will largely come from the Treasury. Meanwhile, Bernanke has made it
clear that the most important tool of the Fed during the interim will
not be liquidation of these securities, but instead the payment of
interest on bank reserves.
If one is
alert, it is evident that the Federal Reserve and the U.S. Treasury
have disposed of the need for Congressional approval, and have
engineered a de facto bailout of Fannie Mae and Freddie Mac, at public expense.
Below
is a chart of the composition of the Federal Reserve's balance sheet,
in billions of dollars. Against these assets, the Fed creates currency
and bank reserves, which comprise the "monetary base." Clearly, the
volume of Fed-supplied stabilization funding in the system is still
enormous. As James Hamilton has observed, "it seems not coincidental
that, when you look at the total of all the assets the Fed is holding,
the expansion of MBS purchases exactly offsets the declines from
phasing out the short-term lending facilities. As a result of the MBS
and agency purchases, the total assets of the Federal Reserve today
exceed the total reached at the peak level of activity for the lending
facilities in December 2008."
How
will the Fed "unwind" this position? Given the additional information
of the past few weeks, we can update the steps that I suggested in A Blueprint for Financial Reform
How to spend (up to) $1.5 trillion without Congressional approval (updated)
Step 1:
Federal Reserve purchases $1.5 trillion in Fannie Mae and Freddie Mac
securities, creating $1.5 trillion of monetary base to pay for these
purchases.
Step 2: U.S.
Treasury quietly announces unlimited 3-year support for Fannie Mae and
Freddie Mac on December 24, 2009, indicating that it is acting under
the authority of a 2008 law (HERA) that was originally written to
insure a maximum of $300 billion in total mortgage principal (not
losses, but principal).
Step 3:
Fed Chairman Ben Bernanke testifies to the House Financial Services
Committee on February 10, 2010 that "I currently do not anticipate that
the Federal Reserve will sell any of its security holdings in the near
term. However, to help reduce the size of our balance sheet and the
quantity of reserves, we are allowing agency debt and MBS to run off as
they mature or are prepaid. In the long run, the Federal Reserve
anticipates that its balance sheet will shrink toward more historically
normal levels and that most or all of its security holdings will be
Treasury securities." During the interim, the Federal Reserve indicates
that it expects to limit the extent to which banks lend out the base
money created in Step 1, through a policy of paying interest on bank
reserve balances.
Step 4:
On February 11, 2010, with Treasury backing in place, Fannie Mae and
Freddie Mac (whose delinquency rates have more than doubled over the
past year) announce the purchase of $200 billion in delinquent
mortgages that they had previously guaranteed. The entire remaining
principal balance will be paid to investors at face value. This action
provides a glimpse into the future: Fannie and Freddie take bad
mortgages onto their balance sheets, extinguish the MBS securities at
face value, and rely on Treasury funding to fill the gap.
Step 5:
In the next few years, the U.S. Treasury can be expected to issue up to
$1.5 trillion in new Treasury debt to the public, taking in much of the
$1.5 trillion in base money created by the Fed in Step 1.
Step 6:
Proceeds (base money) received from new Treasury debt issuance are
periodically transferred to Fannie Mae and Freddie Mac in order to
cover cumulative balance sheet losses.
Step 7:
Over a period of years, Fannie Mae and Freddie Mac use the proceeds to
redeem mortgage securities held by the Fed, thus reversing the Fed's
transactions in Step 1, without the need for liquidation or any other
"unwinding" transactions. If the MBS securities extinguished in Step 4
are not directly held by the Fed, the Fed can be expected to
simultaneously sell an equivalent amount of its own holdings out to the
public, so that the publicly held stock of MBS remains constant. In any
event, the base money created by the Fed ultimately comes back to the
Fed, and the mortgage securities purchased by the Fed disappear, by
burdening the American public with a new, equivalent obligation in the
form of U.S. government debt.
Outcome:
The Federal Reserve closes its positions in Fannie Mae and Freddie Mac
securities, the quantity of outstanding Fannie Mae and Freddie Mac
liabilities declines by as much as $1.5 trillion, thus allowing their
remaining assets repay the remaining liabilities despite insolvency,
and the outstanding quantity of U.S. Treasury debt expands by as much
as $1.5 trillion in order to protect the lenders, while ordinary
Americans continue to lose their homes and jobs.
This would all be really clever if it weren't so insidious.
On
Bloomberg television last week, James B. Lockhart III, the former head
of the Federal Housing Finance Agency (Fannie and Freddie's regulator)
commented on the bailout funds already provided to Fannie and Freddie,
saying "Most of that money will never be seen again. They were just
allowed to leverage themselves so dramatically."
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Good post, right on.
Exhibit A on why you should own as much gold as possible if you want to preserve your wealth.
If we are moving on Zimbabwe Ben's time line to shrink the Fed book then might as well wait for the heat death of the universe. I hear Ben is looking at waiting till 2 quarters after that to make a final determination.
Whazzis sell Treasuries? They don't own any. The balance sheet's all MBS (crack houses in Detroit) Maiden Lane (Glad that loss is only on paper!) type assets.
Ultimately contract? Right, just let the stuff just run off, like China is doing with our T-bills. That's ultimate. Heaven forbid, there's no reason to inject anymore reserves into the banking system, so no reason to buy anymore assets, other than support social policy of legislative and administrative branches.
Good old solid central banking. Look at the mess you got us into this time, Bennie.
Even in a system evolving toward maximum entropy, there will be some regions that achieve perfectly random decay sooner than others. Ben Bernanke is on a path to reduce our American system to chaos in a time frame significantly shorter than Lord Keynes' "long run". I guess you could say that Bernanke's ahead of his time.
Or is it 3000AG
Dont be silly. Mortgages are roughly 5-yr assets. The amortize, foreclose and pre-pay. They dont last long.
Tbills and govt bonds are even shorter. VERY VERY little of US govt debt is in long-term bonds (<25%).
The problem kinda solves itself (and already has...).
I ponder. Why is it that there are absolutely no whistleblowers in either the Fed, Treasury, FDIC, SEC, FHA, or any other finance/banking related agency? Is it that there are no shenanigans to blow the whistle on? Are these good government servants too afraid of their own careers to report wrongdoing? Is it the code of the business sector (finance/banking) that precludes reporting fraud? Is everything, in a sense, legal?
There must be two (or perhaps more, such as the special exemption given lawyers) different codes of conduct (laws). One for the financial elite and one for the rest of us.
most everyone is just too damn confused and scared to do anything
Praise big government for helping keep all those hard working Americans in their $400k+ homes they bought at the peak.
I can't wait until my kids are old enough to pay taxes, so I can explain to them why they have to fork over half their money to pay for the failures of our generation.
A bit misleading. The GSE are "buying out" seriously delinquent loans from MBS pools so that they do not have to forward P+I to holders of MBS - it is optional once a loan becomes 120 days delinquent buy mandatory after 24 months. Holders of these MBS loans are actually HURT by this action in that it results in a prepayment at PAR of a security that in many cases are trading well above par. The GSE will not buy out a loans from MBS pools that are trading at discounts (until the 24 month period ends). Harley Bassman put out an excellent piece on this and I suggest anyone interested in the subject should read it but this action is long overdue and will save the GSE (taxpayers) 10-12 bb a year.
Regarding the 1.5 trillion of Fed holdings, the vast majority will not be impacted. THey own very few MBS pools with coupons above 6.5% (those are the most delinquent loans) and thier holdings of 5/5.5 and 6% coupons may pay down maybe up to 15% of the balance and since the Fed is not reinvesting paydowns, this is a good thing. The people that will get hurt are those MM, HF, MTG REITS that hold the vast majority of premium MBS.
Last point - holders of banks stocks beware. While it is likely that when all is said and done the GSE may lose 3-400bb dollars, they are going thru every single one of these delinqent loans to see if there have been any misrepresentations so the GSE can put some of these loans back to the BANKS at PAR. Some people estimate it could be as many as 20% of these loansmay get put back. That is 60-80 bb of losses that will be transferred from the public sector (GSE) to the banks. This is a story that has yet to have been written,
If you are looking for commentary on the effects of transferring loans back onto the balance sheets of the banks may I suggest you check out the work at the IRA.
http://us1.institutionalriskanalytics.com/www/index.asp
rewsienna -- very insightful comments and much appreciated. One thing you stated caugh my eye:
I'm really not terribly convinced that a "vast majority" of the Fed's $1.5 trillion of holding will not be impacted.
The delinquency trends are a moving target. Sure the stuff below 6.5% is fine now, but it appears we haven't gotten to the point where delinquencies have turned the tide. There's still a lot of underlying delinquent mortgages owned by Fannie/Freddie that are going through various stages of "lateness".
Perhaps the total loss for Fannie/Freddie is in the $3-400 billion range. I think it's north of that... just an opinion. I do agree that there will be an effort to sell back mortgages that smack of fraud, and I'd be disappointed if it were only in the $60-$80 billion range.
I think the Hussman piece does a great job of explaining the mechanics of the money laundering going on here. I agree that it's not going to be close to $1.5 trillion. What bothers me most is how the Treserve has managed to "fudge the game" and bypass Congress to essntially approporaite a huge backstop at taxpayer expense.
This is one major reason nobody in the Senate should have voted for re-appointment. And hopefully that's why most of them will be voted out.
Freddie released delinquency data with their buyout announcement and they break it down by coupon and year of origination. Buyouts will impact mostly mortgages originated 2005-2008 and will impact all coupons (for example, approx 9% of all FHR 6s from 2006/7 are delinquent over 120 days - 6.5s are 20+ delinquent by loan balance) and the 30-90 day delinquent loan bucket ranges from 4-10 % depending on coupon so you are correct. The losses may be more than 400bb but that is very tough to say and depends on a bunch of factors. Key take away is that the this move by the GSE is good for tax payers and bad for bond holders.
The back stop had to happen otherwise Agency MBS would probably have been downgraded. Not saying it is right, but that is/was the problem with the implied guarantee. The best we can hope for now is that the GSE get to "put" back loans that were misrepresented to the banks that originated them (gSE just insures em) and that may lesson the burden to the taxpayers. At the end of the day, the housing bubble was the result of a huge subsidy underwritten by the govt through underpriced insurance from the GSE. The problem still exists in the FHA program - but the govt is afraid to charge the "correct" insurance premium due to fears of another housing downturn.
Great texture folks. thanks
Agree with what you said, except the idea that putting loans back to originators will lesson the hit to the taxpayer. The taxpayer will still pay, the burden just gets shifted from straight up taxes to every escalating oligopolistic bank fees.
Much appreciated, rawsienna... you pack a lot of great information in only 2 paragraphs! :)
I'm not sure about your key takeaway being "good" for taxpayers, but you're certainly correct in an incremental sense. It certainly could have been a lot worse, but someone is going to have to absorb a $400b plus loss. It won't be investment or commercial bankers, or the effectively insolvent GSEs. Quite frankly, bondholders should have taken the hit a long time ago... but it would have probably wiped out a good handful of pension funds and insurance companies who were overly reliant on {cough} the rating agencies..
I think your comment about why the back stop had to happen is spot on-- not only are these implied guarantees, they are very strong ones. I don't much like it, but it a cold hard reality.
The FHA program is a ticking time bomb, and I think most people don't have a clue on the potential magnitude of related losses there. I know I don't. Perhaps this is a subject matter worthy of further investigation. That, and HELOC exposures.
Appreciate it. Its been bugging me for a while. 400bb is a lot of wood and if that is a good number (as I think most agree it is at least 300) I feel pretty confident that a good protion of those losses will be absorbed by the banks . Obama did state that losses at the GSE's will be less than they originally tought (about 180bb). THat number can only be possible if he KNOWS that the GSE will be putting many of those defaulted loans back to the banks. I am not a stock guy but I would be a bit concerned about bank stocks.
On Bloomberg television last week, James B. Lockhart III, the former head of the Federal Housing Finance Agency (Fannie and Freddie's regulator) commented on the bailout funds already provided to Fannie and Freddie, saying "Most of that money will never be seen again. They were just allowed to leverage themselves so dramatically."
Even when the primary regulator admits to permitting unsound practices at institutions under his control all that is under discussion is how many thousands of billions will get forked over for their success at identifying his and his agencies and those who supervise/d its massive failures. Lockhart owes America several hundreds of billions of present day dollars. It is time he got to work. I am sure there are plenty of jobs within the BOP that pay 13 or 19 cents an hour he could do to meet his financial obligations.
Lockhart tried to change things and was warning of the problem for years. He is basically one of the few guys that knows the deal.
Yes. And members of the Federal Reserve are issuing warnings concerning the potential impairment of future growth due to public & private sector debt levels.
The Fed isn't going to shrink its balance sheet. The balance sheet will continue to grow with long dated paper as long as debt is being destroyed in one way or another. This process will go on for quite some time in the name of price stability.
The Fed will not let the government go bust as it would lead to their own destruction. They will monetize as much federal debt as they can get away with which considering the state of the rest of the developed world and a good junk of the developing world will be quite a bit.
Yeah, I agree... the Fed won't shrink it's balance sheet anytime soon... Bernanke has already stated its balance sheet capacity is in the $8-9 trillion range. Just remember... debt isn't really being "destroyed", it's just being "replaced".
The one major constraint here is the value of the dollar. The Fed can print away, so long as there are greater problems elsewhere-- and there is interest in the quality of AAA-Rated U.S. Treasury debt. What would serious risk the Fed's existence is an outright dollar collapse. We are probably a couple $ trillion of Fed balance sheet bloatedness and serious European sovereign debt austerity before we hit the danger point.
So is there any possible way to look at these interest payments on bank fed reserves as anything but taking taxpayer money and giving it to banks?
I mean, why don't they just raise the capital reserve requirements if they later decide they can't let all that liquidity hit the street? Didn't the Fed hand that money to the banks in order to increase liquidity and promote lending? But now most of that money will never be lent and will require the taxpayer to pay the banks so they don't lend that money? WTF am I missing here?
Good questions. IMHO paying ever-increasing interest on reserves is just a pure scam. But don't forget it was your elected representative who allowed this recently, up until the crisis hit the Fed couldn't pay interest on excess reserves.
Just another way to hand free money to banks, it has nothing to do with controlling the money supply.
This is all street theater, or,you can call it post-crash political/financial triage. The banks get direct injections of taxpayer money but they can only park it at the Fed or buy Treasuries. That's clearly part of the deal; the banks make spread money, appear to stay solvent a while longer and the Fed gets to continue it's high stakes game of three card monte. Were the banks to start lending the money out the old grad school saw about the velocity of money would kick in and set the inflation alarms off. That would trash all of the smoke and mirrors financial statistics and send the bond market into terminal arrest. This extra-legal shadow play will prove to be of long duration and produce innumerable unforeseen outcomes, very few of which will benefit the public at large.
Why not let the UST (FDIC) back all MBS at par and guarantee their income streams ... then let the Fed sell them back to the public ... who would then bid up the risky tranches and the Fed walks away from the whole problem with a profit and head held high. The US public doesn't seem too worried about National Debt ... Congress up's it to 14.1T and no one in the Media notices. Once this is done the Fed can then begin to buy up more paper (Commercial Real estate anyone, student loans, my Visa account)
How putbacks will fit into the picture is worth noting. Path of least resistence will be for lobbyists to ensure that putbacks don't happen and again the taxpayers are stuck holding the bag.
Brilliant summary of how Americans will be shafted while the banksters that tried to rip off others with misrated mortgages get all their money bank. Thank you John Hussman for putting this all together. A must read!
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