New Fed Proposal To Bankrupt America: Government Guarantee Of Entire ABS Market

Econophile's picture

From The Daily Capitalist

Let us assume for the purpose of argument that our corporate bond market is and always has been backed by federal government insurance. In its many years of operations companies would float bonds at relatively low interest rates because of the government's guarantee. Industry would be financed for their various projects, and, perhaps because of the lower cost, maybe this would be the preferred financing option for seasoned companies rather than common stock.

If anyone were to suggest that this market should shed its guarantee and rely on the private securities market to finance corporations, I am sure they would be laughed down by most economists and politicians. They would use the standard arguments against free markets. Everyone knows that without the guarantee corporate bonds would not get financed, or, there is not sufficient evidence that the private market would finance bonds without the guarantee, or, if they did, the lending covenants would be too harsh or the interest rate would be too high for corporations to afford. And, of course, the government has a "strong social interest" in maintaining a stable source of capital for corporations.

We all know, of course, that such thinking is wrong, and that the securities markets can well provide bond financing for business without the government's guarantee.

Yet I just read an article about a forthcoming paper coming from two Fed economists recommending that the federal government guarantee all asset backed securities.

Wayne Passmore and Diana Hancock, the associate director and deputy associate director, respectively, in the division of research and statistics at the Fed — argue that an explicit backstop of certain asset-backed securities could ensure the stability of the system in future financial crises and help eliminate the concept of "too big to fail" institutions.


"People who hold mortgage-backed securities or asset-backed securities are happy as long as they know there is no credit risk," Hancock said in a recent interview. "When they're really concerned that there is credit risk, they may run. That's not good for a securitization market."


To protect against such securitization runs, which can dry up credit availability, the two economists said an insurance fund should be created to cover catastrophic risks on a wide range of asset classes, including mortgages, credit cards and auto loans.


"We are arguing we should create an FDIC-like entity to explicitly price this form of guarantee," Passmore said in the same interview. "It will capture many of the benefits that have been associated with the GSEs, they will allow the government to accumulate an insurance fund, or reserves, to pay for supporting the fund up front. That's really the essence of why people want the government in the mortgage market. It defines well what the government's role will be."

Just the other day Pimco's Bill Gross said:

"Without a government guarantee, mortgage rates would be hundreds -- hundreds -- of basis points higher, resulting in a moribund housing market for years," Gross said.


He said Pimco would not consider investing in a private, or privately insured, mortgage pool unless it was accompanied by 30% down payments -- far above the current norm.

It is dismaying to see famous financiers and respected economists have so little faith in, or so little knowledge of, how free markets work. The bond market works well precisely because there are no government guarantees. Investors seem to be able to assess and accept risk.

Perhaps I should wait until the paper is published before I comment, but it is already making the rounds at conferences. According to the above article, the paper will be published just at the "critical juncture of the debate over the future of the government-sponsored enterprises." It appears to be an idea that Chairman Bernanke favors.

I did read an earlier paper by Passmore and Hancock ("Three Initiatives Enhancing the Mortgage Market") that argued in favor of this idea for the mortgage market. But now they are expanding it to include all ABS (asset-backed securities, such as auto loans, consumer loans, credit card debt, and the like). I also saw Dr. Passmore's presentation material of the idea at a May conference sponsored by the Chicago Fed.

It appears from their writings that they believe the major reason for the bust of 2008 was because the ABS market lacked uniform explicit federal guarantees. They completely ignore the role of the Fed in creating the boom-bust cycle and the role of the government in creating the guarantees that encouraged and funneled vast sums of money into mortgage-backed securities and other securitized assets. Their solution looks to control the effects of the problem rather than cure the causes. It is much like the doctor breaking the thermometer of a fevered patient.

It was just this same kind of well meaning thinking that created the mess that is Fannie Mae, Freddie Mac, and Ginnie Mae (GSEs). As always, this well-meaning legislation was used by politicians for political ends rather than for market-driven goals. That is, they substituted their personal wishes for the choices of millions of individuals who vote in the marketplace every day with their own dollars. The rules were eventually corrupted to permit loose lending standards resulting in risky loans guaranteed by these agencies.

Who can forget Barney Frank's comments about  the GSEs:

House Financial Services Committee hearing, Sept. 10, 2003:

Rep. Barney Frank (D., Mass.): I worry, frankly, that there’s a tension here. The more people, in my judgment, exaggerate a threat of safety and soundness, the more people conjure up the possibility of serious financial losses to the Treasury, which I do not seeI think we see entities that are fundamentally sound financially and withstand some of the disaster scenarios

As of Q1 2010, Fannie had lost double its profits made for the previous 35 years. It has already cost taxpayers about $85 billion. Estimates of bailout costs range as high as $1 trillion if home values decline another 20% and foreclosure rates continue to climb.

Passmore and Hancock take a little different approach to the ABS guarantee markets than presently exists. In their version they envision a federal entity like the FDIC to insure ABS like the FDIC insures banks. Thus, securitizers would pay for the insurance as do banks for the FDIC guarantees. This new entity would probably replace the GSEs.

There are several things to consider about this proposal. First is the huge size of the market they propose to backstop. The U.S. mortgage market is about $10.5 trillion in size. If you add in all the other types of ABS securities, you could probably double that amount. It is likely that government guarantees would quickly become the standard insisted by the buyers of ABS, so we could expect the government's role in this market to be dominant.

In essence these economists are saying that bureaucrats are capable of managing the insurance of markets that may exceed $20 trillion. I suggest that is fanciful and naive thinking, but not atypical, of central planners who think they have the ability to better manage the decisions of millions of people than those millions themselves. The history of most such central planning schemes have ended badly. In fact the ABS market that fared the worse in the crash were residential mortgage-backed securities, the underlying loans of which were often guaranteed by the GSEs; as guarantors of one-half of this mortgage market, those infamous toxic assets were created because of the implicit federal guarantees.

Second, the idea presupposes increased government regulation of the ABS markets that few bureaucrats understand. To guarantee the enormous ABS market, new rules and regulations need to be devised to define the conditions of the guaranty. In order to protect taxpayers they will establish rigid standards that would be more conservative than are currently required by the market. It is likely that the rules will initially tend to stifle the ABS market and inhibit innovation. At least until the special interests work their magic to allow special rules for their needy industry. Sound familiar?

The recently passed Dodd-Frank Wall Street Reform and Consumer Protection Act gives a vast new federal bureaucracy almost diktat powers over the financial industry. There is almost nothing these new czars cannot do if they find that a company "threatens financial stability." Passmore and Hancock's idea is just another extension of the Dodd-Frank Act. Sadly, neither the Act nor the ABS guarantee idea do anything to prevent another boom-bust cycle from occurring.

While I understand the nature of Passmore and Hancock's job, their idea is an excellent, yet unfortunate, example of short-term thinking coming from government economists and politicians. Perhaps they should have considered the real causes of the last crisis before they made recommendations to cure the next one.

To propose a vastly expanded system of government guarantees of financial markets in light of the failed history of Fannie and Freddie is irresponsible.

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knukles's picture

Oh Jeeeezzzzzzzmy hernioplasty just broke.  Please, stop with the bad news already. 

Same folks screwing with something else they don't know anything about except the extortion angle. 

We are so screwed.

Christ that hurts! 

justtotaketheedgeoff's picture

Oh my f-ing God! Just when I think it can't get any worse, it does! Can we please get on with the total collapse of the financial system and get it over with already!!

TheMonetaryRed's picture


The government didn't create the Financial Crisis, fraud did. 

[Please insert your standard "the government is fraud" remark here]

In a market ruined by fraud, low prices will not help. You need quality guarantees.

ABS is now in a "Market For Lemons". Without real, government guarantees of ABS quality, the ABS market is not going to come back. 

I've said it from the beginning: "Greenspan, CRA, Franklin Raines - that is all bullshit. The market collapsed because major banks sold hundreds of billions of dollars of fraudulent mortgages."




rlouis's picture

It would be nice if we could just put them out to sea in a boat and let them sink only themselves. 

MrSteve's picture

Bring this US taxpayers guarantee everything on Wall Street issue up at the next open bottle of beer you see and ask if the drinker owns any gold: if not, suggest the idea. That's your good deed for the day.

Rusty_Shackleford's picture

A bit OT but when speaking of absurdity and institutionalized fraud, all of this is connected, right?


FASB's James Blaine

Telling the truth is "Theoretically arrogant, in practice insane; financially negligent and reckless."

skippy9's picture

Capitalistic System= Strong survive weak fail! Where do these idiotic ideas about the perils of risk come from? Not from academia,where the average professor never had a real job except teaching a group of brainless lemmings who would follow there professor over a cliff if it meant a good grade. Oh no ! It can't be.

tony bonn's picture

"To propose a vastly expanded system of government guarantees of financial markets in light of the failed history of Fannie and Freddie is irresponsible."

responsibility has absolutely nothing to do with the fed's recommendations. evil and enslavement are the only goals those assholes have in mind. the aggrandizement of the bankster masters of the universe is the total end of the fed.

Ripped Chunk's picture

People who hold mortgage-backed securities or asset-backed securities are happy as long as they know there is no credit risk," Hancock said in a recent interview. "When they're really concerned that there is credit risk, they may run. That's not good for a securitization market."

 Because they can't imagine a market without massive securitization. It would stop the rapid growth of the ponzi scheme. If they relied on normal market growth they would go into shock and die.

whwood75's picture

Socialism we can believe in, eh?

Vampyroteuthis infernalis's picture

This reeks of communism. We know the fate of that system.

old_turk's picture

Thanks for the timely post, once again, you nail it.

The ABS market has been a smoking hole in the ground since 2007.  It won't fix itself because the underlying 'issues' of 'lair' or 'NINJA' loans are still there.  Not that yield chasing idiots won't buy small piece here and there but the non-FRE or FMN ABS market is as good as dead.

So, now, the deal is for the gov't to back these non-agency issues (for things other than houses) to 'prime the pump'.

Yeah, right.

Apparently, the banks are getting nervous about serial defaults and want some coverage so it's 'risk off' on just about everything, leaving more capital allocation for the prop desks and HFT ops.

We're not going to get out of this until you start addressing the real issues which will mean the re-instatement of Glass-Segall and enforcing it.

Of course GS would not stand for such a thing so they need to be the first to go.

viahj's picture

Apparently, the banks are getting nervous about serial defaults and want some coverage so it's 'risk off' on just about everything, leaving more capital allocation for the prop desks and HFT ops.


yep, they are a coming.  them there serial defaults..

MrPalladium's picture

I think all of you have missed the central point of this proposal.

The federal insurance for ABS - autos, credit cards, etc. is merely a way of extending auto loans, credit cards, etc. to sub prime borrowers who cannot afford to repay. It is a vote buying sop to the vast and expanding low IQ welfare population who vote Democratic. It is another step forward in the darkening of America - subsidizing our slide into third world demographics and status as the PTB ensure the continuing servitude of the core, middle class population.

All of this is carefully pre-planned.

iDealMeat's picture

Problem is that more stupid people are breeding to increase they're subsidies.

Dumb fat-ass Americans = Alternative energy resource.

Oswald Spengler's picture

" It is a vote buying sop to the vast and expanding low IQ welfare population who vote Democratic. "

How true! Democrats keep their parasites on the dole but Republicans aren't much better. When the job of politicians is to bring home the bacon, it's a Hobson's choice between the symbiotic two party system. 

Mercury's picture

Right, the lesson the government has learned about privatized profits and socialized risks is that they just need to make it official policy (all debt gets to be triple-A) for the benefit of the constituency that keeps them in power.

Moonrajah's picture

America, have faith. The 40" dildo that has been ramming you lately is about to get bigger. United States of Casino for everyone but the taxpayer. Can you spell 'slave'?

Oswald Spengler's picture

In my small town in Montana where I have a vacation cabin,the few merchants who can supply most of our basic needs, have banded together to accept only gold and silver for their merchandise. Total annual sales are less than 250K and the local bank keeps paper records of all transactions and segregates the PM in its vaults.Sales taxes are remitted in FRNs.

PulledPorkBBQ's picture

This probably Fred Mishkin's idea.  He was on CNBC a few months ago bitching about how he can't sell his 2nd million-dollar home since the securitization market went away.  Boo Hoo.  What a pathetic PhD cry-baby.  Typical Banker.

Downtoolong's picture

the two economists said an insurance fund should be created to cover catastrophic risks on a wide range of asset classes, including mortgages….

How do you justify guaranteeing the value of a mortgage but not the value of the collateral asset? I bet a lot more credit worthy people would be buying homes right now if they new the government was going to guarantee the price of their new home from falling further. Leave it to the Fed to favor protecting the value of debt (paper assets) over real property. What would one expect from an institution that creates debt instead of physical assets, and has a hard time believing that a world beyond Wall Street really exists?

AccreditedEYE's picture

This keeps getting more and more frightening. Just when you think they have tried everything in the book, they find another way to take more control and in the process, distort and pervert more as well. Do they honestly think the world market is not watching this, or won't react to this? What the heck happens to issues without the "guarantee"? The level of arrogance that the Fed is operating at (from the top down) is unbelievable. By taking risk off the table you are also lowering returns. This will ripple through every other asset class... how sad.

MayIMommaDogFace2theBananaPatch's picture

They are quite imaginative aren't they?

dcb's picture

each and eve

Maybe the market isn't functioning because it should not have existed in the first place. But we can't let anything get in the way of bank profits now can we.


as I have always said every effort to help the economy is just an excuse to get money to the bankers. More proof.

Scisco's picture

Don't forget, economics are too hard for bloggers, better leave it those with PhDs. Excuse me while I go drool in a corner and practice my arthimetic using bullion.

RockyRacoon's picture

I know!  This is just too technical for me as well.  I almost knocked over the stack of silver Eagles I was putting into the tube.   Looks like to me, call me simple, that the Fed is knotting its own rope.  Pretty soon even I will be able to see the absurdity of their moves.  Creating an "insurance fund"?  Wow, kinda like Social Security!  A great idea.

DosZap's picture

Well, we cannot FUND the SS Fund NOW, with tax inflows.

So, HOW do we form another FUND that takes another bite of NON existent taxes?.Soon, people are going to say FKIT, and stop working completely.

And, who can blame them?.Why should the FEW, be responsible for the MAJORITY, and these Corporate Gamblers?.

fearsomepirate's picture

We have this technology, called a "printing press"...

RockyRacoon's picture

Let's see 'em print more gold or silver.  Good luck with that plan.

Translational Lift's picture

"It will capture many of the benefits that have been associated with the GSEs, they will allow the government to accumulate an insurance fund, or reserves, to pay for supporting the fund up front."

Are these people fucking real???  Just what we need....another F-ing GSE that will become another Gubment slush fund and eventually become bankrupt like all the other GSE's.  Un-F-ing real.........

Defenestrate's picture

If they're going to backstop mortgages, why not backstop them for homebuyers? (Aka homebuoyers?) If you buy a house, keep it for at least 10 years and it's worth less when you go to sell, we'll  make up the difference between original mortgage amount and underwater amount.


MarketFox's picture

Same faces...same places = DEMISE

How much clearer does it need to get ?


Tax structure change

The complete removal of individual/corporate income taxes...

Replaced by a small basis point monthly charge on cash balances and a mandatory reduction of government not to exceed 10% of the economy....


All other approaches = FAIL 

zhandax's picture

Anyone need directions to the "sell to open" button?

Sean7k's picture

Thanks for an important piece. Let me see if I understand:

1. all corporations would be protected from loss, so less costs and zero responsibility.

2. Most bondholders are in the higher economic classes, therefore, their investments would be guaranteed and zero risk.

3. The total risk would be born by the taxpayer and their future earnings.

4. Without risk, investment could proceed regardless of profit potential as it would  essentially be guaranteed.

5. Why not? We can no longer pay the debt anyway. When they come to put us in chains, we merely have to revolt. 

6. Just another argument that asks the question: will we revolt or not?


MayIMommaDogFace2theBananaPatch's picture

...and a little bit of caulk and some paint -- and then we should be GOOD-TO-GO!

Eternal Student's picture

I'm going to Vegas this weekend. Can I get some gambling insurance, to protect me from any losses?

This proposal is no different. They do this, and I'll leverage to the moon on whatever they are insuring. So will everyone else. AIG redux here we come.

Insuring gambling is a really stupid idea. Unless you just intend to take their money and run.

IAmTheStig's picture

I wonder what other crap like this is going to come out of the Jackson Shit-Hole Symposium this week. 

MayIMommaDogFace2theBananaPatch's picture

I can't remember who said it first: "The A-Hole at the J-Hole" 

Tic tock's picture

I thought a 'ZIRP policy for an extended period' was this already.

Testicular Cancer's picture

Oh I don't know. May be doing this is not such a great idea. Something could possibly go wrong & then we would really be in trouble. This could even cause the dollar to devalue or something.

TimmyM's picture

There already exists a market for insuring credit risk, it is called the credit default swap market.

The essence of what these ivory tower egg heads are saying is that the government knows better than the private market how to price credit risk. Or, that the private market charges too much for credit insurance. 

On its face, this is a fraudulent statement. This is the misleading subterfuge of justification for subsidizing credit. Keynesian monetorists are always using this presumption of expertise or pretense of knowledge to justify credit subsidies.

They believe the price and availability of credit is to be managed from on high. They will not accept that when the market prices and drives credit, that this is an essential resource allocating mechanism. Yet, any meddling with this private allocating mechanism is a recipe for bubbles, booms, and busts.

The price and availability of credit operate within the confines of supply and demand dynamics just like every other resource we take for granted as most effectively allocated by the free market. Only in a society where we have been captured by a banking cabal are such facist notions considered.

granolageek's picture

The wonderful CDS market, eh? Where have I heard that before?


O yeah. That would be AIG.


Where you can buy insurance without an insurable interest. And then toss a match.


Great thing the CDS market.

AccreditedEYE's picture

Stop painting everything with the same brush Granola. The CDS market IS a good thing that can be used for wrong purposes. As many have mentioned on this post and several others, it is a great way to see how the market at large views all manner of different debt investments. It provides insurance for investment portfolios that HAVE a position in a given credit and need to hedge and it can also be used to speculate by people who put in the time and research and smell something rotten.

Not every CDS is bought by The Squid and used to undermine the world financial system and rob the middle class at gunpoint.

Gwynplaine's picture
Gwynplaine (not verified) TimmyM Aug 26, 2010 10:03 AM

Timmy, I think you hit the essence of the plan.   There is no way the Fed can backstop a 20T dollar market.  As Econophile said, this is basically a joke.  I don't even trust the FDIC could pay off on failed bank deposits.

What they can accomplish is a subversion of the CDS market.  This way, there will be no accurate indicator of danger for US debt... when that day eventually arrives.  I believe that Washington never wants to be in a position where they are humiliated (like Greece) where the world watches their CDS price go skyward.  Hiding the accurate risk pricing data won't stop the eventual outcome, but it may delay it.

ATG's picture

Socialism by any other name.

Doesn't work...

MichaelG's picture

They'll be backstopping the freaking CDS market next!  (Oh, wait, they already AIG-are.)

To propose a vastly expanded system of government guarantees of financial markets in light of the failed history of Fannie and Freddie is irresponsible.

Admirable terminological restraint demonstrated there, Econophile...