politicalOBSERVER

THE RECKONING
New York Times
October 9, 2008
By PETER S. GOODMAN

“Not only have individual financial institutions become less vulnerable to shocks from underlying risk factors, but also the financial system as a whole has become more resilient.” — Alan Greenspan, former Federal Reserve chairman, 2004

George Soros, the prominent financier, avoids using the financial contracts known as derivatives “because we don’t really understand how they work.” Felix G. Rohatyn, the investment banker who saved New York from financial catastrophe in the 1970s, described derivatives as potential “hydrogen bombs.”

And Warren E. Buffett presciently observed five years ago that derivatives were “financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.”

One prominent financial figure, however, has long thought otherwise. And his views held the greatest sway in debates about the regulation and use of derivatives — exotic contracts that promised to protect investors from losses, thereby stimulating riskier practices that led to the financial crisis. For more than a decade, Alan Greenspan has fiercely objected whenever derivatives have come under scrutiny in Congress or on Wall Street.

“What we have found over the years in the marketplace is that derivatives have been an extraordinarily useful vehicle to transfer risk from those who shouldn’t be taking it to those who are willing to and are capable of doing so,” Mr. Greenspan told the Senate Banking Committee in 2003. “We think it would be a mistake” to more deeply regulate the contracts, he added.
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• “…(Congress) seemed alternately grateful and resentful of the new power couple in Washington. Some referred to “President Paulson” and others groused about an unelected central bank chairman doling out hundreds of billions of dollars…

In the end, what left so many lawmakers and economists frustrated was the sense that no one had a better idea. So they waited for Mr. Paulson and Mr. Bernanke to give them more details about what they wanted to do.” – from A Professor and a Banker Bury Old Dogma on Markets

• “(T)he prospect that the government is preparing to wade in deep — perhaps sparing families from foreclosure and banks from insolvency — has muted talk of the most dire possibilities: a severe shortage of credit that would crimp the availability of finance for many years, effectively halting economic growth.

“The risk of ending up like Japan, with 10 years of stagnation, is now much lessened,” said Nouriel Roubini, an economist at the Stern School of Business at New York University. “The recession train has left the station, but it’s going to be 18 months instead of five years.”

If the plan works, it will attack the central cause of American economic distress — the continued plunge in housing prices. If banks resumed lending more liberally, mortgages would become more readily available. That would give more people the wherewithal to buy homes, lifting housing prices or at least preventing them from falling further. This would prevent more mortgage-linked investments from going bad, further easing the strain on banks. As a result, the current downward spiral would end and start heading up.

“It’s easy to forget amid all the fancy stuff — credit derivatives, swaps — that the root cause of all this is declining house prices,” Mr. Blinder said. “If you can reverse that, then people start coming out of their foxholes and start putting their money in places they have been too afraid to put it.”…

…(Financial) institutions are deeply intertwined with the American economy. When the financial system is in danger, it stops investing and lending, depriving ordinary people of financing for homes, cars and education. Businesses cannot borrow to start up and expand…

…The economy has shed roughly 600,000 jobs since the beginning of the year. If healthy companies cannot get their hands on financing, they will not be able to expand and hire.

“What we’re looking at now is simply an amplified version of what we’ve been in since last August,” Mr. Bernstein added. “You’re witnessing a sudden death instead of a slow bleed.”

The impact of the pullback among banks was evident in the interest rates banks pay other banks to borrow money short-term. Traditionally, banks charge one another a little more than 0.2 percentage point over the rate on the safest investment, United States Treasury bills. But on Friday that spread was more than two percentage points, meaning a bank must pay an enormous premium to persuade another to part with its money.

And still no one knows the extent of the carnage. The financial system has acknowledged roughly $400 billion in losses so far, Mr. Roubini estimates, yet as much as another $1.1 trillion may be lying in wait.

As the government steps in to take over bad debts, it is aiming to clear away the detritus and lift the uncertainty, emboldening banks to lend anew.

Whether it will work in the long term is a question that awaits reaction from investors. But even the most skeptical economists say this is the path the government must take for confidence to crystallize that a genuine fix is under way…” – from But Will It Work?

$700 Billion Is Sought for Wall Street in Massive Bailout

New York Times
September 21, 2008 (found on the NYT.com web site one day before publishing)
By DAVID M. HERSZENHORN

WASHINGTON — The Bush administration on Saturday formally proposed to Congress what could become the largest financial bailout in United States history, requesting unfettered authority for the Treasury Department to buy up to $700 billion in mortgage-related assets.

The proposal, not quite three pages long, was stunning for its stark simplicity. It would raise the national debt ceiling to $11.3 trillion. And it would place no restrictions on the administration other than requiring semiannual reports to Congress, granting the Treasury secretary unprecedented power to buy and resell mortgage debt.

Staff members from Treasury and the House Financial Services and Senate banking committees immediately began meeting on Capitol Hill, where negotiations were likely to be complicated but quick. Democratic Congressional leaders have pledged to approve legislation by the end of this week.
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LEGISLATIVE PROPOSAL FOR TREASURY AUTHORITY

TO PURCHASE MORTGAGE-RELATED ASSETS

Section 1. Short Title.

This Act may be cited as ____________________.

Sec. 2. Purchases of Mortgage-Related Assets.

(a) Authority to Purchase.–The Secretary is authorized to purchase, and to make and fund commitments to purchase, on such terms and conditions as determined by the Secretary, mortgage-related assets from any financial institution having its headquarters in the United States.

(b) Necessary Actions.–The Secretary is authorized to take such actions as the Secretary deems necessary to carry out the authorities in this Act, including, without limitation:

(1) appointing such employees as may be required to carry out the authorities in this Act and defining their duties;

(2) entering into contracts, including contracts for services authorized by section 3109 of title 5, United States Code, without regard to any other provision of law regarding public contracts;

(3) designating financial institutions as financial agents of the Government, and they shall perform all such reasonable duties related to this Act as financial agents of the Government as may be required of them;

(4) establishing vehicles that are authorized, subject to supervision by the Secretary, to purchase mortgage-related assets and issue obligations; and

(5) issuing such regulations and other guidance as may be necessary or appropriate to define terms or carry out the authorities of this Act.

Sec. 3. Considerations.

In exercising the authorities granted in this Act, the Secretary shall take into consideration means for–

(1) providing stability or preventing disruption to the financial markets or banking system; and

(2) protecting the taxpayer.

Sec. 4. Reports to Congress.

Within three months of the first exercise of the authority granted in section 2(a), and semiannually thereafter, the Secretary shall report to the Committees on the Budget, Financial Services, and Ways and Means of the House of Representatives and the Committees on the Budget, Finance, and Banking, Housing, and Urban Affairs of the Senate with respect to the authorities exercised under this Act and the considerations required by section 3.

Sec. 5. Rights; Management; Sale of Mortgage-Related Assets.

(a) Exercise of Rights.–The Secretary may, at any time, exercise any rights received in connection with mortgage-related assets purchased under this Act.

(b) Management of Mortgage-Related Assets.–The Secretary shall have authority to manage mortgage-related assets purchased under this Act, including revenues and portfolio risks therefrom.

(c) Sale of Mortgage-Related Assets.–The Secretary may, at any time, upon terms and conditions and at prices determined by the Secretary, sell, or enter into securities loans, repurchase transactions or other financial transactions in regard to, any mortgage-related asset purchased under this Act.

(d) Application of Sunset to Mortgage-Related Assets.–The authority of the Secretary to hold any mortgage-related asset purchased under this Act before the termination date in section 9, or to purchase or fund the purchase of a mortgage-related asset under a commitment entered into before the termination date in section 9, is not subject to the provisions of section 9.

Sec. 6. Maximum Amount of Authorized Purchases.

The Secretary’s authority to purchase mortgage-related assets under this Act shall be limited to $700,000,000,000 outstanding at any one time

Sec. 7. Funding.

For the purpose of the authorities granted in this Act, and for the costs of administering those authorities, the Secretary may use the proceeds of the sale of any securities issued under chapter 31 of title 31, United States Code, and the purposes for which securities may be issued under chapter 31 of title 31, United States Code, are extended to include actions authorized by this Act, including the payment of administrative expenses. Any funds expended for actions authorized by this Act, including the payment of administrative expenses, shall be deemed appropriated at the time of such expenditure.

Sec. 8. Review.

Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.

Sec. 9. Termination of Authority.

The authorities under this Act, with the exception of authorities granted in sections 2(b)(5), 5 and 7, shall terminate two years from the date of enactment of this Act.

Sec. 10. Increase in Statutory Limit on the Public Debt.

Subsection (b) of section 3101 of title 31, United States Code, is amended by striking out the dollar limitation contained in such subsection and inserting in lieu thereof $11,315,000,000,000.

Sec. 11. Credit Reform.

The costs of purchases of mortgage-related assets made under section 2(a) of this Act shall be determined as provided under the Federal Credit Reform Act of 1990, as applicable.

Sec. 12. Definitions.

For purposes of this section, the following definitions shall apply:

(1) Mortgage-Related Assets.–The term “mortgage-related assets” means residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case was originated or issued on or before September 17, 2008.

(2) Secretary.–The term “Secretary” means the Secretary of the Treasury.

(3) United States.–The term “United States” means the States, territories, and possessions of the United States and the District of Columbia.

“We have got to deal with the foreclosure issue. You have got to stop that hemorrhaging..If you don’t, the problem doesn’t go away. Ben Bernanke has said it over and over again. Hank Paulson recognizes it. This problem began with bad lending practices. Those are his words, not mine…” – Senator Christopher J. Dodd, Democrat of Connecticut and chairman of the Banking, Housing and Urban Affairs Committee

New York Times
By DAVID M. HERSZENHORN

WASHINGTON — It was a room full of people who rarely hold their tongues. But as the Fed chairman, Ben S. Bernanke, laid out the potentially devastating ramifications of the financial crisis before congressional leaders on Thursday night, there was a stunned silence at first.

Mr. Bernanke and Treasury Secretary Henry M. Paulson Jr. had made an urgent and unusual evening visit to Capitol Hill, and they were gathered around a conference table in the offices of House Speaker Nancy Pelosi.

“When you listened to him describe it you gulped,” said Senator Charles E. Schumer, Democrat of New York.

As Senator Christopher J. Dodd, Democrat of Connecticut and chairman of the Banking, Housing and Urban Affairs Committee, put it Friday morning on the ABC program “Good Morning America,” the congressional leaders were
told “that we’re literally maybe days away from a complete meltdown of our financial system, with all the implications here at home and globally.”

Mr. Schumer added, “History was sort of hanging over it, like this was a moment.”

When Mr. Schumer described the meeting as “somber,” Mr. Dodd cut in. “Somber doesn’t begin to justify the words,” he said. “We have never heard language like this.”

“What you heard last evening,” he added, “is one of those rare moments, certainly rare in my experience here, is Democrats and Republicans deciding we need to work together quickly.”

Although Mr. Schumer, Mr. Dodd and other participants declined to repeat precisely what they were told by Mr. Bernanke and Mr. Paulson, they said the two men described the financial system as effectively bound in a knot that was being pulled tighter and tighter by the day.

As he spoke, Mr. Schumer swooped his hand, to make the gesture of a plummeting bird. “You know we’d be lucky …” he said as his voice trailed off. “Well, I’ll leave it at that.”
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• “The Bush administration’s great irony is that by abstaining from any kind of involvement in the market, they created a situation where they are more deeply engaged with the market, in a financial entanglement with the market, than the liberals ever wanted to be.” - Rep. Barney Frank

Charlie Rose interviews, even if you are not a big fan of the Charlie Rose style, tend to get into the kind of information exchange that you don’t see on Television programs driven by advertisements–no commercial interruptions and the final editor is the Charlie himself instead of a corporate chain of command. The Charlie Rose website states: “I believe that there is a place in the spectrum of television for really good conversation, if it is informed, spirited, soulful.” Here is a set of links to five interviews appearing over a span of two days with three people: a corporate executive, a politician, and a DC journalist.

Hank Greenberg : an American businessman and former chairman and CEO of American International Group (AIG), the world’s largest insurance and financial services corporation. In 1962, Greenberg was named by AIG’s founder.

Interview 1 on September 16th 2008
Interview 2 on September 17th 2008

Barney Frank : an American politician and a member of the United States House of Representatives. He is a Democrat and has represented Massachusetts’s 4th congressional district since 1981. Following the Democratic takeover of the House of Representatives in the 2006 midterm elections, Frank assumed the chairmanship of the House Financial Services Committee.
Interview on September 17th 2008

Barney Frank talks about how Monday of this week was the only day in which the Bush Administration stuck to its ‘Free Enterprise’ ideology. He talks about how we got into this problem: the lack of the appropriate regulation–a trend which began with Ronald Reagan who said “Government is not the answer to our problems, government is the problem.” This week the Bush Administration has ’sent’ the Fed Chief and the Treasury Secretary to Wall Street to say in effect: “we are from the Government and we are here to help you.”

If you don’t have appropriate regulation, if you don’t have a set of rules for financial activities to be conducted, you get the kind of problems that we have now. The Bush administration’s great irony is that by abstaining from any kind of involvement in the market, they created a situation where they are more deeply engaged with the market, in a financial entanglement with the market, than the liberals ever wanted to be.

Frank goes on to talk about appropriate regulation, particularly regulations that Alan Greenspan passed over and failed to act upon. In 1994, the Democratic congress passed legislation, the Homeowners Equity and Protection Act, which said to the Federal Reserve that their needed to be regulations for mortgages created by banks-which are regulated entities-which began to make loans then immediately sold the mortgages to brokers with unregulated pools of capital. The banks became less concerned if the mortgages would be able to be paid back since they were not going to hold the paper long term. Thus the banks became less concerned to who they were lending to, their underwriting criteria loosened, then the banks got involved with making the kind of loans that started the problems that we are facing now. Alan Greenspan famously responded that ‘he was not smart enough’ to make rules to regulate this because regulation ‘was up to the market.’ If Alan Greenspan would have used the authority given to him by congress to restrict sub-prime mortgages, we would not be in this crisis.

Investment houses need to be more tightly regulated, particularly by creating a criteria where they need to hold more capitalization so they can not leverage highly wound positions in the market.

Frank also notes that after 8 years of Reagan in the 80’s, Congress was controlled by the Republicans from 1995-2007 which is the span of time which the approach of laissez faire management of the market (deregulation) by the government was more deeply entrenched.

If we would have had regulation the crisis would not have happened: this is undisputable.

Bob Woodward : an assistant managing editor of The Washington Post, has written 12 best-selling non-fiction books and has twice contributed reporting to efforts that collectively earned the Post and its National Reporting staff a Pulitzer Prize.
Interview 1 on September 16th 2008
Interview 2 on September 17th 2008

“(T)he 694-page bill contains a sweeping new regulatory structure for the mortgage giants, including the creation of an independent regulator, a stand-alone federal agency with a director appointed by the president and confirmed by the Senate.”

Increased risk for the US government too: “even that $100 billion could seem small compared to the Treasury Department’s authority to spend unspecified amounts of tax dollars to rescue Fannie Mae and Freddie Mac if they are in peril of collapse.”

New York Times
July 27, 2008
By DAVID M. HERSZENHORN

WASHINGTON — Hoping to stretch a safety net under the nation’s tumbling housing market, the Senate voted overwhelmingly on Saturday for final approval of a huge package of legislation that includes an ambitious program to save hundreds of thousands of families from losing their homes to foreclosure.

The housing legislation is the latest in a series of extraordinary interventions this year by the Bush administration, Congress and the Federal Reserve as they seek to limit the risk that shockwaves in the housing sector will ripple across the American economy and the world financial system. In the process, the central bank and taxpayers have taken on what critics warn are incalculable liabilities and risk.

The bill grants the Treasury Department broad authority to safeguard the nation’s two mortgage finance giants, Fannie Mae and Freddie Mac, potentially by spending tens of billions in federal money to prevent the collapse of the companies, which own or guarantee nearly half of the nation’s $12 trillion in mortgages.

To accommodate the rescue plan for the mortgage companies, the bill raises the national debt ceiling to $10.6 trillion, an increase of $800 billion and the first time that the limit on the government’s credit card has grown to 14 digits.

The Senate, convening for a rare Saturday session as it neared summer recess, approved the bill by a vote 72 to 13. The measure now goes to President Bush, who has said he will sign it, perhaps early next week, to send a reassuring message to the credit markets.
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There is very significant uncertainty involved here

New York Times
July 23, 2008
By DAVID M. HERSZENHORN

WASHINGTON — The proposed government rescue of the nation’s two mortgage finance giants will appear on the federal budget as a $25 billion cost to taxpayers, the independent Congressional Budget Office said on Tuesday even though officials conceded that there was no way of really knowing what, if anything, a bailout would cost.

The budget office said there was a better than even chance that the rescue package would not be needed before the end of 2009 and would not cost taxpayers any money. But the office also estimated a 5 percent chance that the mortgage companies, Fannie Mae and Freddie Mac, could lose $100 billion, which would cost taxpayers far more than $25 billion.
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New York Times
July 18, 2008
By DIANA B. HENRIQUES

Financial industry executives are mustering on Capitol Hill to head off a Congressional effort to rewrite the rules for the nation’s energy markets, saying it could unsettle already nervous markets and push more energy trading abroad, beyond the reach of domestic regulators.

The primary focus of Wall Street’s concern is a bill entitled the Stop Excessive Energy Speculation Act of 2008, introduced on Tuesday by a group of Democratic senators led by Harry Reid of Nevada, the majority leader.

The bill would substantially broaden federal regulators’ authority over the vast marketplace for privately negotiated derivatives, called swaps. It also would limit the stakes that speculators and other noncommercial energy traders could take, both in private transactions and in the public futures markets, which allow oil producers and users to hedge their price risks.

And it would require regulators to distinguish between “legitimate” and “nonlegitimate” hedging transactions and subject the latter to increased scrutiny and tighter market limits.

Since the bill’s introduction, lobbyists for the futures industry and other institutional interests in the energy markets have significantly bolstered their efforts in Washington.
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“Fannie Mae has been a government-sponsored wealth generator for its executives. That is wonderful … except for the small fact that this private wealth was gained by public support.”

NPR.org
by Dick Meyer
July 17, 2008 ·

I know the prospect of reading a column about Fannie Mae, the mortgage crisis and government bailouts is as appealing as a bowl of cough syrup. So let’s consider the latest news about the giant company something young parents today call a “teaching moment.”

The lesson is about this old and ignored government truism: The worst scandals are the ones that are perfectly legal.

The electorate and its press corps can get into an outraged lather about whether John McCain improperly took a ride on a crony’s Gulfstream or whether Barack Obama is too close to a shady real estate operator. Congressional staffers are trained to know whether a gift basket of walnuts is kosher, and the difference between legal finger food and an illegal sandwich.

Fannie Mae is different. It is what is called a government-sponsored enterprise. It was established by Congress in the New Deal to buy mortgage loans from banks so they could unload some of the risk and make loans to homebuyers more safely. Wonderful.

So Fannie Mae was allowed to borrow money more cheaply than private mortgage security businesses and allowed to keep less emergency capital in the safe than competitors. As if that weren’t enough, Fannie was made exempt from state and local taxes. Imagine if Goldman Sachs didn’t have to pay New York City taxes.

There are strong arguments that Fannie Mae should have government backing to make home buying easier. There are strong arguments that the government should help stabilize Fannie Mae right now. I am agnostic on both points.

The ethical, as opposed to economic, fight is about whether the government-sanctioned benefits Fannie Mae has enjoyed should have been used to create the executive largess it did.
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