The politics of bailout: a waiting game
Commentary: 'Truly extraordinary measures are required'
By Lou Barnes, Friday, September 12, 2008.
Mortgage rates have not been able to hold the early-week low at 5.875 percent, but are no worse than 6 percent for the lowest-fee deals.
The Fannie-Freddie takeover instantly knocked retail mortgage rates down 0.375 percent, but that's been it. The sky-high spread versus the 10-year Treasury note has compressed from 270 basis points to mere cloud-height 235 basis points -- but that's still 70 basis points too high. I have argued all year that the spread was not a credit matter, instead an artifact of an insolvent banking system unable to leverage positions. I win, and wish I hadn't.
Economic data are sliding all over the world. U.S. retail sales in August were the worst of the year, minus 0.7 percent excluding autos. Newly surveyed consumer confidence rose here, probably on cheaper gas, but anxiety and confusion among civilians runs deep.
To describe where we are today, begin with a review of the last year: In August 2007, the large end of the banking system suddenly froze. Sixty percent of total U.S. banking assets reside in the top 10 institutions, and the freeze came from sudden awareness that too many of those assets were bad. The bad ones were spread across all large firms, banks and securities dealers alike.
From August to early spring oil spiked from $90 to $145 while the housing bubble blew -- one inflationary, the other deflationary. The Fed fought both threats: one by letting the credit freeze slow the economy, the other by slashing its interest rate and making massive loans to the banking system. In that August-March interval, most people thought markets would heal with the Fed's help. Bottom would be found. The halfway point would be reached. Surely we were in a late inning. Then Bear Stearns blew, and the Fed again rescued the system -- extraordinary action in its finest hour.
The political world was not ready. Post-Bear, Congress flayed Bernanke & Co. The average citizen and pol were more angry at perpetrators than in pain. Bailouts, big and inventive ones, never fly through Congress until pain exceeds anger. That moment came in August, the Fannie/Freddie takeover marking the moment. Except for a pair of legislators (Dodd, D-Conn.; Bunning, R-Ky.), congressional reaction has been "well done."
The hell of the politics of bailout: You can't get permission until it's really ugly, and then it might be too late.
In public and private messages the authorities now know that the banking system is beyond self-healing, is in a downward and self-reinforcing spiral, and traditional measures are exhausted. Ordinary rate cuts and discount-window lending will not fix the fundamental problem: "Capital" in the banking system is net worth and equity, and the large end of the system is just as underwater as too many homeowners. Truly extraordinary measures are required.
I think I hear the hoofbeats of cavalry. The Fannie-Freddie takeover was routine except for the astounding, plain-English word that the Treasury will begin to buy mortgage-backed securities to drive down spreads. Housing must bottom and it will require cheap credit.
We now know that President Bush, with striking courage at the end of a tough run, has backed Hank Paulson, will not kick the can to January, and will act as necessary in the middle of an election. Well done, indeed.
Lehman Brothers will not exist on Monday. It may be bought whole or in pieces, but it will not receive Bear-style federal assistance and may be liquidated (that's my guess). It has had a year to sell itself, but the apparent massive arrogance of its CEO and fiduciary failure of its board have brought its end.
Then, right quick, showtime for the cavalry: WaMu, AIG, and several other banks and firms threaten a failure cascade. That spiral must be stopped. Right now.
And it must be done with as little federal cash as possible: T-bill yields are falling on credit fear, but bonds are losing value on fear of a bailout avalanche of Treasury sales. There is no way to know quite how (direct injection of capital, accounting fiction, glom wrecks into a giant workout zombie ...), but the authorities have the will, the skill and support.
Lou Barnes is a mortgage broker and nationally syndicated columnist based in Boulder, Colo. He can be reached at lbarnes@boulderwest.com.
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Submitted by Commercial Mortgage Loans - Privately Funded - MasterPlan Capital LLC on September 12, 2008 - 1:34pm.
Very well said. The fact that this is a liquidity crisis (not a capital crisis)can not be overstated. The credit markets are disfunctional and banks CAN NOT lend unless and until they have a secondary market to sell into and/or borrow from. The pull quote: (the spread) "was not a credit matter, instead an artifact of an insolvent banking system..."
Banks can't let a dime out the door or they risk becoming insolvent. They MUST have a market that will buy mortgage paper from them or they can not function as banks.
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Simple, 1 page
Submitted by Justin Britt on September 12, 2008 - 2:39pm.
Ok, we all want the downward spiral to stop, but if it's not going to be fixed with Federal cash, how do we do it?
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Justin Britt
Head-Web-Head
Hawaii Life Real Estate Services, LLC
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Submitted by Caterina Platt on September 12, 2008 - 4:01pm.
Justin,
There has to be sweeping and meaningful reforms put in place. Fannie and Freddie's books need a cleansing and full disclosure needs to be made. There is currently no credibility. The investing public (and I mean on an international basis) needs to have reason to regain confidence in these mortgage backed securities before any sort of cash flow of meaningful proportions will happen.
Fannie Mae spent the last 10 years breaking down all barriers that maintained the integrity of their assets and system. In an effort to automate property valuation and underwriting, they removed many of the human decision makers. They took on far riskier portfolios than should have ever been allowed by the corporate officers, let alone the stockholders.
Fannie is just a start. This no holds barred attitude along with greed and corruption was rampant, from the small time mortgage shops with net brokers all the way up to the mega banks.
The American people need to re-think a few principles as well. Homes are not annual ATM machines. If you make $50,000 annually, you do not spend $60,000.
When you're a 20 something with a brand new baby, you are a fool if you think you need to stretch your credit cards to the max and have 2 tricked out SUV's with $600-700/mo payments EACH in the driveway of the new home you just bought with zero down and expect it to appreciate 15% annually to keep up with your overspending. Yes, that was a run on sentence. Forgive me. I'm on a soap box.
I'd have to call this the house of cards phenomenon. As with the greed and corruption issue affects the lenders of all shapes and sizes, this house of cards problem is found everywhere from Fannie Mae's financial health, to John and Cindy Public. No savings, too much debt, no budget, no plan, and no self control.
Submitted by Jillayne Schlicke on September 12, 2008 - 6:35pm.
Justin asks, "Ok, we all want the downward spiral to stop, but if it's not going to be fixed with Federal cash, how do we do it?"
There is nothing we can do to fix this.
There is nothing government reforms can do to fix what's happening.
We simply have to wait and let all the bad loans cycle out of the system.
It's a financial crisis hurricane, slow moving but very destructive. Not everyone got out in time and not everyone will be able to be rescued.
Submitted by TWAs Real Estate Investing School on September 13, 2008 - 2:46pm.
Warren Buffett said it best--when the tide goes out, you see who's been swimming naked. Well, the tide is out, there are a lot of naked swimmers, and it ain't pretty.
__
Two Wise Acre's Real Estate Investing School
Submitted by Ki Gray on September 13, 2008 - 7:38pm.
I think the fannie and freddie mac move was not a bad one. I think long term we need to have more banking regulations to stop this from happening. But I think we should start putting those in place after we get through this mess. I think the issue is do we have a soft landing and recover or do we crash. I think moves like the freddie mac can help us have a soft landing
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Submitted by Shan in Austin on September 14, 2008 - 8:06am.
Well said, Caterina Platt. This problem is greater than just the real estate market and Fannie and Freddie. The mentality of the public has been one of excess and, until there is a change in that mentality, we will continue to see economic turmoil. I suppose that is the one possible positive aspect to the current economy - perhaps it will be enough to give Joe Public a wake up call.
Submitted by Tego Venturi on September 14, 2008 - 7:17pm.
It is sad for the people that work at Lehman but I am glad to see that the Gov is not going to bail them out of this… consequences needs to be in the system, companies need to fail, and management that makes bad decisions need to suffer the consequences (not get golden parachutes).
Albuquerque Real Estate
Submitted by Jeff Manson on September 15, 2008 - 9:59pm.
If the government bails out every institution things will be a lot worse in the long run. You need to let the markets adjust and run the natural course after a bubble. It may be tough, but that is what happens when everyone rides the big wave up. There is almost always going to be a big crash. The markets will have another big run up in about 4 - 6 years. Hopefully people will be a little more responsible next time around.
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Submitted by Justin Britt on October 1, 2008 - 5:27pm.
I agree with Jillayne. A bailout only enhances the problem. Let the bad loans cycle through. Let people lose their homes. Let banks go under. And let us learn from our mistakes!
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Justin Britt
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Hawaii Life Real Estate Services, LLC
Oahu real estate | Real Estate Marketing