Governments are Making Things Worse
Jonathan Macey, writing in the WSJ, calls for an end to the demonisation of markets:
Despite all the hard work and good intentions on the part of our public officials, when economists and historians look back on the current financial crisis they are likely to conclude that government intervention prolonged and deepened it. In particular, officials at the Federal Reserve, the Securities and Exchange Commission and the Treasury Department are to blame for publicly losing confidence in the very economic system they are supposed to protect.
The Fed, the Treasury and the SEC appear to be in a state of panic. A crisis mentality led the custodians of the U.S. capital markets publicly to jettison their lifelong commitments to the capital markets in favor of a series of short-term regulatory quick fixes…
Letting markets work is messy and costly. Nevertheless, the only sensible way to deal with the current crisis is to force the companies who created the mess to bear at least some of the costs of their mistakes. Most of all, if the markets are to get back on track our regulators must put an immediate stop to their current practice of publicly demonizing the markets and work to restore confidence in the system.
posted on 11 October 2008 by skirchner in Economics, Financial Markets
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US 2009 Depression
For the truly bearish, Intrade launches a US 2009 depression contract. Depression is defined ‘as a cumulative decline in GDP of more than 10.0% over four consecutive quarters… Negative quarters in the preceding year will count towards the total GDP decline for expiration purposes.’
The contract is yet to trade, but the bid-ask is 5.1/15, with most of the volume on the short-side.
posted on 08 October 2008 by skirchner in Economics, Financial Markets
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RBA Once Again Shows the Irrelevance of RMBS Intervention
The statement accompanying today’s 100 bp easing in the official cash rate by the Reserve Bank once again makes explicit that the RBA calibrates monetary policy to changes in retail interest rates:
the Board judged that a material change to the balance of risks surrounding the outlook had occurred, requiring a significantly less restrictive stance of monetary policy. The Board also took careful note of movements in funding costs in wholesale markets. Having weighed these considerations, the Board decided that, on this occasion, an unusually large movement in the cash rate was appropriate in order to bring about a significant reduction in costs to borrowers.
The RBA has always acknowledged that it is the average level of market interest rates over time that matters for the transmission of monetary policy. Much of the commentary on the extent of pass through by the banks has ignored this obvious point. Unfortunately, it is easier to bash the banks than to explain how monetary policy actually works.
Today’s announcement also shows the RBA can deliver a more substantial easing in credit conditions than could ever be achieved through government intervention in the market for residential mortgage-backed securities. The best way for the RBA to pull the rug out from under the RMBS interventionists is to be even more explicit about the extent to which it is discounting government policy in setting the cash rate.
posted on 07 October 2008 by skirchner in Economics, Financial Markets
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The Political Economy of RMBS Intervention
I have an op-ed in today’s Age on the politics behind the government’s intervention in the market for residential mortgage-backed securities.
It was pleasing to see the Australian Financial Review take a strong editorial stance against the intervention (‘Swan Banks on a Very Bad Idea,’ AFR, 29 September 2008, p. 62). The AFR attributed the very transparent politics behind the intervention ‘to the Hollowmen school of policymaking.’
posted on 30 September 2008 by skirchner in Economics, Financial Markets
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Government Shows the Irrelevance of AussieMac
Treasurer Swan has announced that:
To reinvigorate the Australian RMBS market and support competition in mortgage lending, I will direct the AOFM to invest in AAA rated RMBS in two initial tranches of $2 billion each.
The government’s intervention in the RMBS market shows that we don’t need a GSE to support market liquidity. Both the RBA and AOFM can perform this function, if deemed necessary.
I doubt an intervention of this size will do much to ease liquidity premia or see much pass through to retail mortgage interest rates. But even allowing for some small pass through, all the government has done is marginally weaken the case for further reductions in the official cash rate by the RBA. Whatever the AOFM giveth, the RBA will surely taketh away.
posted on 26 September 2008 by skirchner in Economics, Financial Markets
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Are the RBA and Treasury ‘Ideologically and Factually Flawed’?
AussieMac proponent Joshua Gans says:
It is not hard to imagine that Labor politicians are left wondering how they appear to have gotten themselves alligned [sic] with Terry McCrann and the CIS. The answer is that the advice they are getting is flawed both ideologically and factually.
Since this is much the same advice that the government has been getting from those notorious right-wing think tanks, the RBA and Treasury, one can only assume that Joshua thinks that these institutions are similarly in error. What exactly does it mean to be ‘ideologically flawed’ anyway?
The main reason the Treasurer is uninterested in AussieMac is that we already have institutions such as the RBA that stand ready to supply market liquidity, to the extent that it is needed. The experience both in Australia and overseas has been that central bank liquidity operations have been undersubscribed. Governor Stevens complained at the most recent House Economics Committee hearing that they practically had to brow-beat the market into stumping-up enough RMBS.
The government can also assist home buyers directly, without needing to intermediate that assistance through a GSE and the mortgage securitisation industry. The UK government has taken this more direct approach, but we are a long way from needing that sort of intervention in Australia.
The RBA can be expected to calibrate its new easing cycle to conditions in credit markets. If the banks fail to fully pass on cuts in the official cash rate, the RBA will just cut by larger amounts to get the desired change in retail lending rates.
posted on 26 September 2008 by skirchner in Economics, Financial Markets
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Why Freddie and Fannie are to Blame for the Credit Crisis II
From Bloomberg’s Judy Shenn.
posted on 25 September 2008 by skirchner in Economics, Financial Markets
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The Blindsiding of Peak Oil
T Boone Pickens pays the price for being long peak oil:
the downturn in energy has blindsided the industry veteran, leaving one of his hedge funds that focuses on energy stocks down almost 30% through August. A smaller commodity-focused fund is down 84%.
All in, the funds have lost around $1 billion this year, a figure that includes $270 million of personal losses. “It’s my toughest run in 10 years,” said Mr. Pickens, a former geologist who earned billions by building an oil company and investing in energy. “We missed the turn in the market, there’s nothing fun about it.”…
Mr. Pickens says he’s shifted his funds’ portfolios to a more neutral stance, to keep his losses in check. That means he hasn’t fully benefited as oil prices jumped in the past few days to $106.61 a barrel from about $90.
posted on 24 September 2008 by skirchner in Economics, Financial Markets
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Why Freddie and Fannie are to Blame for the Credit Crisis
Contrary to the picture of Freddie and Fannie painted by Christopher Joye and Joshua Gans, Charlie Calomiris and Peter Wallison highlight their role in causing rather than ameliorating the credit crisis:
In order to curry congressional support after their accounting scandals in 2003 and 2004, Fannie Mae and Freddie Mac committed to increased financing of “affordable housing.” They became the largest buyers of subprime and Alt-A mortgages between 2004 and 2007, with total GSE exposure eventually exceeding $1 trillion. In doing so, they stimulated the growth of the subpar mortgage market and substantially magnified the costs of its collapse.
It is important to understand that, as GSEs, Fannie and Freddie were viewed in the capital markets as government-backed buyers (a belief that has now been reduced to fact). Thus they were able to borrow as much as they wanted for the purpose of buying mortgages and mortgage-backed securities. Their buying patterns and interests were followed closely in the markets. If Fannie and Freddie wanted subprime or Alt-A loans, the mortgage markets would produce them. By late 2004, Fannie and Freddie very much wanted subprime and Alt-A loans…
So it was that, beginning in 2004, their portfolios of subprime and Alt-A loans and securities began to grow. Subprime and Alt-A originations in the U.S. rose from less than 8% of all mortgages in 2003 to over 20% in 2006. During this period the quality of subprime loans also declined, going from fixed rate, long-term amortizing loans to loans with low down payments and low (but adjustable) initial rates, indicating that originators were scraping the bottom of the barrel to find product for buyers like the GSEs.
posted on 23 September 2008 by skirchner in Economics, Financial Markets
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In Defence of Short Selling
I have an op-ed in today’s AFR arguing against the ban on short selling, which is reproduced over the fold (text may differ slightly from the edited AFR version).
Richard Heaney from RMIT provides the other side of the argument on the same page. Heaney concedes that banning short selling makes no sense if the market is behaving rationally, but questions ‘whether the equity market is behaving rationally at present.’ I would argue that you need to be consistent in your choice of behavioural model. It makes no sense to argue that the same investors who were rational one day are suddenly irrational the next.
Macro Man, channeling A E Houseman, puts the case against short selling restrictions more poetically:
Smart lad, to turn the other cheek
And hide as regulators seek,
A culprit for the tempest’s wind
And those that profited and sinned
By selling as the tide went out,
Revealing who was left with nowt.
No more, your selling of the banks
Neither the Brits’, nor else the Yanks’:
Now you will not swell the rout
Of long investors getting out.
The emperor’s new clothes can stand
Unmolested by your hand.
continue reading
posted on 23 September 2008 by skirchner in Economics, Financial Markets
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Robert Shiller’s Subprime Solution: The Democratisation of Finance or the Socialisation of Risk?
Following is a review of Robert Shiller’s The Subprime Solution, part of a longer review essay I’m preparing on ‘Depression Economics.’
Robert Shiller’s The Subprime Solution illustrates the extent to which New Deal mythology still has a stranglehold on contemporary thinking about the recent credit crisis. Shiller romaticises the New Deal, maintaining that ‘somehow a spirit of cooperation and change developed… ultimately embodied in the New Deal; while there was great unrest, there was also a sense of positive institutional change and progress, which offset the despair of the Depression. Hostility between labor and management, and between rich and poor, was tempered by the sense that we were all moving together toward a more enlightened world’ (p. 99). Shiller argues against ‘waging war on the financial elite’ (p. 177) in response to the recent credit crisis. But as Amity Shlaes demonstrates in her history of the Great Depression, the New Deal was anything but cooperative and enlightened and waged an indiscriminate war against all levels of society.
continue reading
posted on 22 September 2008 by skirchner in Economics, Financial Markets
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Kiwi Prediction Market
iPredict is New Zealand’s first real money prediction market. In addition to the usual political contracts, iPredict is running markets on whether New Zealand will be in recession with the June quarter GDP release, as well as the September quarter CPI outcome.
posted on 18 September 2008 by skirchner in Economics, Financial Markets
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Mac Attack III: Joye Changes his Tune
AussieMac co-author Christopher Joye changes his tune:
Property sector funds management and indices business Rismark International has called on the federal government to introduce an “Aussie Mac” mortgage financing conduit along the same lines as ailing US giants Fannie Mae and Freddie Mac.
But Rismark managing director Christopher Joye said the differentiator for Aussie Mac would be that it remained in government hands, given that he considered the demise of Fannie and Freddie to be directly attributable to dominance supplied through government guarantee.
In their original paper, by contrast, Joye and Gans argued that:
In the near- to medium-term we would expect AussieMac to be privatised with the result that its debt would be taken off the government’s own balance sheet.
Joye and Gans can’t seem to make up their minds whether they want AussieMac to be publicly or privately-owned, but ownership in and of itself does not define the nature of the relationship with government (just ask any US taxpayer). As they noted in their original paper, AussieMac would be ‘leveraging off the Commonwealth’s secure credit rating.’ In other words, its position in capital markets would be defined by its relationship to the government’s credit rating, which in turn depends on the government’s power to tax.
In their original paper, Joye and Gans said that ‘Fannie Mae and Freddie Mac have been extraordinary successful institutions for the best part of 50 years.’ Joye now concedes that ‘There’s a question as to whether Fannie and Freddie were conceived in the right manner.’
The only point of difference between the US GSEs and AussieMac is that Joye and Gans argue that AussieMac should be kept strictly limited in scope:
Mr Joye said his vision for Aussie Mac would be that it ordinarily sat on the sidelines, and would not actively pool mortgages, repackage them and on-sell the vehicles to promote liquidity.
Instead, Aussie Mac would lie in wait as a backup in the case of any liquidity crisis.
As I noted in my paper on AussieMac, the RBA already provides a much more robust infrastructure for supporting market liquidity. There are few limits in principle to the RBA providing liquidity in relation to an almost limitless range of counter-parties and assets, if deemed necessary. The only rationale for AussieMac is thus to create a GSE that would be soft touch for the mortgage securitisation industry compared to the RBA.
posted on 15 September 2008 by skirchner in Economics, Financial Markets
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Any Excuse Will Do
RBA Governor Glenn Stevens puts the House Economics Committee in perspective:
Mr MARLES—Can I start by apologising, Governor, for being late this morning. I was taking my son to school down in Geelong.
Mr Stevens—I think that was probably more important.
posted on 15 September 2008 by skirchner in Economics, Financial Markets
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Freddie and Fannie: Poster Children for Corporate Welfare
Peter Wallison argues that the Paulson rescue plan will further entrench Freddie and Fannie:
Recent statements by Barney Frank (D., Mass.), the chairman of the House Financial Services Committee, and Chuck Schumer (D., N.Y.), a powerful member of the Senate Banking Committee, make clear that Congress will never let them be privatized, broken up, slimmed down, nationalized or any of the other options hopeful reformers are putting forth today. Fannie and Freddie in their current form are just what Congress wants: an inexhaustible source of campaign contributions and funds for favored groups.
Here’s how it works. Fannie and Freddie are backed by the federal government, which allows them to borrow money at interest rates lower than any other shareholder-owned company. With these cheap funds, they buy and hold mortgages and mortgage-backed securities with considerably higher yields.
But the huge profits from this government-subsidized arbitrage do not mean lower mortgage rates for the American homebuyers. Studies by the Federal Reserve have shown that Fannie and Freddie have essentially no effect on mortgage rates. The profits instead go to shareholders and managements, lobbyists, favored community groups, and of course to members of Congress through campaign contributions.
The Paulson plan, regrettably, will restore these two companies to their positions as poster children for corporate welfare.
Wallison et al were sounding the alarm on Freddie and Fannie back in 2004.
posted on 12 September 2008 by skirchner in Economics, Financial Markets
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