Mortgage crisis has Washington putting aside free-market ideology

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Mortgage crisis has Washington putting aside free-market ideology
By Nelson D. Schwartz, Sunday, September 7, 2008

Despite decades of free-market rhetoric from Republican and Democratic lawmakers, Washington has a long history of providing financial help to the private sector when the economic or political risk of a corporate collapse appeared too high.

The effort to save Fannie Mae and Freddie Mac is only the latest in a series of financial maneuvers by the government that stretch back to the rescue of the military contractor Lockheed Aircraft and the Penn Central Railroad under President Richard Nixon, the shoring up of Chrysler in the waning days of the Carter administration and the salvage of the U.S. savings and loan system in the late 1980s.

More recently, after airplanes were grounded because of the terrorist attacks of Sept. 11, 2001, Congress approved $15 billion in subsidies and loan guarantees to the faltering airlines.

Now, with the U.S. government preparing to save Fannie and Freddie only six months after the Federal Reserve Board orchestrated the rescue of Bear Stearns, it appears that the mortgage crisis has forced the government to once again shove ideology aside and get into the bailout business.

“If anybody thought we had a pure free-market financial system, they should think again,” said Robert Bruner, dean of the Darden School of Business at the University of Virginia.

The closest historical analogy to the Fannie-Freddie crisis is the rescue of the Farm Credit and savings and loan systems in the late 1980s, said Bert Ely, a banking consultant who has been a longtime critic of the mortgage finance companies.

The savings and loan bailout followed years of high interest rates and risky lending practices and ultimately cost taxpayers roughly $124 billion, with the banking industry kicking in another $30 billion, Ely said.

Even if the rescue of Fannie and Freddie ends up costing tens of billions of dollars, the savings and loan collapse is still likely to remain the costliest government bailout to date, said Lawrence White, a professor of economics at the Stern School of Business at New York University.

“The S.& L. debacle cost upwards of $100 billion, and the economy is more than twice the size today than it was in the late 1980s,” he said. “I don’t think this will turn out to be as serious as that, when over 2,000 banks and thrifts failed between the mid-1980s and mid-1990s.”

Most of those losses were caused by the shortfall between what the government paid depositors and what it received by selling the troubled real estate portfolios it acquired after taking over the failed thrifts.

In the Chrysler case, Carter and lawmakers in states with auto plants helped push through a package of $1.5 billion in loan guarantees for the troubled carmaker, while also demanding concessions from labor unions and lenders.

While Chrysler is remembered as a major bailout, White says it was minor compared with the savings and loan crisis or the current effort to shore up Fannie and Freddie.

The government did not have to give money directly to Chrysler, and it actually earned a profit on the deal because of stock warrants it received when the loan guarantees were provided. At the time, Chrysler had a work force of more than 100,000 people.

Still, Ely makes a distinction between the rescue of Fannie and Freddie and the thrifts versus the aid packages for Chrysler and other industrial companies. “They didn’t have a federal nexus,” he said. “They weren’t creatures of the federal government.”

This effort is also different from the others because of the potential fallout for the broader economy and especially the beleaguered housing sector if it does not succeed.

Unlike a particular auto company or even a major bank like Continental Illinois National Bank and Trust, which was bailed out in 1984, “we depend on Fannie and Freddie for funding almost half of our mortgage market,” said Thomas Stanton, an expert on the two companies who also teaches at Johns Hopkins University.

“The government,” he added, “has many less degrees of freedom in dealing with these companies than in the earlier bailouts.”

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China and India lose their appeal for investors on inflation fears

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Fund managers are still super-bullish on Russia, betting that the energy boom has life yet. A net 62pc are overweight oil and gas shares. The most hated trio are travel and leisure (-66), banks (-62) and property (-60).

Karen Olney, Merrill’s European equity strategist, said oil is nearing its cycle peak. “Is the trade too crowded? Probably. As long as fundamentals remain strong, we retain our overweight stance,” she said.

“The burning question is when to sell oil companies and move back to banks.

“We resist the temptation. The time is nearer when inflation rolls over, towards the end of this year and certainly into 2009.”

A record number (net 29pc) are now underweight on European equities; many have switched into cash as they wait for the European Central Bank to inflict punishment – ever more likely after eurozone inflation reached an all-time high of 3.7pc in May.

The ECB’s chief economist, Jurgen Stark, said yesterday that the price spike was a “cause for alarm”.

Mr Bowers said Europe is now facing a triple whammy as the downturn in global export markets combines with a strong euro and a monetary squeeze.

“Eurozone retail sales have been worse than in the US on a year-on-year basis and eurozone GDP growth has also been worse,” he said. “If you look at Spain and Italy, and even France, they are very weak.

“The Fed has eased dramatically, but the ECB hasn’t eased at all. It intends to tighten regardless of the consequences on growth. This is what is eating away at confidence in Europe,” he said.

Merrill Lynch said fund managers were belatedly adapting to a global inflation shock that poses a serious danger to asset prices, and risks setting off “civil protest” in Argentina, Indonesia, South Africa and the Gulf states.

As the new story unfolds, America is coming back into favour, emerging as a sort of safe haven in a fast-changing world where trusted institutions command a premium. Investors are quietly rotating back into Wall Street – despite a chorus of pessimists. A net 23pc are overweight US equities, the highest since August 2001.

The long awaited “decoupling” has begun.

The United States looks like the winner after all.

RBS issues global stock and credit crash alert

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By Ambrose Evans-Pritchard, International Business Editor

The Royal Bank of Scotland has advised clients to brace for a full-fledged crash in global stock and credit markets over the next three months as inflation paralyses the major central banks.

“A very nasty period is soon to be upon us – be prepared,” said Bob Janjuah, the bank’s credit strategist.

A report by the bank’s research team warns that the S&P 500 index of Wall Street equities is likely to fall by more than 300 points to around 1050 by September as “all the chickens come home to roost” from the excesses of the global boom, with contagion spreading across Europe and emerging markets.

Such a slide on world bourses would amount to one of the worst bear markets over the last century.

RBS said the iTraxx index of high-grade corporate bonds could soar to 130/150 while the “Crossover” index of lower grade corporate bonds could reach 650/700 in a renewed bout of panic on the debt markets.

“I do not think I can be much blunter. If you have to be in credit, focus on quality, short durations, non-cyclical defensive names.

“Cash is the key safe haven. This is about not losing your money, and not losing your job,” said Mr Janjuah, who became a City star after his grim warnings last year about the credit crisis proved all too accurate.

RBS expects Wall Street to rally a little further into early July before short-lived momentum from America’s fiscal boost begins to fizzle out, and the delayed effects of the oil spike inflict their damage.

“Globalisation was always going to risk putting G7 bankers into a dangerous corner at some point. We have got to that point,” he said.

US Federal Reserve and the European Central Bank both face a Hobson’s choice as workers start to lose their jobs in earnest and lenders cut off credit.

The authorities cannot respond with easy money because oil and food costs continue to push headline inflation to levels that are unsettling the markets. “The ugly spoiler is that we may need to see much lower global growth in order to get lower inflation,” he said.

“The Fed is in panic mode. The massive credibility chasms down which the Fed and maybe even the ECB will plummet when they fail to hike rates in the face of higher inflation will combine to give us a big sell-off in risky assets,” he said.

Kit Jukes, RBS’s head of debt markets, said Europe would not be immune. “Economic weakness is spreading and the latest data on consumer demand and confidence are dire. The ECB is hell-bent on raising rates.

“The political fall-out could be substantial as finance ministers from the weaker economies rail at the ECB. Wider spreads between the German Bunds and peripheral markets seem assured,” he said.

Ultimately, the bank expects the oil price spike to subside as the more powerful force of debt deflation takes hold next year.

Where American Tax Dollars are Spent?

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Do Americans know where their Tax Dollars are being spent? If 63% cannot find Iraq on the world map, probably safe to assume they cannot accurately answer this question.

How the Pie is Divided;

1. 42.2% = Military Spending

The biggest chunk of your money — 42.2 cents of every income-tax dollar — goes to fund the military. Over half of it, or 28.7 cents, goes to pay for the current war and military, 10 cents goes to interest payments on past and present military debt and 3.5 cents is allocated for Veterans’ benefits.

2. 22.1% = Health

The second largest amount is spent on health care initiatives, including Medicare

3. 10.2% Interest on non-Military Debt

About ten cents of every federal tax dollar is spent on interest for non-military related national debt.

4. 8.7% = Anti-Poverty Programs

These funds go to a variety of programs to help the underprivileged. They include food assistance, supplemental income for those with low incomes and assistance for foster care and adoption programs.

5. 4.4% = Education, Training & Social Services

These funds go towards paying for elementary, secondary and higher education. Other beneficiaries include employment training centers.

6. 3.9% = Government & Law Enforcement

This area covers a variety of programs, including the cost of running the justice system, the cost of running the Social Security program and federal employee retirement and disability.

7. 3.3% = Housing & Community Development

This money is spent on housing assistance and community development programs

8. 2.6% = Environment, Energy & Science

Spending in this area goes to environmental programs, energy exploration and any programs that deal with general science, technology and space.

9. 1.5% = Transportation, Commerce & Agriculture

One-and-a-half cents of every federal income tax dollar is going towards agriculture and transportation spending

10. 1.0% = International Affairs

The smallest amount of your tax dollars goes to foreign affairs, including foreign humanitarian assistance, conduct of foreign affairs and international financial programs.

The median income family in the United States paid $2,628 in federal income taxes in 2007. Here is how that money was spent:

  • Military $1,109
  • Health $581
  • Interest on Non-military Debt $269
  • Anti-Poverty Programs $228
  • Education, Training & Social Services $115
  • Government & Law Enforcement $102
  • Housing & Community Development $88
  • Environment, Energy & Science $69
  • Transportation, Commerce & Agriculture $40
  • International Affairs $27

uncle sam wants out

Read the Full Report from the The National Priorities Project

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