The views expressed in this column are those of the author and not SVB Financial Group.
Gimme back my bullets
Put'em back where they belong
Ain't foolin' around 'cause I done
had my fun
Ain't gonna see no more damage done
Gimme back my bullets
The bullets we need for economic recovery have been with us all along. For evidence, you need look no further than the first report card on Fannie and Freddie since conservatorship.
The Federal Housing Finance Agency (FHFA) last week released their first "Conservator's Report on the Enterprises' Financial Condition" and the numbers are staggering.
The twins had just $78 billion in total capital at the end of 2007, but this has been more than wiped away by $226 billion in losses since that time. Much of the loss came from mortgages made in 2006 and 2007 at the height of competition.
Looking back at the state of the market at that time, it seems obvious investors had gone overboard in their determination to provide capital to this sector. The myriad of "no-doc, no income, no equity, no problem" activities during this time is enough to make any true credit analyst puke.
But competing right alongside the insanity of the private sector were the twins. In fact, the share of sub-prime and Alt-A loans climbed from just 9 percent of the market in 2003 to an astounding 33 percent in 2006. (Recall that "Alt-A" refers to loans that were assumed to be prime, but no one ever really confirmed the data on the applications.)
Think about that for a second. One-third of the mortgages being created were admittedly for low-quality borrowers — or those borrowers who didn't want anyone investigating their vital signs.
As publicly traded organizations, the twins had an obligation to maximize shareholder wealth, but as government agencies they could finance their growth at much lower rates than their competitors. And so they did, expanding their business greatly as these loss figures now prove. But there is hope on the horizon.
As I wrote earlier this month in my August 17 column, the Obama administration has finally kicked off a debate on what to do with the twins and how the government should interact with the mortgage market in the future.
It's a good thing this debate has been moved forward from their previous target of 2011 as well. It can come none too soon after digesting the Fed Chairman's speech in Jackson Hole last Friday. That widely anticipated speech was to include a look into the Fed's remaining tools for stimulating growth and avoiding deflation. But in my opinion, this glimpse was disappointing at best.
There were three specific strategies Bernanke described in brief, plus one he readily admitted had no support at the FOMC. The three were:
- Expand the Fed's holdings of longer-term securities to bring down borrowing rates across the curve. Unfortunately, companies are not restricted by rates so much as a lackluster outlook for final demand as consumers remain on the sidelines.
- The Fed could "ease financial conditions through its communication." If only life were so easy!
- The Fed could lower the interest rate it pays to banks that are keeping excess reserves there instead of lending them out. Today, the Fed pays 0.25 percent, so what the Chairman is saying is that banks would reject a new rate of say 0.15 percent on their $1 trillion deposited there and instead lend the money out elsewhere. My question is: Where can banks get 0.25 percent with the same credit quality the Fed provides? (To be fair, Ben acknowledges this would have only a "relatively small" effect on behavior and could do "permanent damage" to the Fed funds market itself.)
Hmm, I'm trying to believe the Fed isn't out of bullets.
The "extra" option (which apparently no one in the Fed supports so why mention it in such a high profile speech) is to have the Fed "increase its medium-term inflation goals above levels consistent with price stability."
Frankly, this sounds a lot like option two above — let's just figure out something to say that will get the economy moving again!
Unfortunately, the answer to our economic woes no longer resides at the Fed. We have a demand problem that is not affected by the price of money (interest rates). It is driven by consumers' concern about two things: their job and their wealth.
I look forward to a long and healthy debate on how the mortgage market should be regulated and how taxpayer dollars should be used in support. But the solution will not come quickly and the economy will continue to muddle along "for an extended period of time."
Deflation Not an Issue
I should clarify that I am not saying the Fed is "out of bullets" and that a deflationary spiral is upon us. Quite the contrary is true as long as we solve our mortgage woes before we experience a cultural shift in consumer behavior.
Consumerism is alive and well and will come back strongly once these uncertainties are wiped clean. We look at the recent burst in savings as a war chest for our next trip to the mall. The only question is when that will occur.
Home sales plummeted in the latest month, suggesting the real estate sector remains weak, especially now that the federal home buyer tax credit has expired. Purchases of existing homes dropped to a 3.83 million annual pace, the lowest in a decade of record keeping. At the current pace, it would take 12.5 months to sell those houses. Sales of new homes also hit a record low of 276,000 annual units. These depressed sales figures came in light of lower median prices and cheaper borrowing rates.
The U.S. economic recovery weakened in the second quarter more than previously estimated, as GDP was revised down to 1.6 percent from 2.4 percent. The downward revision was due to lower net export and inventories. The bottom line is that after the strong 5.0 percent growth in Q4 of last year, GDP looks to have slowed in each successive quarter, which suggests a very anemic economy.
Durable goods orders rose 0.3 percent in July after an upwardly revised 0.1 percent decline in June (previously -1.0 percent). However, this was well below the forecast for an increase of 3.0 percent.
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