Page 1 of 2 Jaws close in on Bernanke
By Julian Delasantellis
As he was winding down his days of dissoluteness and reprobation, the 4th
century Christian philosopher Augustine of Hippo, commonly referred to as St
Augustine, begged for just a few more rounds of divinely sanctioned debauchery.
"Lord," he cried out to the heavens, "Give me chastity and continence, but not
quite yet."
Currently, as a result of the ever-worsening crises in US housing finance, a
crisis being illustrated by the absolute devastation of the shares in the US
government's semi-private semi-public secondary market mortgage wholesalers
Fannie Mae and Freddie Mac, and in the government seizing control of mortgage
lender IndyMac in one of the largest bank failures in American history, Federal
Reserve chairman Ben Bernanke must be raising his
gaze to the heavens for a similar entreaty.
"Lord, give me credibility as, and the ability to be, an inflation fighter -
but not quite yet."
The history of the financial markets since the rescue of Bear Stearns last
March 15 is similar to that of the fictional Amity Island in between the first Jaws
movie, released in 1975, and its sequel, Jaws 2, from 1978.
At first, after the initial shark had been killed, after Bear Stearns had been
saved by aggressive Federal Reserve intervention, everything seemed OK. The
markets rallied into mid-May. I would imagine that the souvenir shops selling
shark-themed toys and back scratchers on Amity's beaches did likewise. But,
then, the markets rolled over: the Dow Jones Industrial Average, after topping
out close to 13,200 on May 19, has since lost more than 2,000 points, or 15%.
To borrow from the tagline of Jaws 2, "Just when you thought it was safe
to go into the stockmarket ... "
Of course, the real danger laying in wait to devour the markets continues to be
the crisis in US housing values, as it has now become obvious that the entire
edifice of the US financial markets over the past few years has been built on a
foundation just about as sturdy as a sandcastle on one of Amity's beaches - the
inflated value of US real estate.
It had been thought that the crisis in subprime mortgages, the root of the
financial crises, would leave Fanny and Freddy untouched, since both their
respective charters forbid the two enterprises, called government-sponsored
entities (GSEs), from investing in them. But it is truly indicative of just how
pernicious and metastizing this crisis is that, after devastating all that it
has come in contact with for almost a year and a half now, it now strikes deep
at the heart of a target previously thought immune.
No one who has wealth or assets in any form, in any currency, is safe - you
might as well consider yourself as being at least knee-deep in the shark
infested waters of the financial markets.
My colleague Chan Akya ably described this burgeoning crisis last week (see
And now, for Fannie and Freddie, Asia Times Online, July 12.) He
accurately described the possible grim consequences possibly resulting from it,
especially a huge expansion of the US federal government's indebtedness, but
one thing that needs to be stressed is that because of these events the fight
against inflation will most likely once again be placed on the back burner.
"Roosevelt is dead!" the relentlessly rotund radio rabble-rouser Rush Limbaugh
cries out every afternoon on the American airwaves, referring to Great
Depression and World War II-era US president Franklin Delano Roosevelt. At
first, this might seem to be something of an obsessive compulsion with the
absolutely obvious, as Roosevelt took his last actual physical breath on earth
in April, 1945, shortly before the Allied victory in Europe.
But what is really being expressed by Limbaugh is less a declarative statement
than a fervent wish that conservatism's triumphs and successes might some day,
maybe today, be so overwhelming and comprehensive that, at last, the American
public will begin to clamor for the dismantling of the government social safety
net emplaced in the Roosevelt era and which has for so long tied the American
public to the Democratic Party.
Shortly after his re-election victory in 2004, George W Bush apparently thought
so, for he immediately staked his political capital on a laissez-faire
free-market restructuring plan for the gem in the Roosevelt crown, old-age
Social Security. That, and the unpopularity over the Iraq war, drove the
Republicans from control of both branches of Congress in the 2006 mid-term
elections. Former Republican Senator Rick Santorum of Pennsylvania, defeated in
2006, now probably wishes that he did not have supporters at a 2005 rally that
included elderly Social Security pensioners chanting the phrase "Hey hey! Ho
ho! Social Security's got to go!"
Like a fungus that dies on exposure to light, the Bush Social Security scheme
was dead a few months after it was released. However, it was then impossible
for the general media to cover serious issues for much longer; they had to come
up for sweet draughts of clean and clear tabloid oxygen. Starlets were getting
drunk and Brangelina was getting pregnant; both warranted more attention than
what the Bush administration was doing with the rest of the government,
particularly concerning the always riveting, ever-popular issue of financial
markets regulation.
Grover Norquist, the anti-government jihadi who once said that he wanted to
shrink government to such a size that it could be drowned and killed in a
bathtub, and his fellow zealots in the Bush administration, certainly got water
under their fingernails in dealing with the GSEs.
In responding to a series of accounting scandals at the agencies similar to
what the rest of the private sector suffered in 2002 and 2003 (see
The decline of US equity markets, Asia Times Online, May 10, 2007) Bush
and Co pushed the line that these agencies, just like the rest of the
government, were poor stewards of, and could not be trusted with, the public
purse.
They may have aimed for a bridge too far with the attempted privatization of
Social Security, but in then aiming squarely at Fannie and Freddie, which, by
financing the suburbs that the GIs returning from World War ll populated en
masse, influenced the shape of postwar American life as much as the automobile,
the anti-government zealots were zeroing in on a very critical consolation
prize.
Hoping to hobble the decision making of the two housing agencies, Bush stopped
making new appointments to the boards of the GSEs in 2004. He also restricted
the amount they could underwrite. There were repeated calls for new regulation
of Fannie and Freddie, probably just about the only calls for enhanced
regulation that have come out of the US executive branch this millennium.
Hearings in the then Republican-controlled Congress were laced with outrage for
these two wasteful, bloated government enterprises, whose functions could
obviously be carried out in a far superior fashion by the private sector.
The Internet from that era is littered with weighty think tank tomes by such
reliably conservative outlets as American Enterprise Institute and Cato
Institute, calling for a new, private-sector, risk-transfer mechanism that was
not centered around the GSEs. As in the famous curse where the Greek gods would
punish mortals by granting their every wish, the free marketeers would get
their wish in the next few years, to their, and the rest of the financial
markets, continuing mortification.
The core of Freddie and Fannie's operations was to buy up mortgage-backed
securities in the open market then either hold them to maturity or sell them
back to the market as mortgage-backed securities with the US government's
implied backing. Both dispositions transferred the risk of mortgage default
away from the banks to Fannie and Freddie.
Up until the freeze up in the credit markets and the crash in subprime finance
that occurred last summer, a new risk-transfer mechanism stood as competition
in the wholesale mortgage markets. Market shills postulated that, since it did
not require participation by the government, it was obviously superior.
Instead of having Fannie and Freddie buy the mortgage securities, the new plan
involved these being rolled up into mortgage-backed securities (MBS), then sold
to other private investors, whether they be other commercial and investment
banks, hedge funds, or even, as the New York Times reported last December, the
city treasury of Narvik, Norway.
After they were sold off once, they were invariably sold off again and again
and again, each time, due to the devastatingly alluring miracle of leverage,
the original nominal amount of the mortgage being used as collateral for much
larger amounts of borrowing and lending.
But by not retiring the mortgages with the GSEs, whoever did wind up with the
bonds were still stuck with the risk that the mortgage holders might someday
default on the loans. This eventuality was to be covered with an instrument
called a credit default swap (CDS), in essence, an insurance policy the
bondholder would purchase from a bank that would pay off in case of a mortgage
holder's default.
With the stranglehold that the Bush administration, and its threatened veto
pen, had on any legislative attempts to modernize and adapt the GSEs to current
times, slowly the US mortgage market began to evolve away from the purview of
Fannie and Freddie.
Regulations prevented Fannie and Freddie from buying up, from "underwriting",
most subprime mortgages because these typically did not carry the substantial
borrower downpayments and detailed financial documentation that the agencies'
regulations required. This, about one third of all mortgage borrowing as the
real estate boom frothed over from 2004-2006, went to the CDSs. So did the
wholesale market for mortgage loans above the GSEs' statutory limits of
$417,000; this meant that, by the end of the boom, even modest three-bedroom,
one-bath bungalows in the coastal markets of California and the US Northeast
were not longer being
Head
Office: Unit B, 16/F, Li Dong Building, No. 9 Li Yuen Street East,
Central, Hong Kong Thailand Bureau:
11/13 Petchkasem Road, Hua Hin, Prachuab Kirikhan, Thailand 77110
