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Jim Cook



Every once in a while I switch the TV channel from Fox to CNBC to see what the liberals are saying.  After listening awhile I get a deep sense of hopelessness and foreboding for our country.  The most important thing for the left is giving money to people.  They are happy to see the growth of food stamps, disability payments, housing subsidies, free healthcare and all the other welfare benefits.  They utterly fail to see the damage it is doing to the recipients.  Whole cities that once flourished have deteriorated into rotting eyesores populated with shambling hulks of chemically dependent drones.  These people are no longer employable.  They have become incompetent and helpless and the liberals can’t see that it’s their doing.

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The Best of Jim Cook Archive

Best of Doug Noland
February 23, 2011
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In an interview with the Financial Crisis Inquiry Commission, JPMorgan Chase’s CEO Jamie Dimon referred to Fannie Mae and Freddie Mac as “The biggest disasters of all time… that one was an accident waiting to happen.”  As someone who warned about the dangers of these institutions going back to the 1990s, I am particularly frustrated by another Dimon quote (from Bloomberg):  “We all knew about it, we all worried about it, no one did anything about it.”

One could argue that the timing is right today for a GSE “exit strategy.”  After all, the economy is expanding and housing markets have generally stabilized.  Moreover, there is these days quite weak demand for mortgage Credit (total mortgage Credit continues to contract).  The revitalized banking system could easily handle today’s mortgage financing needs.  Yet, according to Bloomberg data, GSE MBS issuance jumped to $450bn during the three-month period November 2010 through January 2011, with Fannie leading the charge.  Why?

Mortgages have traditionally been an unattractive investment.  When market yields rise, the duration of your instrument extends as borrowers hold tightly onto below-market mortgages.  As an investor, you lose.  And a lender will often receive an early return of principal when yields decline and borrowers gleefully refinance into more attractive mortgages.  Here, you don’t win.  Potential losses of principal from difficult to forecast Credit costs and losses also create considerable investor uncertainty, especially in periods of rampant Credit expansion and inflationary risks.  If you’re going to lend to someone to buy a house in an arms-length transaction in an unstable environment, you would demand a hefty risk premium.
No one today seems willing to live with anything close to hefty lending premiums.  So there remains an impetus to heavily intermediate - to “slice and dice,” securitize, throw on guarantees and insurance and, in the process distort various risks (including Credit, interest-rate and liquidity).  This is all done in the name of ongoing cheap mortgage Credit – one way or the other backstopped by Washington.  No one is willing to tolerate the pain of real reform.

One cannot overstate the role that the taming of (unwieldy) mortgage Credit risk over the past two decades has had on the U.S. financial sector, the U.S. economy, the global financial system and the structure of the global economy.  The securitization – and effective nationalization – of upwards of $10 TN of U.S. mortgage debt risk altered the rules of U.S. and global finance.  On the margin, it allowed our massive Current Account Deficits; it worked to de-industrialize our economy; and, over time, unleashed our Credit Bubble upon the world.
One could argue that there’s now “no turning back.”  A strong counter-argument would posit that the past 20 years of mortgage Credit reform – the U.S. mortgage finance Bubble - was a historical aberration (recalling John Law).

For years now I’ve dismissed notions of privatizing the GSEs.  These gigantic and meagerly capitalized institutions simply could not stand on their own, least of all in a post-mortgage finance Bubble/housing mania backdrop.  Besides - and especially after the policy actions of the past few years - the markets would gladly assume an implied “too big to fail” government backstop.  For now and for the foreseeable future, any institution acting singularly as a mortgage risk repository poses a systemic risk.
The private mortgage insurance stocks rallied sharply today on notions that these companies will benefit from reform.  Today’s white paper suggested a lesser role for FHA insurance and possibly additional reliance on private insurance to protect Fannie and Freddie.  Long-time readers know that I am no fan of Credit insurance.  It tends to distort risk and exacerbate the upside of the Credit cycle, while providing no real protection when the bust arrives.  As appealing as it sounds, private mortgage insurance is not part of any long-term solution to our festering mortgage crisis.