The Real Reason for the Rush?

One of the questions that has come up in connection with this week's scramble to pass a $700 billion bailout package for the beleaguered financial sector is: Why the rush? Why not take some time to fully explore the risks, discuss the financial, economic and political ramifications, and figure out ways to minimize the cost to taxpayers?

Although those in charge have attributed their sense of urgency to fears of an imminent seize-up in financial markets, it is conceivable that policymakers could have applied a few more of the band-aids they have been using prior to now so that the issues and prospective outcomes could be examined more fully in the harsh light of day.

Unless, of course, there is more to it than what our leaders are admitting to. In "Brad Setser: Extraordinary Times," the London Banker blog suggests the pressure for a rapid-fire solution stems from the precarious financial position of the rescuer-in-chief: the Federal Reserve.

Brad Setser has a fascinating insight to offer in his newest post, Extraordinary Times:

In the last two weeks — if I am reading the Federal Reserves’ balance sheet data correctly — the Fed has:

Increased “other loans” to the financial system by around $230 billion (from $23.56b to $262.34b);

Increased its “other assets” by about $80b (from $98.67b to $183.89b);

Increased the securities it lends out to dealers by $60b (from $117.3b to $190.5b);

That works out to the provision of something like $370b of credit to the financial system in a two week period. And that is just what I saw on a cursory glance.

The most that the IMF ever lent out to cash strapped emerging economies in a year?

$30b, in the four quarters through September 1998 (i.e. the peak of the 97-98 crisis).

The most the IMF ever lend out over two years?

$40b, in the eight quarters through June 2003 (this covered crises in Argentina, Brazil, Uruguay and Turkey)

This is a very real crisis. The Fed’s balance tells a story of extraordinary stress. I never would have expected to see the Fed lent out these kinds of sums over such a short-period.

My response:

Excellent and timely, Brad. I’ve been speculating all week that the pressure being used on the Congress to pass the Paulson Plan is the threat of Fed illiquidity. As of two weeks ago, the Fed had lent out more than $600 billion of its $800 billion balance sheet Treasuries against crap MBS collateral.

The Paulson Plan would have allowed the banks to unwind the repos putting the Treasuries back in the Fed, get cash for the crap MBS, and get more Treasuries from the issues financing the $700+ billion funding of the Plan. As a bonus, the Paulson mark-to-maturity price becomes the implicit Level 3 price for capitalisation of all the firms and banks in the system, giving them some breathing room to stay in business. Everyone wins except the poor American taxpayer.

The Fed is very close to being illiquid. That is the fear factor we are seeing at work, and the reason no one will discuss why the bailout is needed - only emphasise the urgency.

Comments

[b]

How A Clinton-Era Rule Rewrite Made Subprime Crisis Inevitable

Terry Jones
Wed Sep 24, 7:19 PM ET

One of the most frequently asked questions about the subprime market meltdown and housing crisis is: How did the government get so deeply involved in the housing market?

The answer is: President Clinton wanted it that way.

Fannie Mae and Freddie Mac, even into the early 1990s, weren't the juggernauts they'd later be.

While President Carter in 1977 signed the Community Reinvestment Act, which pushed Fannie and Freddie to aggressively lend to minority communities, it was Clinton who supercharged the process. After entering office in 1993, he extensively rewrote Fannie's and Freddie's rules.

In so doing, he turned the two quasi-private, mortgage-funding firms into a semi-nationalized monopoly that dispensed cash to markets, made loans to large Democratic voting blocs and handed favors, jobs and money to political allies. This potent mix led inevitably to corruption and the Fannie-Freddie collapse.

Despite warnings of trouble at Fannie and Freddie, in 1994 Clinton unveiled his National Homeownership Strategy, which broadened the CRA in ways Congress never intended.

Addressing the National Association of Realtors that year, Clinton bluntly told the group that "more Americans should own their own homes." He meant it.

Clinton saw homeownership as a way to open the door for blacks and other minorities to enter the middle class.

Though well-intended, the problem was that Congress was about to change hands, from the Democrats to the Republicans. Rather than submit legislation that the GOP-led Congress was almost sure to reject, Clinton ordered Robert Rubin's Treasury Department to rewrite the rules in 1995.

The rewrite, as City Journal noted back in 2000, "made getting a satisfactory CRA rating harder." Banks were given strict new numerical quotas and measures for the level of "diversity" in their loan portfolios. Getting a good CRA rating was key for a bank that wanted to expand or merge with another.

Loans started being made on the basis of race, and often little else.

"Bank examiners would use federal home-loan data, broken down by neighborhood, income group and race, to rate banks on performance," wrote Howard Husock, a scholar at the Manhattan Institute.

But those rules weren't enough.

Clinton got the Department of Housing and Urban Development to double-team the issue. That would later prove disastrous.

Clinton's HUD secretary, Andrew Cuomo, "made a series of decisions between 1997 and 2001 that gave birth to the country's current crisis," the liberal Village Voice noted. Among those decisions were changes that let Fannie and Freddie get into subprime loan markets in a big way.

Other rule changes gave Fannie and Freddie extraordinary leverage, allowing them to hold just 2.5% of capital to back their investments, vs. 10% for banks.

Since they could borrow at lower rates than banks due to implicit government guarantees for their debt, the government-sponsored enterprises boomed.

With incentives in place, banks poured billions of dollars of loans into poor communities, often "no doc" and "no income" loans that required no money down and no verification of income.

By 2007, Fannie and Freddie owned or guaranteed nearly half of the $12 trillion U.S. mortgage market -- a staggering exposure.

Worse still was the cronyism.

Fannie and Freddie became home to out-of-work politicians, mostly Clinton Democrats. An informal survey of their top officials shows a roughly 2-to-1 dominance of Democrats over Republicans.

Then there were the campaign donations. From 1989 to 2008, some 384 politicians got their tip jars filled by Fannie and Freddie.

Over that time, the two GSEs spent $200 million on lobbying and political activities. Their charitable foundations dropped millions more on think tanks and radical community groups.

Did it work? Well, if measured by the goal of putting more poor people into homes, the answer would have to be yes.

From 1995 to 2005, a Harvard study shows, minorities made up 49% of the 12.5 million new homeowners.

The problem is that many of those loans have now gone bad, and minority homeownership rates are shrinking fast.

Fannie and Freddie, with their massive loan portfolios stuffed with securitized mortgage-backed paper created from subprime loans, are a failed legacy of the Clinton era.

[Independent Accountant]

I read the London Banker post earlier today. I read his blog regularly and think highly of him. I've wondered about it too.
That said, I think there is another issue here: criminal liability. If the big banks, investment and commercial, are forced to sell their junk paper at market, they would need multi-billion dollar writedowns. The immediate question: why weren't they recorded before? I think part of what's going on is Paulson is looking to keep his old cronies out of jail for securities fraud. The Paulson plan is the banksters "Get Out Of Jail Free Card" from Monopoly.

[Oct 7th]

My compliments on the post....
It really gets to the quick (or plausible one).

I'm in sales and see how the "you gotta buy at this price today" or some other hokey near term time limit rarely works to get the sale and always seems to raise antennae that something may be amiss if there is that much urgency.

My question is what would occur (consequence wise) if the Fed were to be "illiquid"?

For the US and others?

Thanks,
OCT7

[Terry]

To answer the qeustion raised by OCT17 (What would happen if the Fed were illiquid?), I believe the answer is that they just borrow from the Treasury. Indeed, the Fed can borrow as much and as often as it wants, always adding to the money supply. Could be they'd borrow $700 billion, maybe more, maybe less. The move would drive down the dollar value significantly and be sharply inflationary domestically.

[hurl]

buy the rumor, sell the news

the rumor, a savior plan to keep stocks from falling

the news, a stockholder bailout is approved, and will have little actual immediate impact other than a few hundred Dow points

do credit markets unfreeze on the news? probably not

does the bailout cause real estate prices to bottom? probably not

do lending standards loosen? probably not

then, september auto sales, earnings warnings and forcasts, unemployment on friday

in 1929, the market crashed on October 29

in 1987, the market crashed on October 19

in 2008, how long could it take once the corporate sector starts breaking the bad news on the real economy?

[Anonymous]

I am astonished that this financial catastrophe would be blamed by some on minorities buying homes. The problem was clearly not just flexibility in loaning standards, but a complete lack of any underwriting standards, along with the securitization of mortgages mislabeled as being triple A rated. That is a problem with lack of transparency, the rating agencies, and accurate accounting. As to the minority loans, it has been shown that even minorites who qualified for better terms were given adjustable rate loans with high interest resets because it was more profitable upfront for the loan broker and supposedly would be for the downstream buyer. The US financial system is corrupt and reflects the true character of the nation.

[Tobby]

I am amazed at the number of people who slept through "Money, Banking, and Credit" during their Junior year in college. The Fed can borrow from the treasury. I repeat, the Fed can borrow from the treasury. The FDIC is backed by the Fed, which can borrow from the treasury. Any published funding limits are mere accounting metrics and do not represent some impending bankruptcy.

[VoiceFromTheWilderness]

You are surprisingly willing to grant behind the scenes reasonable-ness to the administration. Significant portions of the American public do not share your sanguine assesment of their goals, methods, or abilities.

Maybe you saw the Daily Show on Wed where he showed a speech in the run-up to the War in Iraq side by side with his current 'crisis'.

There is absolutely no reason whatsoever to believe that anything this administration does is on the up and up -- none. They have lied, cheated, stolen, and lived to do so again. Crony Capitalism is the clear defining characteristic of their war in Iraq, and indeed of their response to 'disasters' altogether.

It is more than naive not to think they are doing it again, it is foolish.

[weinerdog43]

You've gotta love b's wingnut approved diatribe that poor people caused the crisis. Not Bubbles Greenspan's interest rate actions, nor banker greed. Nope. Those darn poor (read black) people who wanted to join in the 'Merkin dream of homeownership. They're the real reason. Oh, wait. Don't forget to blame Clinton.

The wingnut plan: Always blame Clinton. Never admit any responsibility. Ya gotta love it.

[John Taurus]

Where has the gold reserves of the United States gone? Are there any left?? Has it all beens stolen and shipped to Israel??

This will go down in history as the largest theft ever...billions in gold stolen from the United States by a foreign country that conquered the United States years ago....and most citizens don't have a clue that they don't have a clue...that they don't have a clue.

[licksquid]

How can they go Illiquid when they print the money?
They have liquidity up until the time the dollar is inflated to zero.

[Able Dagger]

The Zionist Gangsters (aka Russian-Israeli Mafia) have orchestrated another 911. This time it is a financial armageddon. It is interesting that some of the same people (aka Hank G. at AIG) are associated with the latest 911. People should be taking this more seriously given the connections of this mafia to Russia.

It is interesting that the congress only has a 15% approval rating, according to recent polls. The reason the approval rating is so low is because none of the politicians are discussing what they are going to do about the Zionist/Wall Street gangsters.

Also interesting that the WM CEO (Alan F.) is walking away with $20 million after a short time on the job. It seems like the gangsters like to rub their exploits in the publics faces.

[Dr. Bombay]

I've heard that the mortgages that were issued under the
Community Reinvestment Act had some of the highest
repayment rates of any of the mortgages that were
made. Can anyone verify this? Thanks..

[Ugly American]

re: b

CLAIM: This was all caused by Clinton policies.

RESPONSE: In your own post you point to policies from 2001. Bush Jr was already president in 2001. In fact, despite ever stronger warnings by Ron Paul, James Rogers, Warren Buffet & others - Bush Jr & company spent 8 years making everything worse.

The mechanics of the failure are the same as the huge S&L failure under Bush's dad due to corporate junk bonds. You'll even find many of the same families involved.

The real problem is lenders are allowed to transfer the risk of their bad loans to others (pension funds, etc). And make no mistake, that's is where the toxic waste got dumped because people investing their own money wouldn't buy it.

Anytime an entire class can pass their risk to others it will be abused.

[V]

Good article, insightful comment as also. Always good to hear from our friends in the U.K.
I'll get to the point. Anyone remember the 1995 $500
Billion bailout? (it almost identical).
Well, Henry Paulson was the architect of THAT little
nightmare also. ( he was CEO of Goldman-Sachs from 2000-2006. He then somehow landed this job...Hmmm.
Again, his conditions are "no oversight, reviews and NO legal charges for any of his cronies!
Moreover, this was the "Keating 5" Scandal"
.....of the 5 senators who were caught.....yep,
John Mcain. How curious
Instead of a bailout, I hope they just get bail, heh.

[MJI]

Thomas Jefferson was concise in his early warning to the American nation, "If the American people ever allow private banks to control the issuance of their currency, first by inflation and then by deflation, the banks and corporations that will grow up around them will deprive the people of all their property until their children will wake up homeless on the continent their fathers conquered."

[FRN4U]

Get rid of the FEDERAL RESERVE.

[Dan]

The banks say that we can clean up this mess with $700 billion. Right now the banks are borrowing $188 billion a day from the FED. That's the numbers for this week. Last week, it was $48 billion. What does this imply for bank solvency? Monday morning is going to be exciting.

[LAStevens]

"The Fed can borrow from the treasury."

NOT at their discretion.

[Jean-Claude]

We're hit on all sides with political correctness ... this has destroyed our nation. It's the end of meritocracy. Of course, it was the idiot white liberals who caused this. The comment in this link about the minority communities, "investment" and political favors says it all.

Of course we must realize that many decent, Christian minorities work hard and got caught up in this nightmare. Can you really blame them per se? My how things have changed, today even poor people have lots of toys, fancy cars and of course, have you ever asked why poor people seem to be so darned fat? The poor have always been abused since they built the Pyramids, perhaps it is the method of control that has changed?

That said, greedy white men ran the machine at the top ... from Clinton to the Fed. They are the lowest form of oxygen stealing parasites. Capitalism without God is just as bad as Marxism and Communism without God.

It's just disgusting. The whole society is controlled by seemingly anti-human, Satanic elites. They have divided and conquered.

All normal people, those who are left, be they white, black, Asian, Hispanic, Muslim, Jewish, Christian, gay, not gay ... whatever ... need to stand together.

Another Boston Tea Party anyone?

[Pepper]

I would also suggest this is a part of the "globalization" agenda.... I saw it today for the first time in a news article quoting Paulson, as a cure for what is ailing us. Also remember Paulson wants to use the money to bail out foreign banks as well.

Just another step toward globalization....Obama and McCain both have CFR advisors on their staff, with Obama having the most (6) which includes the sociopath, Zbig...who wants to invade Russia and steal all its natural resources as written in his book back in 1997. Zbig made it clear that a democracy (elections) is "inimical to Empire building". So he suggests we do something about that.... well, that is going on as we speak. This link reads like a blueprint for global fascism, where corporations and bankers "govern regions" of the planet...These same guys currently in the process of scamming us and stealing...

http://www.cfr.org/publication/9903/sovereignty and_globalisation.html

While they are doing what ever it is they are doing.... they are also stealing by borrowing money from German banks the day before the announcement of the insolvency, keeping the $350 million Euros they borrowed, then placing the brand new debt into the bail out for the taxpayers to pay.

Believe it or not, that is a crime, its fraud. Lehman bros and possibly AGI (AIG) also was involved. It was in the German papers that the bank in germany involved had two bank directors who cooperated in that huge theft and the bank was considering prosecuting them..

Nice, huh??? If I tried to borrow a $100,000 one night, then the next day file bankcruptcy, I will be in jail so fast it would make my head swim... and here we are getting ready to hand the thieved the keys to the treasury room.... Amazing.

[milidude]

these criminal bankers were hedging their portfolios with derivatives AND THAT IS THE EXACT REASON WE ARE IN THIS MESS, DUE TO THEIR GREED, ARROGANCE, AND CRIMINAL ACTS. if nobody notices, the whole mortgage default market(1-200 billion) could be paid off in 1 quarter if we stopped this goddam war and used that money to help mom and pop on main street as well as the homeowners living in the neighborhood.these derivatives bundled as triple aaa investments were actually valued only on and in these banking criminals computers and were nothing more than a bet on when and if a particular investment would go bad and then bets(options) were made and sold thru the investment houses. the problem with this is EVERYONE INCLUDING MUNICIPALITIES ALONG WITH THE MAINSTREAM INVESTMENT FUNDS HOPPED ON-BOARD. this is exactly why we are in trouble and the only way to clean out an infection which is what our government and wallstreet has become. the elitest bankers dont give a dam about you or me, because we are goyim(sheep) to them and unless and until they are excised from the wound to our country and then antiseptic put on them until they are terminated, only then will our country and its wound begin to heal. these people worship none other than lucifer and their goal is to destroy life and our world as we know it. wake up and let the revolution begin.

[CaraJane]

Wall Street is Main Streets siamese twin with a drug problem. The time has come when we need to say to them its 3am no more cocaine. Really a bailout would just enable the addict.

[John]

Let the FED fail. Abolish the FED. Pass Ron Paul's bill to abolish the FED and re-enact JFK's Executive Order printing US dollars via the Treasury rather than via the debt of the corporate banker owned FED.

That's what the urgency is. The FED has been gaming the US since 1913 and MIGHT just fall if enough congressmen and women have BALLS.

[Johnny Cache]

I'm not wild about the notion of the government "bailing out" any entity, public or private unless and until you can show me that in the U.S. Constitution.
Thank you, that is all.