Paul Krugman is Very, Very Wrong
by Mike Kimel
Update …Since this post has gotten a lot of attention, jump here for my
final word on this topic.
I’m sure I’m missing something here, because Paul Krugman is so often extremely perceptive, but I think here he is very, very wrong. He writes:
The naive (or deliberately misleading) version of Fed policy is the claim that Ben Bernanke is “giving money” to the banks. What it actually does, of course, is buy stuff, usually short-term government debt but nowadays sometimes other stuff. It’s not a gift.
To claim that it’s effectively a gift you have to claim that the prices the Fed is paying are artificially high, or equivalently that interest rates are being pushed artificially low. And you do in fact see assertions to that effect all the time. But if you think about it for even a minute, that claim is truly bizarre.
Um, I dunno. Perhaps on specific day to day operations Ben B. is not giving money to the banks, but things look very different with a 30,000 foot view. (I suspect “the banks” most people mean if they say there are giveaways going on are not all banks but rather a small subset of basket cases.) Remember the toxic asset purchase? When the Fed spends over a trillion bucks paying the face value for securities whose real worth has declined to a fraction of that face value, to me that is both an expansion of the money supply and a give-away to those from whom one “purchases” those assets. There have been any number of similar, er, programs the Fed has run in the last few years which have had the same purpose: injecting money into a small number of entities that made extremely bad lending decisions in ways that specifically avoid making those entities pay any sort of market or reasonable price for that money.
That isn’t the only error in Krugman’s post. He also tells us this:
Furthermore, Fed efforts to do this probably tend on average to hurt, not help, bankers. Banks are largely in the business of borrowing short and lending long; anything that compresses the spread between short rates and long rates is likely to be bad for their profits. And the things the Fed is trying to do are in fact largely about compressing that spread, either by persuading investors that it will keep short rates at zero for a longer time or by going out and buying long-term assets. These are actions you would expect to make bankers angry, not happy — and that’s what has actually happened.
Yes, the Fed is sending a message that it well keep short rates at zero for a while longer. But which short rates and which long rates is Krugman talking about? Because banks can borrow at one rate – the effective federal funds rate, and they loan money to the public at a number of other rates.
I wandered over to FRED, the economic database of the St. Louis Fed and downloaded the Effective Federal Funds rate and the Average 30-Year Mortgage rate, which should be a good representation of a long rate used in loans by banks to the public.
The thirty-year mortgage is first reported on 5/7/1976 and is reported weekly thereafter. The FF tends to be reported a day or two earlier or later depending on the week, holiday schedules, and the like. Here’s what the 30-year Mortgage less the Fed Funds rate looks going back that far:
As is evident from the graph, whatever the Fed has been doing since the recession began in December of 2007, it isn’t compressing the spread between the 30-year mortgage rate and the Fed Funds rate.
Perhaps things might look different if the Fed followed more of a Banco do Brasil model, where the public could borrow directly from the Central Bank. But as things stand, pace Krugman, the Fed’s interventions since the recession began have only increased the spread between the rate at which banks can borrow and the rate at which they can loan out money.
The ideal money system would be one where money was denominated in actual useful work, useful innovation, and useful production. Only 25 % of accumulated wealth could be passed to first generation progeny. Credit would be a state function given to those with a track record of useful work, et.al., or a reasonable idea to create useful work et.al.
Laws established would protect the underlying precepts and severely penalize money creation from other than the precepted good economic activity.
Ours is a money-asset- debt macroeconomic system. The primary goal of the current system is not to produce useful economic activity but reward manipulative non precepted good behavior and protect accumulated wealth of the bond holders.
This is a horrific maximum nonlinear system, where gamed activity is rewarded right up to the end time limit before necessary interrelated and exponentially cascading system wide debt default occurs. The current system is at its limits. It is also self assembling and quantitatively mathematical.
Keynes, Benancke, and Krugman all had a grasp that the money system is best used for employing people in some type of useful economic activity.
Protecting bond holders or employing the masses to buy shelter and bread? What is the best purpose of money?
The world will dramatically change in very short time as the current money-debt-asset system undergoes historical transitonal collapse.
” When the Fed spends over a trillion bucks paying the face value for securities whose real worth has declined to a fraction of that face value, to me that is both an expansion of the money supply and a give-away to those from whom one “purchases” those assets.”
That’s because you have been lied to. The Fed DID NOT BUY BELOW MARKET VALUE. In fact, Fed holdings are making the Treasury a lot of money. The “progressives” seem to have been victims of ideological capture from anti-government Libertarians and have been repeating gold–bug level nonsense for years now. The Fed purchases have been reasonable: they acted to stop a panic by buying on the open market when nobody else would. Their purchases have been prudent and profitable for the taxpayer.
Another point that is constantly ignored in these complaints is that the Fed purchased mostly TREASURY BILLS and AGENCY BONDS. What seems to escape the “progressive” critics is that by doing so the Fed did not increase the risk for the public, but did make it capture the upside – using money that was printed for the occassion. That is, at no additional risk to the public and no additional taxpayer expense, the Fed built up a huge source of government revenue. It’s no wonder that Gold-Bug wingnuts hate this idea, but I don’t get why “progressives” hate it too.
it’s clear to anyone who’s paid attention that the purpose of Fed ZIRP policy was to recapitalize the banks, and that QE has largely benefitted risk assets & has done little for main street…figure that PK must have just woke up on the wrong side of a WSJ article…
Mike:
Which banks? Are we talking Citigroup, BofA, Wells Fargo, etc. or are we talking the pseudo banks which were made banks in order to be rescued under TARP? Goldman Sachs, etc.
A…I don’t think mortgage rates are the long term rates Prof. Krugman is talking about. He’s talking about 10-30year treasury rates. 10yr is at 1.97%, 30yr is at 3.13. Siphon off 2% inflation and your banker margin looks pretty sad to me.
…ditto to what rootless_e said! In a similar thread see Jared Bernstein here:
http://www.washingtonpost.com/opinions/tarp-worked-but-its-not-the-end-of-financial-reform/2012/04/19/gIQAgHH8TT_story.html?wprss=rss_opinions
So why it is that there is no attempt at a response? I am pointing out a fundamental factual error in your argument, an error that can be exposed by simply looking at readily available documentation on the FRB web site or in many articles. When the Fed purchased US Treasury bonds (at low prices), it reduced the borrowing costs for the government in two ways – both by reducing yields for new bond issues and by returning interest payments to the Treasury. When the Fed purchased agency bonds, which were already guaranteed by the Treasury, it reduced the default risk and captured a huge revenue stream for the taxpayer. But the Gold-Bug narrative of the Evil Banksters At The Fed is so ingrained by now that it’s just an article of faith.
Sigh. That’s not at all clear, in fact it is plain wrong.
Mr. Kimel is probably referring to Maiden Lane I, Maiden Lane II, etc. These were “structured investment vehicles” incorporated as Delaware LLCs to buy the assets of Bear Streans and AIG. Those assets were illiquid at the time, so this was a bailout of the creditors on the other side of these transactions. The Fed provided the cash indirectly, because its charter only allows it to purchase debt instruments backed by the “full faith and credit of the United States.” Maiden Lane I and Maiden Lane II were circumventions of the Fed’s charter and, in the eyes of some, illegal.
QE operations are not a giveaway – it is an exchange of assets – and are within the scope od the Fed’s charter.
I do not think that correct. Kimel wrote ” When the Fed spends over a trillion bucks paying the face value for securities whose real worth has declined to a fraction of that face value”. Maiden Lane purchases were well below that level so I assume he is discussing the direct purchases of agency bonds, agency debt, and treasuries. However, even if we were limited to Maiden Lane (which is an order of magnitude less than this trillion), he’d be totally wrong. Because the Maiden Lane transactions have been profitable to the Fed and the taxpayer – and in fact, AIG asked to be permitted to repurchase one of the 3 chunks. The Maiden Lane transactions involved the Fed stepping in to stop a panic – a sensible thing to do. There should have been a follow-up increased tax/fee on the financial sector – but the Obama administration proposals for such fees were killed in Congress while the supposed “left” was telling Gold-Bug stories.
“Effective Federal Funds rate” is where the argument goes wrong. FF is the rate at which banks borrow/lend short-term amongst themselves on an uncollateralised basis, in order to avoid having to put up collateral when going to the discount window. (Yes, it’s a rubbish name.)
A better rate would be yields on long-term debt issues. For example, Citi just paid 4.48% on its $2.5bln five-year issue.
rootless_e,
Sorry, no. The things were called toxic assets for a reason. If they had been worth something, anything, the Fed wouldn’t have had to buy them up. There would have been a market for it. The fact that nobody wanted to buy the stuff and all the banks wanted it off their balance sheets should give you some indication of what they were worth.
As to making money on this stuff… I think until the books get opened up completely some years down the line, there’s no way to make that statement. But there is plenty of indication that the statement is very, very unlikely, exhibit A being that the banks were so eager to shovel this stuff off onto the Fed.
run,
My guess… a few from your first group, and all of them from your second group.
Hyperion,
Borrowing from the Fed at zero and buying Treasuries is not business, its arbitrage. It is no surprise that the rewards for engaging in a riskless activity are so low. In fact, they should be zero.
The business model of banks, historically, has been something other than to borrow money from one government entity and loan it to another entity of the government of the same nation. There used to be consumers and businesses involved in the process too somewhere along the line.
As I noted above, for the various programs (and I have been purposely avoiding mentioning which ones – as I said in the post, take the 30,000 foot view) to be making money, you have to believe that every one of the banks involved underestimated the value of the assets it held, and every other bank and hedge fund also underestimated the value of those assets. After all, the banks were extremely happy to unload “toxic assets” (remember that term?) onto the Fed at prices that allow for that healthy return you are assuming is there.
Not only that, none of the other banks or funds thought to knock on the door of the holders of these toxic assets to offer to take those assets off their hands, and as you said, that would have netted them a good return. So… you can either conclude that not a single one of the entities involved in valuing these assets got it right (in which case, I might add, you clearly believe the entire financial system doesn’t work, down to its most distant dusty corner), or you can assume that the opaque figures we are seeing are, well, opaque.
Pick your poison.
Cameron,
“ FF is the rate at which banks borrow/lend short-term amongst themselves”
Correct, but I don’t see what you’re objecting to…. using the yields on the long term debt issues misses the point of Krugman talking about the compression between long and short term rates – you’d be talking about a differential between some long term rates and other long term rates. That may have some validity (and I say some – the FF is still a rate at which banks can borrow, and the arbitrage from being a prime broker and knowing what the Fed is planning to buy before the fact is a de facto subsidy to the prime brokers in good times and bad which it seems everyone accepts and nobody ever measures) but I imagine Krugman wasn’t talking about 5 year bond rates when he said mentioned short term rates.
I would add one more thing. If the Fed would like to provide me with treasuries equal in value to the MSRP of my ten year old car, I’d be happy to accept it.
My bet is if they rented out my (former) car they probably would make some money at it during the short term too, particularly given the Fed not needing to pay interest on the funds it used to pay for the asset. The problem is not whether the assets they are picking up can produce short term returns. The question is whether the principal on the asset, its underlying asset, can possible be worth anything near what they paid for it. And you cannot possible know tht before you try to unload the asset.
Your lack of specificity only highlights the hand waving nature of your argument. But let me try to explain: during a panic, not only do investors make stupid decisions, but they are often forced to make stupid decisions because they are over-leveraged. So many of the assets purchased by the Fed were purchased because, e.g. AIG needed CASH and only had securities. And at the time, most of the big market participants were in the same situation. So the Fed, which never has a cash shortage, stepped in – correctly. Here’s a tip: market price is often nonsense. As for the opaque figures, I have no idea what you are talking about. The Fed assets are completely documented. Perhaps you believe that because Naked Capitalism says things are murky then they must be, but that’s not true. The fact is that the Fed assets have APPRECIATED and have generated large cash streams for the Treasury which have reduced Federal borrowing. Your theories about what banks believed as just misdirection: The assets the Fed purchased are solid and most of those “trillions” that worry you are agency bonds and treasury bonds that the government guaranteed ANYWAY.
Your car theory is just more misdirection and hand waving. You made a concrete assertion about trillion dollar purchases at face value that is absolutely false. You cannot wriggle out of that by changing the subject.
Do you even know what face value means on a mortgage bond?
rootless_e,
First off, your statement that the Fed did not pay full price may be true for some toxic assets but not for others. This took me thirty seconds to locate on teh google (I went with AIG because you mentined it): http://www.insurancejournal.com/news/national/2009/03/11/98586.htm
Notice… AIG, through interventions by the FED, was able to pay banks back virtually 100% on bets that had soured using assets that had already devalued. A 99.8% recovery rate. Call that whatever you want, I call it paying face value.
As to the assets making money, again, another thirty seconds on teh google, also focusing on AIG since you brought it up: http://247wallst.com/2012/03/16/goldman-may-buy-aig-toxic-assets-from-fed/
“These collateralized debt obligations now held by the New York Federal Reserve have a face value of $47 billion. But, they could be sold for much less.”
I’m not handwaving or trying to change the subject. I am telling you straight up: yes, the assets they received are paying interest (i.e., generating huge cash streams), which means that, yes, they are making money. And yes, the Fed may even show those assets, on average, appreciating, on its balance sheet. And yes, the Fed does have the advantage that its cost of capital is essentially zero.
But like in the used car example, none of that is the point. The point is simple: will the discounted stream of interest payments plus the sums received for selling the assets exceed the amount paid for those assets. You are asserting yes. I am saying that, based on what we observed so far, we have no reason to believe that the Fed is valuing these assets corectly and that when the time comes to sell, the Fed is going to do it the way it sells Treasuries (i.e., telegraphing to the primary dealers, and getting a lower price in the process).
if you think the valuation process is not opaque, that’s your opinion. Mine is a bit diffferent.
You do not understand the process. AIG had obligations – some of them to pay off derivative bets. To get the cash they got loans from the government, some of which they guaranteed by collateral payments. That AIG paid the full value of its obligations tells you zero about how much collateral they had to put up and and what the value of that collateral was. So obviously it is opaque to you because you don’t follow the transactions. Quantum mechanics is similarly opaque to me, but that’s not a problem in quantum mechanics. Similarly you don’t understand that second news item – because for example the AIG assets in Maiden Lane 2 were all eventually sold and at a profit
http://www.bloomberg.com/news/2012-02-28/fed-sells-maiden-lane-ii-assets-to-credit-suisse.html
Here’s the FRB publication on Maiden Lane.
http://www.newyorkfed.org/markets/maidenlane.html
There is no opacity at all. If you bother to read the (hostile) inspector Generals report on how these came about you will understand just how prudent the Maiden lane transaction were. If AIG had collapsed, there would have been triggers that would have forced insurance companies to dump their securities in the middle of a panic which would have killed a number of pension plans etc. etc. The Fed was bailing out the economy, not the banks. To be sure, it’s a serious problem that the financial sector was permitted to both centralize and speculate, but that was a political decision, not a Fed decision. And it’s a problem that Bush’s government was thrashing incompetently during the crash too – clearly the Fed would have benefitted if, for example, Paulson had been on the line telling the French banking authority to back off. But given their situation they did a credible job.
And your original statement was ” Remember the toxic asset purchase? When the Fed spends over a trillion bucks paying the face value for securities whose real worth has declined to a fraction of that face value, to me that is both an expansion of the money supply and a give-away to those from whom one “purchases” those assets.”
Did you mean Maiden Lane? Those were LOANS of $50+ billion – a long way from a “trillion”? Did you mean the QE programs in which the Fed purchased Treasury bills, Agency Debt and Agency Bonds? Those were not “toxic assets” because they were all guaranteed “face value” by the US government. And those purchases have been great for the US taxpayer. So what “toxic asset purchases” do you have in mind? I think you have the mythical purchases that Gold-Bug right wingers and naive “progressives” have obsessed about – not actual purchases that happened in the real world.
You do not understand the process. What you found on google does not say what you think it says. The first news article says that AIG paid its obligations at 100%. To get that money, AIG borrowed money from the FRBNY and provided collateral – the “toxic assets”. You then assume that the collateral was valued at face value based on absolutely nothing. In fact that collateral was valued at a consideral discount. That’s fact, not your surmise based on misunderstanding the transaction.
Here’s a description of the Maiden Lane transactions
http://www.newyorkfed.org/markets/maidenlane.html
There is nothing opaque about it. By the way, if you do not know this, the collateral the Fed obtained in maiden lane transactions is in the form of loans and CDOs – it does not need to be sold to convert to cash. So market value is not all that critical unless the FRB runs out of cash which it cannot. If you hold onto those assets long enough they will be paid off by borrowers (except in cases of default). As you can see from the FRB document, the collateral has paid interest and paid off much of the collateral.
But the Maiden Lane transactions, your best bet at “toxic assets” amounted to $70billion which is a long way from the trillion of “toxic assets” you CLAIMED were purchased at way below real value. The trillion dollar transactions involved TREASURY BONDS, AGENCY DEBT, and AGENCY MORTGAGE BONDS. If you want to argue those were toxic assets, you have an even more difficult job because all of those were guaranteed by the government in the first place. And, if you look you will see that not only has the US government not defaulted on its loan obligations, but the Fed purchases have been highly profitable to the taxpayer.
So yes you are handwaving. You wrote: “Remember the toxic asset purchase? When the Fed spends over a trillion bucks paying the face value for securities whose real worth has declined to a fraction of that face value, to me that is both an expansion of the money supply and a give-away to those from whom one “purchases” those assets.”
and that statement is demonstrably false.
rootless_e,
One more follow-up, about the valuation of some of these assets… Here is a table showing the supplemental info on the MBS on the Fed’s balance sheet http://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab3 )
Right at this moment, it owns 855 million bucks worth of MBS. This is table 1:
“Guaranteed by Fannie Mae, Freddie Mac, and Ginnie Mae. Current face value of the securities, which is the remaining principal balance of the underlying mortgages.”
We can ignore the first sentence, since that just says “the Federal gov’t is now responsible for guaranteeing this garbage.” But how exactly would you interpret the second sentence, bearing in mind underwater mortgages, foreclosures, etc.? Are there a lot of loans that weren’t performing when the Fed picked this stuff up that are now fully paid up and performing?
rootless_e,
Another follow-up… here’s a time series of a piece of the Fed’s balance sheet (http://www.federalreserve.gov/releases/h41/hist/h41hist3.txt)
A casual look indicates that holdings of MBS reached a peak in mid 2010, when it was a couple hundred billion more than now. But it goes up and down every week. So… to the opacity issue… where’s the table showing how much of that up and down is due to sales of the assets and how much due to revaluation? Because I can’t find it. If its there, be so kind as to point it out.
Please note that the Federal government was always responsible for guaranteeing those assets. That’s why they are called “agency” bonds. It’s important to realize that the FRB did not add to government risk – it actually reduced government risk – when it purchased these bonds. How? Because the Treasury was on the hook for agency bonds that failed – it had an obligation to pay the individual holders (via the agency guarantees ). By printing money to turn those bonds into Fed assets, the Fed brought the potential upside back into the government and also reduced Treasury risk (since it can basically blow off obligations to the Fed).
The Feds purchased this stuff at “market rates” which priced in the expected default rate but also priced in the value of the Agency guarantee. If you hold a MBS you get regular checks (as long as it does not default) from the borrowers as they make their monthly mortgage payments. This is not directly related to the market price. During the panic, many people discounted MBS values because they thought the agencies might default or because they wanted cash so prices dropped. Face value is going to drop as payments arrive.
These are bonds, not stocks. Unlike stocks, bonds have a “hold to maturity” path which has nothing to do with market value. So the answer to your question is that this has nothing to do with reevaluation. The face value is the unpaid balance on the loan which decreases as borrowers pay.
Just want to point out that the Fed emergency program was ok – but only in the context of the existing agency bond system which definitely was not ok. Basically, for decades Fannie&Freddie subidized bank and real-estate profits by providing below market rate government backed insurance on securitized mortgages. This was a massive subsidy of finance, of construction, real-estate, commercial real-estate, and middle class homeowners whose assets were bubbled along with the rest. By adopting the far rights attack on the Fed, the “progressives” missed an opportunity to attack the fundamental system of subsidy of the FIRE sector. And Feddie and Fannie were themselves terrible examples of public risk and private gain – the very idea of private companies with public debt guarantee is repulsive.
Instead of asking why the Fed was not able to e.g. provide industrial development bonds or lend money for infrastructure projects (so municipalities did not have to subsidize the bond market) or why the Fed could not finance Federal infrastructure projects directly, the “progressives” bought into the libertarian theory that the Fed itself was scandalous and that market prices were infallible indicators of value.
rootless_e,
A couple points you seem to be handwaving away:
1. You kept telling me that the trillions of dollars thing was fiction… and I noted that the MBS holdings alone were at a trillion bucks on the Fed’s balance sheet.
2. I’m no expert on bonds, but I do like to stare at data and try to reason out what is going on and I simply cannot put all the stated facts into a coherent story. I’d love to hear your hold to maturity path explanation that results in the value going up some weeks and down in others as I noted above, without sales taking place (Bernanke was very clear recently (http://www.federalreserve.gov/mediacenter/files/FOMCpresconf20120125.pdf) that “the initial sales from our balance sheet, which again are far down the road….will be presumably in 2015.”). Since you were quite insistent that the Fed’s balance sheet is not opaque, I’m sure you can explain it with facts and figures and easy to follow links.
rootless_e,
Noted upthread – see the Fed’s historical balance sheet: http://www.federalreserve.gov/releases/h41/hist/h41hist3.txt
Please note the last column – the Fed apparently shared my delusion that they bought more than a trillion dollars worth of MBS alone, leaving aside other stuff. Since you know better, I strongly suggest you contact the Fed and inform them of their error.
You claimed that those Federally insured assets were “toxic assets” sold at a value far above their real value. But you have (a) been unable to show that the Fed claim of open market purchase was false and (b) don’t seem to come to grips with the fact that the government had already taken on the obligation of guaranteeing those bonds. So I don’t claim that the purchase of a trillion dollars of Agency MBS is fiction, that’s undoubtedly true. The fictional part is the claim that the government paid too much for these. And please note, normally MBS will sell for MORE than face value because the investor anticipates interest earning.
Face value will go down in some weeks as bonds pay off. It will go up in some weeks as the Fed reinvests profits back into the MBS market as it says it has been doing.
And a follow-up…. as I noted downthread, the debt wasn’t guaranteed by the gov’t. As it says in the footnotes to the Fed’s balance sheet (see below): “Guaranteed by Fannie Mae, Freddie Mac, and Ginnie Mae. Current face value of the securities, which is the remaining principal balance of the underlying mortgages.”
That is to say, it is guaranteed by the gov’t now. Now is the key word. It wasn’t gov’t guaranteed before the gov’t had to take over Fannie Mae & Freddie Mac. Before that, it was guaranteed by some private companies – Fannie and Frieddie – which couldn’t handle their obligations. Taking them over, and assuming their guarantees, is another unpriced subsidy.
Just to hammer home a point that seems difficult: If you own MBSs, then face value will go down over time WITHOUT ANY SALES.
And for the record, the “opaque” documents of the MBS purchase program are
http://www.federalreserve.gov/newsevents/reform_mbs.htm
including a spreadsheet that easily allows you to compute that the fed purchased MBSs at about 1/2 face value.
Mike:
Perhaps, Krugman was not definitive enough in what he meant? I would say it is good to rescue banks which impact all of the middle class that are truly banks. In any case, they desrved a haircut and new limitations on what they could invest on Wall Street which was covered by Section 20 of Glass Steagall and the National Bank Act (as if they were not making a killing on credit card rates with the death of usury in the SCOTUS decision in 78).
GS, etc should not continue as a bank unless it truly wishes to be a bank instead of an investment firm. Why should GS, etc. be allowed to borrow cheaply from the gov at taxpayer expense and invest? GS and other investment firm must decide which teat they wish to nuture from . . . either they are banks or they are investment firms. They need to be weaned from the corporate welfare teat.
Snort. Fannie and Freddie were never private companies. They were hybrid companies with an “implied backing” by the US government. When things collapsed Paulson decided to make the implied backing an explicit backing.
Sorry Mike, but Rootless_E is spot on here.
If the Fed was really handing money to the money-center banks, then these “gifts” should have shown up years ago as a loss on the Fed’s balance sheet. Where are these losses?
Are you really trying to argue that the Fed is covering up billions (if not trilions) of dollars of losses? If so you must also believe that the Fed is insolvent and needs to be recapitalized. The Fed’s equity cushion is a lot smaller than that of the banks it lends to. Maybe Ron Paul supporters believe the Fed has negative equity, but I, for one, would sure like to see some evidence.
If, on the other hand, the Fed stepped into a panic, as the lender of last reserve, and bought severely distressed securities from desparate financial institutions, then it made money and essentially taxed these institutions for its “kindness”. Tell me why this narrative is false????
Nick R.
Kyoto, Japan
rootless_e,
Snort. Fannie and Freddie were originally gov’t owned. They went private decades ago. The implied backing was precisely that: implied backing, but the implication was made by the private companies, not the government.
A lot of companies imply things that aren’t true in order to make themselves more profitable. A lot of times their customers believe it. That doesn’t make it true.
When things collapsed, Paulson decided to make something that private companies had falsely implied true. Yet another example of unkosher behavior.
rootless_e,
“Instead of asking why the Fed was not able to”
I’ve been peddling a variation of the Banco do Brasil model around here for a while. Don’t look in my diorection.
“You claimed that those Federally insured assets were “toxic assets” sold at a value far above their real value. But you have (a) been unable to show that the Fed claim of open market purchase was false and (b) don’t seem to come to grips with the fact that the government had already taken on the obligation of guaranteeing those bonds.”
Nooooooo. B is easiest to deal with. I’ve noted over and over that Fannie and Freddie were private companies, and they were selling an implied gov’t guarantee that hadn’t been there since they went public years ago. That the gov’t stepped in when the doo doo hit the fan doesn’t make that false guarantee they had been making true retroactively any more than the gov’t stepping in with AIG made AIG’s guarantees that they could cover their obligations true.
As to a – this makes no sense whatsoever. What market? As you yourself noted upthread: “The Fed purchases have been reasonable: they acted to stop a panic by buying on the open market when nobody else would. “
That means the market had collapsed. You can step in right now and buy stock in Pan Am Airlines right now if you did a bit of digging, but whatever you pay for those shares is more than they’re worth.
“ust to hammer home a point that seems difficult: If you own MBSs, then face value will go down over time WITHOUT ANY SALES.”
Exactly. And as I pointed out, a spreadsheet on the Fed’s own site showing the Fed’s balance sheet over time shows the value going up some weeks and down others, and they supposedly aren’t buying these things now. As I noted, you can only have the stated value go up in some weeks without buying any more if in those weeks a whole bunch of these mortgages that weren’t performing and are in arrears are suddenly made whole. I asked you to point to examples of that happening.
“And for the record, the “opaque” documents of the MBS purchase program are..”
Once again… since the purchases stopped, we have some weeks where the value of these assets have gone up. The spreadsheet you linked to stops when the purchases stop, and regardless, provides no indication of how the value of the Fed’s MBS assets could go up in some way in a week in which there has been no purchase of MBS shares. As a simple example… the value of the Fed’s MBS holdings is higher in the latest reported figure (April 18) than in any week going back to October 26. (Once again, that data is here: http://www.federalreserve.gov/releases/h41/hist/h41hist3.txt)
I’m trying to figure out how it happened, and you keep telling me a) it can’t happen and b) the Fed is being perfectly clear. Don’t you see an inconsistency in you position?
Of the paper they issued, the GSE’s stated explicitly: “The certificates and payments of principal and interest on the certificates are not guaranteed by the United States, and do constitute a debt or obligation of the United States or any of its agencies or instrumentalities other than Fannie Mae.”
These private companies may have implied to their hearts’ content, but taxpayers were never under any obligation to buy this junk until Geithner made it so.
Paulson was a Bush administration Treasury Secretary, not a FRB official. If you could clarify your complaint into one about Bush administration response to the crisis, you’d have a better case.
And Fannie/Freddie etc. were called GSE’s (Government Sponsored Entities) for a reason. They were a strange hybrid of supposed private ownership, but both an “implied guarantee” and elaborate Congressional management.
Nevertheless, the FRB purchases of agency MBSs came after Bush/Paulson converted the GSEs into directly managed government agencies.
Look it up
http://en.wikipedia.org/wiki/Federal_takeover_of_Fannie_Mae_and_Freddie_Mac
To be fair, once the crisis started, the Government really did not have a serious alternative of letting the GSEs totally collapse. However, Bush/Paulson made no effort to make bondholders share the pain although they did essentially zero out the share value of the GSEs.
It’s impressive how completely “the left” has swallowed the Republican line that the Evil Geithner and President Obama are responsible for the actions of George W. Bush and Paulson. The implied guarantee was converted into an explicit one by the Bush administration even though it is convenient for many parties to pretend otherwise.
You said “face value”. I pointed you to the spreadsheet showing that purchase were at 1/2 of face. I also have noted a number of times that the price paid by the Fed was perfectly reasonable as it has made profits from those investments. 40 to 70 billion a year in profits have flowed into the Treasury – a significant boost to the federal budget. So it was a prudent investment. At a period of low liquidity, the Fed purchased bonds at a discount from face determined by an analysis of the underlying mortgage strength. The charter of the Fed is not to speculate, but to certainly introducing liquidity into financial markets is something it is supposed to do.
It’s been fascinating to see how the right wing theory that instantaneous market price is oracular has become part of progressive doctrine.
As for the increase in value of their holdings, they have at various times been reinvesting payouts in either Treasury bonds or additionalagency bond holdings.
http://www.newyorkfed.org/markets/ambs/ambs_faq.html
There is no mystery. I’m not telling you it can’t happen, I’m explaining that the scandal narrative you began with is factually challenged.
That’s a truly hilarious argument. I point out that your narrative about “toxic assets” is bullshit and you argue that just calling them toxic assets somehow retroactively generates a reason. You sound like Colbert explaining “facteseque” but – he’s making a joke.
I don’t think you understand market dynamics. Contra the Chicago school fantasists, financial markets are not rational. During booms they lend money for crazy reckless purchases and during busts many market participants are brought down by cascades of collateral demands while others are panicked seekers of stability. That’s why we have a Federal Reserve and FDIC. So the “banks [being] so eager to shovel stuff onto the Fed” doesn’t mean that the stuff was valueless, it means that the banks were desperate for cash to pay down their over-leveraged positions. That’s why the Fed was able to purchase at a low price and why, for example, as soon as the panic was over AIG asked if it could buy its collateral back and collect those fat interest payments.
The Fed and the government in general moved to stabilize the banking system, its job. The problem is that the way left to stabilized the system was dictated by thirty years of really bad decisions
The first really bad decision was to remove the barrier between the boring but economically vital functions of the banks, the Main Street ones of making prudent loans to keep the economy functioning, from the exciting but largely irrelevant to the economy zero sum gambling games of Wall Street. This resulted in the creation of what was widely perceived as banks too big to fail. Wherer they were or not is irrelevant, in this case perception is all that mattered.
The other really bad decision that forced the government’s hand was that the private, for profit sector could take on the job that the government had been doing of backstopping not only the mortgages but the entire banking sector. It doesn’t matter what rational was offered to privatize Fannie Mae, for example, the important point is that it was a job that a private, for profit enterprise couldn’t do. That we allowed people to make a profit promising to do something that it is now obvious that they couldn’t do. Meanwhile the pressure to make the same profits that other enterprises were making actually forced the management into the riskier investments, ones a government agency wouldn’t have made.
It finally doesn’t matter if the Fed and the government makes or loses money on the Mortgage backed securities that it purchased. The government is the one enity that can’t go bankrupt because it can create money. The important point is that neither the left or the right seems to have understood the lessons from the financial crisis and the recession. And that just means that we will have the same problems reacurring until they do.
Of course it doesn’t matter – unless we are trying to cut through the Gold-Bug narrative that has become orthodox left opinion. The “left” response to the crisis should have been to demand a democratization of the financial system with wider access to finance, expanded public financing of critical investment, punitive taxes on speculation and so on. But instead we got 4 years of “GEITHNER IS A BANKSTER” stupidity and counter-factual bullshit about how the Fed bought “toxic assets”.
Nick R,
You’re missing my point. What I am saying is that the Fed has bought a lot of assets that do pay interest. If you bought 100 MBS, and 90% of the underlying mortgages are performing, you are showing a revenue stream coming in each month. The question is – is that revenue stream worth what you paid for it, not are you getting a revenue stream.
Krugman is a total partisan and he’s trying to defend/save Obama, not Bernanke. He has, for the past several years, been willing to make a fool of himself in public because he’s fixated on the “faux” boogiemen in the GOP.
the question is why.
Obama has turned out to be the most audacious and destructive political liar in modern history.
The Dems and the GOP are frauds.
Vote for Dr. Jill Stein
rootless_e,
I was wrong when I implied that all purchases were at face value. Some where (as I noted above, 99.8% the losses AIG was on the hook for were covered by the Federal Gov’t though AIG’s underlying assets had declined well below that level by then), and some weren’t (I’m accept what you wrote about how much was paid for the MBS). But the fact remains, there is a subsidy in place even now. If the MBS were worth what the Fed had paid for them, the Fed could have already unloaded them already on the open market without losing money. There’s a reason Bernanke has stated the Fed won’t start unloading them until 2015.
Even if in 2015 the housing market recovers and the MBS recover their value enough for the Fed to sell them off without losing money (more on this in a moment), the fact that the Fed had to sit on them and bear the risk that long is itself a subsidy to B of A et all who it paid for those MBS. The subisidy is holding risk that B of A didn’t want to hold, and paying a price for the privilege of holding that risk that nobody else was willing to pay.
But as I’ve been saying, why the heck are you concluding that an MBS held by the Fed that can’t be sold at a profit today will fetch a profit in 2015? The reinvestment of payouts into the MBS market is just increasing the subsidy. Sure, they will be able to say: look folks, we spent 1.25 trillion, and between payment streams and the amount we were able to sell the original MBS and the MBS we bought through reinvestment for a smidge more than we paid. But they won’t count any of the risk that it wouldn’t happen in the equation. And that isn’t free.
My problem is not that the Fed is intervening. My problem is that the intervention is specifically geared toward one group of bad actors.
Sorry about the misspelling in my previous post.
Some further thoughts on the costs or profits from the government purchase of the unwanted MBSs, the mortgage backed securities. The only way that the government can make a profit on them is if more of the mortgagees pay back their mortgages than the discount that the securities sold at assumed.
But it is not really desirable for the government to make a profit on them. That profit is money taken out of the economy, out of aggregate demand at a time that it is needed in the economy. In fact the best thing that we could have done for the economy would have been to writedown the mortgages of the seriously underwater people on their primary residence. Yes, it would be hard to do. Yes, it would reward some people for their bad behavior, but this didn’t seem to be a factor wen we paid for the principle, profits and bonuses of the people who were most directly responsible for the financial crisis that almost sunk us.
No, no, no. That’s not what the FF rate is.
If banks borrowed from the Fed and levered up to make loans, there’d be a Fed rate that would be relevant.
But that’s not how banks work!
Banks actually borrow from the private sector (equity, preferred stock, bonds, commercial paper, short-term loans, etc.), deposit some of that in a reserve account at the Fed, lever up the rest and lend it. The FF rate is the rate at which they’ll borrow/lend their reserve balances. Nothing to do with rates at which they’ll lend to the private sector.
The rate at which banks lend is set by either (a) their cost of capital, or (b) the rate at which they can securitise the lending by selling it on to the private sector (pension funds, endowments, what have you). What the Fed’s trying to do by buying MBS (and only the highest-quality MBS, nothing “toxic”) is drive down that latter rate.
Why should the Fed want to tell an income producing asset? They are not short of cash. The assets produce a steady stream of revenue for the Treasury (which acts to limit Fed debt). The GSEs were permitted, encouraged, to produce a vast number of mortgages attached to an “implied” guarantee which is now an explicit one that basically encouraged rent seeking in investors. The Fed has now moved those assets from a volatile and irrational financial market where they were always ready to be part of a panic that would damage US credit to a safe income producing asset for the government without any taxpayer expense. I’d much rather pay my mortgage interest to Treasury than to AIG or Morgan. The Fed has violated 50 years of policy by socializing the profit instead of simply having the public take the risk. If the Government is going to guarantee mortgages – the public should share the profit and so i think the Fed should hold that debt until expiration.
The Fed could sell MBS’s at a profit today – note that Treasury has sold the MBSs it accumulated at a profit ( http://www.foxbusiness.com/politics/2012/03/19/treasury-to-announce-25b-profit-on-mortgage-bonds-wsj/) but they have no reason to do so.
In fact, i think the Fed should be buying municipal bonds too and reducing the cost of borrowing for municipalities. It should be buying DOE loans to energy companies so DOE can make more loans. It should buy more Treasuries so that the debt is paid for by a slight inflationary pressure instead of increased rent payment to “investors”. It should buy up distressed student debt and write it down. Private debt is a tax on the economy that benefits the wealthy and some financial inflation and downward pressure on the dollar would be great for the public (the Obama team has pushed the dollar down a little which is part of the reason we have a manufacturing revival).
interesting discussion.
rootless_e appears to be working for the vampire squid or a subsidiary thereof. Anyway, he appears to have been seen off by the relentless Kimel…Bravo!
interesting discussion.
rootless_e appears to be working for the vampire squid or a subsidiary thereof. Anyway, he appears to have been seen off by the relentless Kimel…Bravo!
interesting discussion.
rootless_e appears to be working for the vampire squid or a subsidiary thereof. Anyway, he appears to have been seen off by the relentless Kimel…Bravo!
rootless_e,
I’ve actually suggested a lot of the uses for the Fed you make. Years ago I noted that the Fed can misread FICO scores as easily as any private bank, and Ben B makes less money than any private bank’s CEO. I suggested we should all be allowed to have an account with the Fed, just like any Brazilian can open up an account at the Banco do Brasil.
If the goal is for the Fed to continue to own and operate Fannie Mae and Freddie Mac going forward, OK. But that’s not what is going to happen. Fannie and Freddie and all these securities will eventually be sold off. And not at the best price either.
The Fed has told us it operates by a specific set of rules. And now we have learned that those rules go by the wayside when push comes to shove, at least for a specific grooup of bad decisionmakers. And we also know who is going to be favored next time the doo-doo hits the fan, because they’re the ones who are getting favored this time around. And that is going to have severe consequences.
Cameron,
Exactly. Krugman mentioned a short term rate at which banks can borrow. I noted that the FF is the best example of a short term rate at which banks can borrow.
Krugman also mentioned a long term rate at which banks lend. I suggested that perhaps the example of a long term rate at which banks lend is the 30 year mortgage.
I don’t think you are disagreeing with me at all.
rootless_e,
As I noted, I’ve been writing for years about letting the public bank at the Fed. That doesn’t preclude me from believing that the policies the Treasury and the Fed are following are more helpful to one particular group of poor decision makers than anyone else (good or bad decisionmakers) in the economy.
bugg,
I think you’re wrong. I dsiagree with Krugman but I don’t see him trying to save Obama. He doesn’t seem all that enamored of Obama to me.
merkin,
I think the best policy would be one that doesn’t excessively reward the bad decision makers. As I wrote in 2008, even handing every American a menu of items and telling them: “pick $20K worth of stuff off this list on us” would have been a better option that whatever they would eventually come up with.
normansdog,
Thanks, but while we often get trolls, I don’t think rootless_e is in that category. His policy recommendations are very similar to ones I have made before in the past and still strongly believe in (i.e., democratize access to the Central Bank).
Where I think we disagree – he is more of a finance guy than I am, and if I read him correctly, he seems to a) have a harder time believing the system can function without the survival of certain players and b) accepts the line that a guarantee by Fannie or Freddie – private companies at the time – meant a guarantee by the Federal gov’t.
Actually, I am. 🙂
Banks borrow “short-term” in the capital markets (say, on average, 3-5 years: JPMC just placed a 30-year bond which extended their debt’s average maturity to 6-ish years, Citi just placed 5-year debt) and lend “long” (10-30 years or more).
FF is more like LIBOR — it’s a sort of liquidity rate. If your business model was to borrow 30-day money to lend 30-year, it would be financial suicide. (And hence, banks don’t do that.)
The Fed decisions during the collapse were pretty good – given their circumstances which included the criminal Bush administration being in power. You cannot, however, generate a positive progressive economic program from the basis of complaining that the Fed did not participate in the market panic or that it should not hold assets or that its prudent intervention to save the world economy was some sort of scandal.
A postal bank would be a great policy advance, but the “left” has not focused its efforts on trying to sell that or any other decent idea to the public. Instead “the left” has been engaged in attacking the only institution that worked properly during the collapse and aiding the GOP effort to cover up their catastrophic management of the economy. If the US had not lost 5 million manufacturing jobs during Bush’s tenure, if he had enforced even the weak financial laws as written, if the Law&Economics movement in the judiciary had not made fraudulent conveyance into a legal business practice, if the Federal government had invested in infrastructure instead of spending trillions on wars for oil that didn’t even work, if the GOP had not pushed for the GSEs to be able to insure luxury housing loans, if taxes on speculation had not been gutted etc. etc. etc. – the financial crisis would have played out very differently. The Fed purchase of agency bonds was unlike all those decisions because it actually was of benefit to the public. Why we should join the GOP and complain about is something I do not get.
What is missed by Krugman et. al. is that at the moment of purchase from the Primary Dealers the new money must be used to buy more financial assets in the moments, hours and days that follow. Stocks, bonds, commodities and various other derivatives thus have a bid placed under them after any permanant add operation. Bernanke has specifically stated many times that boosting financial asset prices is the goal, if you look that is you will find it.
After all there is in fact no mechanism in the Fed/Primary Dealer loop which provides a route for the new money into the real transaction, real people economy. Which in essense is the flaw in the entire system. Since the 1% own most financial assets they get the benefit. Ben, et. al., pretend that trickle down works but they know better and so should anyone who can read and see the bank’s ‘excess reserves’, invested at a negative real rate.
Any such analysis in the end must brush up against the Austrian School and no professional economist dare get close to that. For all his liberalism Krugman in the end must adhere to the standard or neo liberal consensus. To do otherwise would be professional death.
FYI, Krugman responds:
http://krugman.blogs.nytimes.com/2012/04/22/qe-or-not-qe-that-is-the-question/
Bugg is being ridiculous. Krugman has been highly critical of Obama beginning at least when Obama misspoke using coventional but unwise wisdom on Social Security back during the campaign, and on a number of occasions since.
Kimel apparently misses the distinction between ordinary monetary policy and quantitative easing, and also misunderstands what the Fed is buying.
Ordinary monetary policy involves cutting short-term rates to fight a slump; it’s not what we’re talking about here, since it’s hard up against the zero lower bound. But the large-scale conventional expansion the Fed engaged in by getting to the zero bound has, of course, widened the spread between short and long term rates, since markets expect short rates to rise above zero eventually. So looking at the raw data on the short-long spread tells you nothing.
QE is an attempt to get traction despite those zero short-term rates by buying long-term debt, hopefully narrowing the spread and thereby boosting the economy. I don’t think it’s had a large effect, but that’s the goal.
And as for the other thing: Kimel apparently thinks the Fed is buying privately issued MBS, aka toxic waste; actually it’s only buying agency debt, which already has an implicit federal guarantee and is functionally not much different from long-term Treasuries.
Next question?
Oops!
Looks like you were right in your suspicion.
http://krugman.blogs.nytimes.com/2012/04/22/qe-or-not-qe-that-is-the-question/
Turns out your headline was correct except for two words, i.e., it’s Mike Kimel rather than Paul Krugman who is very, very wrong.
Another Harvey Johnson moment.
How does the Fed cut short rates in ‘ordinary’ policy moves? Is it by fiat, magic, or perhaps some mechanism? If the markets are not trending to the desired rate on their own, and the Fed usually is just following the market, not leading it, then the Fed always has used open market operations to provide liquidty to help rates go lower. QE is in the end just like any other Open Market operation where they buy stuff and expand their balance sheet. QE is classic ‘monetary policy’ on with turbo and nitros.
rootless_e,
I’ll give you my reason for complaining – if you’re going to break the rules during a panic, as the Fed did, don’t do it in a way that is designed to benefit one particular grooup of miscreants. Either do it in a way that benefits everyone, or that doesn’t benefit the miscreants. Like I said, hand everyone a menu and tell us all we can have $20K worth of stuff on that menu. Put MBSs on that menu. Fine.
As to the rest of your complaints – this blog has been around since GW’s first term (I wasn’t writing for it until 2006), but you can go back that far and find plenty of criticisms of the way the GW administration was running the economy.
Cameron,do
I understand that the FF is just an overnight rate. I figured it was a good proxy for the “short term rate” Krugman was mentioning. I know banks go to the markets with 5 year and other issues, but it didn’t seem to me that he meant 5 years as short term.
Big Jim,
I’ll be responding to Prof. Krugman hopefully tomorrow. But I suggest you look up the definiton of “agency debt” – it wasn’t guaranteed by the government until the federal government took over those agencies. And what was the likelihood that Fannie Mae was going to be able to meet the obligations to make MBSs it guaranteed whole after the meltdown began but before the gov’t took it over? If your answer is not something very close to 100%, you are essentially saying those assets were toxic.
Ed,
I’ll write up my response tomorrow.
Banco do Brasil is not the Central Bank of Brazil. Its relationship with the BCB is the same as anyother comercial bank in Brazil. If their loans go sour, it is the Brazilian treasury the entity that will have to recapitalize it. Reading your post I got the impression that you think that either the BB is the BCB or that it works diferently from a comercial bank (apart from the fact that it is controled by the fiscal authority and, thus, can be put to lend by a political decision).
Vladimir,
You are corect and I made a mistake. More embarassingly, I made the same mistake before. Urgh.
They did not break the rules to “benefit one particualr group of miscreants”. For example, as the IG points out, they were desperately afraid that AIG default on CDS would precipitate forced liquidation (during a panic) and collapse of some of the biggest pension funds. That is, they intervened to protect the retirement funds of ordinary working people. Within the political and legal limits of their situation, it’s hard to see what they could have done better. My argument is that instead of pushing for an expansion of and democratization of the Fed, the “left” has signed on to the conspiracy theory level anti-Fed program of the far right without thinking it through.
+1
Mike,
I agree.
Also, I’d add the removal of moral hazard. Back in the day when banks were limited partnerships, when one partner made a bet, he was putting his other partners’ assets at risk. Not so today with corporations and the “too big to fail” philosophy the effectively socialized losses.
Mike,
I agree.
Also, I’d add the removal of moral hazard. Back in the day when banks were limited partnerships, when one partner made a bet, he was putting his other partners’ assets at risk. Not so today with corporations and the “too big to fail” philosophy that effectively socializes losses.
Nick R,
“…then these “gifts” should have shown up years ago as a loss on the Fed’s balance sheet. Where are these losses? “
When was the last time the Fed was audited?
“Are you really trying to argue that the Fed is covering up billions (if not trilions) of dollars of losses? If so you must also believe that the Fed is insolvent and needs to be recapitalized.”
Hmmm, is recapitalize really the proper term for an entity that can create fiat money out of thin air? Increasing the money supply dilutes the value of the dollar, so any losses are actually taken out of the pocket of people holding dollars – too bad for you middle class!
As a medium of exchange, money should have some form of commodity basis because at the end of the day, eventually fiat currency will only be worth the paper it is printed on despite all of the government directives to the contrary. Just take a look at Greece now, and you’ll see barter economies popping up around the country.
Bryan,
“When was the last time the Fed was audited?”
Actually, the Fed is audited *every year* by independent auditors, the Fed’s own Office of Inspector General, and the GAO. http://www.federalreserve.gov/newsevents/reform_audit.htm
Bryan,
“When was the last time the Fed was audited?”
Actually, the Fed is audited *every year* by independent auditors, the Fed’s own Office of Inspector General, and the GAO. http://www.federalreserve.gov/newsevents/reform_audit.htm
Bryan,
“When was the last time the Fed was audited?”
Actually, the Fed is audited *every year* by independent auditors, the Fed’s own Office of Inspector General, and the GAO. http://www.federalreserve.gov/newsevents/reform_audit.htm
a less charitable take on krugman’s post than mike’s:
Counterpunch: Why Paul Krugman is Full of Shit – Late last week Princeton University economist and New York Times columnist Paul Krugman wrote a piece on his NY Times blog that history will view as the best evidence to appear in at least several decades of the utter irrelevance of mainstream economics. The piece purported to respond to a Wall Street Journal editorial by Mark Spitznagel in which Mr. Spitznagel argued broadly the Austrian economists’ line that all government spending favors one group over another and more specifically that the Fed’s Quantitative Easing (QE) programs of recent years favor banks and the rich. Mr. Krugman could have argued his New Keynesian shtick that government investment can prevent deflationary spirals in economic downturns and all would be as it was. Instead, he chose to argue (Plutocrats and Printing Presses – NYTimes.com), an astonishing amount of evidence to the contrary, that Fed QE policies have not disproportionately benefited banks and the very rich and were in fact enacted against their wishes and interests.
Uhh, sure. Annual transparency that you can believe in. heh
“And the things the Fed is trying to do are in fact largely about compressing that spread, either by persuading investors that it will keep short rates at zero for a longer time or by going out and buying long-term assets. These are actions you would expect to make bankers angry, not happy — and that’s what has actually happened.”
—
To an extent that may be true, and yet one must also keep in mind that they have a tiger by the tail here. The banks would not be helped if longer term rates went up… it could in fact kill them. It wound tend to crash a housing and commercial real estate market that is already on the ropes, with many properties underwater and a big backlog of foreclosures.
What do you think would happen to their existing loan portfolio if mortgage rates climbed?
Giving them near zero loans on the short end, and plenty of room to make a profit on new loans (if the market doesn’t crash significantly more – and they’re counting on the Fed to continue to have their backs there) has to be quite fine with them, as you’ve shown above.
“anything that compresses the spread between short rates and long rates is likely to be bad for their profits. And the things the Fed is trying to do are in fact largely about compressing that spread, either by persuading investors that it will keep short rates at zero for a longer time or by going out and buying long-term assets. These are actions you would expect to make bankers angry, not happy — and that’s what has actually happened.”
—
That’s true to a certain extent. Compression could eat into potential profits on new loans, but on the other hand allowing rates to go up on the long end would be a nightmare for the banks with respect to their existing real estate loans.
Higher rates would obviously deter people from purchasing properties at existing prices. Many couldn’t qualify for loans at those prices, others wouldn’t want to take on the higher payments necessary to service such loans. That would obviously cause housing prices to drop even further and faster than they have to this point.
That would be a disaster for the banks current portfolio, particularly given that many of their properties are already underwater and many others are in foreclosure. They would be hammered in both the commercial and personal markets.
I would have to think they would be elated to have the Fed step in to keep long term rates artificially low, especially when the spread is still plenty adequate for them to make a profit as you show above.