Steve Sailer has a very funny piece on WaMu’s advertising, which bragged about the company’s contempt for stodgy old bankers. Pretty obvious generational and ethnic subtext in this ad: WaMu positioned itself as a new kind of bank for the the age of diversity and free spirits.
Interesting piece from the Von Mises Institute on the Federal Reserve’s direct involvement in Mortgage-Backed Securities (MBS). I was under the impression almost all of the Fed’s assets were in Treasury Bills, a near equivalent of cash. Since its liquidity, stability, and the like are supremely important, I’m a bit disturbed to learn this was going on through the System Open Market Account (which is also the institution that holds the Bear Stearns bailout entity, Maiden Lane, LLC.) I have no idea how much direct MBS exposure the Fed has, and I’m surprised this has not been discussed by more commenters. Does anyone know the scoop out there? I think from this chart it’s either the “other loans” or “other assets” portion of the Federal Reserve’s asset pool. In any case, this year’s expansion of the Fed’s asset pool should be worrisome; it usually portends an equally significant expansion of their liabilities, i.e., printing of money either directly or otherwise.
Apparently the bailout is a done deal. There is no significant change in concept from original Paulson proposal other than a bit more oversight. Still no word on pricing goal, i.e., lowest possible, above market (to create upward bidding), or something in between. I will make a rare series of predictions: a rally of stocks for 1-2 months with big days this week, i.e., the last of our inflationary bubbles. A few months from now, probably after Christmas, Paulson with lame duck President Bush will solemnly announce massive and continuing losses from first wave of MBS purchases and continued deleveraging by nonparticipating or ineligible entities. The losses will stem from overpricing of the Mortgage and Asset Backed Securities (ABS) Paulson bought for the US, the stagnation of third party securities, the impact of declining credit on our consumption-oriented economy (and trade partners), and the failure of the market to push prices upwards for debt-based assets because of continuing, excessive housing inventory. In other words, this debt is toxic for a reason, and its revival depends upon an upward-moving near-term housing market, which will not materialize.
On news of the failure of the first stage of the bailout, the market tanks. Bonds fail and numerous big, credit-dependent companies seek bankruptcy. Runs on banks become more common. Credit markets manifest serious breakdowns in everything from commercial paper to auto loans. Deleveraging by institutions continues having an additional negative effect on the immediate money supply. Foreign bond rating agencies downgrade Treasury Bills, but the US rating agencies stand firm for fear of retaliation. This creates a crisis of confidence in all US-rated paper. There is a swift shift away from dollars as a reserve currency overseas. A severe and also inflationary recession starts January-February 2008.
The federal government will have blown the foreign creditors’ wads on the first stage bailout. But the more important FDIC bailout for commercial banks will become strained as nervous customers yank money from their longer-term accounts, just as unemployed depositers quit paying on their various loans. Instead of a sharp chastening lesson for Wall Street sorted out reasonably quickly in bankruptcy, the government will find that this bailout has strained its own ability to meet ex ante obligations to ordinary commercial banks. The banks who shifted their mortgage debt off the books to Fannie Mae, Freddie Mac, and other investors will now find the government’s bailouts of third-party holders of ABS and MBS left less money and weaker government credit available to fund the FDIC during the second-stage of the crisis (i.e., more WaMu-type failures and fire-sales). Since money in checking accounts and saving accounts being wiped out is totally unacceptable politically, the government begins monetizing the debt in short order.
I hope I’m wrong. Bonus question below.
Which recessions since the Great Depression have been inflationary?
Answer: Every single one of them.
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I think you’re a little over pessimistic – in the short term at least.
True, the securities are worth much less than anyone thought they were worth when they were packaged together, but just as Wall Street tends to be irrationally exuberant, so too it tends to get irrationally panicked. These securities still have physical houses underlying them, which even in the worst hit markets should at the very least be worth about 50 cents on the dollar. So long as Paulson doesn’t get too generous, the pain will be shared by taxpayers and the original investors.
Also, the surplus housing inventory numbers are high based on the current rate of home purchases. The current rate of home purchases is very low. The pipeline of new inventory is drying up, the population is growing, and people still need a place to live. Thus the current inventory is deceptive.
What’s more, while California, Florida, Nevada, etc, will continue to suffer, in much of the rest of the country prices and supply never got too far out of bounds, and sales volume has been depressed by the uncertainty and fear. Eventually that’s going to give, and prices will creep up in places like Texas and Tennessee as pent up demand is satisfied. This will offset some of the pain in California, Florida, etc.
Finally, foreign investors can’t flee the U.S. They are as dependent on us as we are on them. And for all the schaden freude foreigners have been enjoying lately, it’s not like their economies aren’t also dysfunctional government/private mongrels. There really is no other safe place to flee to, unless you count gold. In fact, so far all this has increased the value of U.S. government debt.
What’s true though, is that this trade imbalance will continue to fuel more global crises, and eventually it will result in either a slow moving away from the U.S. or a very hard landing for everyone concerned. Just not yet.