The US Secretary of the Treasury, Hank Paulson, has at last pulled the plug on the two giant GSEs (government sponsored enterprises), Fannie Mae and Freddie Mac.

That it was the big man himself who wielded the knife (or should that be the bazooka?) rather than his sidekick Jim Lockhart, Director of the Federal Housing Finance Agency (FHFA, the regulator of the GSEs), is clear from Paulson’s statement on Sunday, September 7, 2008: “I support the Director’s decision as necessary and appropriate and had advised him that conservatorship was the only form in which I would commit taxpayer money to the GSEs.”

What was decided? (more…)

I have now watched a brace of US presidential nominating conventions.  This has been a truly mind-numbing and depressing experience - a complete triumph of appearance over substance.

Particularly disturbing has been the willingness (eagerness?) of both the Democratic and the Republican candidates to exploit their minor children in the hope of gaining electoral kudos with the family values crowd. First the Obamas trot out their nine and seven year old daughters (after Michelle Obama had been airbrushed into a tupperware mom).  Then the McCains roll out their seventeen year old daughter.  Not to be outdone, Sarah Palin bounces onto the stage with her newborn baby in her arms.  Even her seventeen year old pregnant daughter was put up for public display, accompanied by the effing and blinding young man earmarked for future son-in-law status.

At least the Obama kids may be too young to suffer lasting psychological damage as a result of their cynical exploitation.  Seventeen-year old teenagers may not be as fortunate.  Should the social services get involved in what has all the hallmarks of emotional child abuse?

Here’s a link to “Central banks and financial crises”, a paper I presented at the Federal Reserve Bank of Kansas City’s symposium on “Maintaining Stability in a Changing Financial System”, at Jackson Hole, Wyoming, on August 21-23, 2008. 

Sorry about the length.  If I had had more time, I could have written a shorter paper.  That’s all for now. Back to the beach until September 1.

The Council of Mortgage lenders has made a constructive proposal for reviving the markets for securitising residential mortgages.  The response from the Bank of England and the Treasury has been a deafening silence.  I believe the Bank and the Treasury are making a mistake.

Legitimate fear of moral hazard should not degenerate into pointless and unnecessarily costly moralizing: they have sinned, therefore they must be punished, even if the punishment goes beyond what is necessary to induce better behaviour in the future.

There is no doubt that in 2005, 2006 and the first half of 2007, mortgage lending in the UK was out of control.  There was reckless lending and reckless borrowing.  Ludicrous loan-to-value ratios became the norm (no mortgage really should exceed 80 percent of the value of a residential property - ever).  Income and asset verification became perfunctory and often degenerated into self-certification.  Just as self-regulation means no regulation, so self-certification means no checking and no verification of the borrower’s capacity to handle increased indebtedness.  Banks and other mortgage lenders offered ludicrously low interest rates on mortgage borrowing.  Borrowers believed that these low rates were part of the New Jerusalem of painless credit.  Even today, real interest rates on mortgages continue to be low, even as nominal mortgage rates have risen.  Further increases, to ensure normal spreads over the funding costs of mortgage lenders, can be expected.

But the correction since the middle of 2007 has been brutal.  New mortgage approvals are at the lowest level ever in a series that goes back to 1987, that is, well before the last great housing market collapse.  Turnover in the housing market is likewise at its lowest level since 1987.  I am aware that both mortgage approvals and turnover were dangerously inflated prior to the middle of last year.  A lot of churning in the housing market may make estate agents and solicitors happy, but does not contribute to economic well-being per se.  Some turnover is a necessary condition for labour mobility, but there can be little doubt that just before the bust, growing numbers of  buyers were taking out mortgages they were not planning or expecting to service, because they expected instead to be able to sell the newly acquired property at a higher price soon after completing their purchase.  (more…)

The UK Treasury are reported to be working on plans to reform the two fiscal rules introduced by Gordon Brown. These are the ‘Golden Rule’, that over the cycle the government’s current account be in balance or in surplus and the ‘Sustainable Investment Rule’ that the ratio of net general government debt to annual GDP be no more than 40 percent.

Before reforming the substance of the rules, the UK government should think about how it would enforce whatever rule or rules it comes up with. Both the ‘Golden Rule’ and the ‘Sustainable Investment Rule’ were respected only as long as they did not bind. When they became binding constraints on the government’s ability to borrow they were bent, fiddled and now ‘reformed’, that is, ignored. The fiscal rules of the EU’s Stability and Growth Pact - the general government financial deficit should not exceed three percent of GDP, and over the cycle the general government financial deficit should be close to balance or in surplus - to which the UK also signed up, have been ignored/violated with equal equanimity. With zero credibility as regards its willingness to respect its own fiscal rules or those of the EU, why would anyone pay any attention to a new set of rules that the Treasury may come up with? (more…)

Ricardo Caballero’s argument in his Financial Times column of July 14,  Moral hazard misconception about moral hazard, is essentially that doing the right thing to minimize moral hazard would be too costly in terms of the likely negative impact of such actions on the real economy.  The way he presents his case is a textbook example of how a combination of lack of commitment/opportunistic behaviour, myopia and strategic interaction between the private sector and the government can create a very bad equilibrium.  I will refute his argument, focusing mainly on the case against bailing out Fannie Mae and Freddie Mac, unless this involves the euthanisia of the existing shareholders of the two GSEs and a material haircut for their creditors.

In what follows I show, first, that even if we wish to keep Fannie and Freddie in their current form, the immediate crisis need not get worse if their shareholders and creditors are treated harshly, thus maintaining incentives for future responsible lending, borrowing and investing.  Second, I show that a more efficient and equitable solution is available that ends the institutional obfuscation inherent in Fannie’s and Freddie’s current form: public sector sheep dressed in private sector wolf’s clothing.

(more…)

The bail-out of Fannie Mae and Freddie Mac by the combined forces of the US Treasury and the Federal Reserve Board is the ugliest exercise of its kind I have ever observed outside early transition economies and mature banana republics.

There are two open-ended (possibly permanent) measures by the US Treasury and one supposedly temporary measure by the Fed.  The Treasury’s proposals require Congressional approval to become effective, something that should be forthcoming some time next week.  The Fed measure does not require Congressional approval. (more…)

Are Fannie Mae and Freddie Mac adequately capitalised, as asserted recently by US Treasury Secretary Hank Paulson, Federal Reserve Board Chairman Ben Bernanke and their regulator Office of Federal Housing Enterprise Oversight Director James B. Lockhart III? The answer is: obviously not, if these two government-sponsored enterprises of the US federal government had to make a living on normal private commercial terms. Obviously not if they were subject to the market discipline preached by Paulson and Bernanke, but not practiced when it comes to large financial institutions perceived as systemically important (too large or too interconnected to fail) or too politically sensitive to fail. (more…)

How far will the real price of oil and other carbon-based resources rise? Experts (I am not one of them) differ widely in their medium-term and long-term predictions, but my reading of the evidence suggests that there is a fair chance that the sky is the limit. In the short run (the next 2 or 3 years) a global cyclical slowdown may provide some temporary relief from rising commodity prices in general and rising oil prices in particular. This temporary cyclical energy price comfort will be deeper and longer-lived if the key emerging markets that have let inflation get out of control (effectively all of them except for Brazil) tighten monetary and fiscal policies to bring inflation down to politically tolerable levels. The resulting cyclical slowdown in emerging market growth will be bad news for economic activity in the industrial world, but will put downward pressure on commodity prices. We will be unemployed but able to afford petrol.

Once global growth returns to its underlying trend, however, say three or four years from now, I expect the relentless upward march of commodity prices, including oil, gas and agricultural commodities, to continue. The reason is simple. Global demand growth is heavily biased towards energy-intensive production and consumption in emerging markets. Even if common sense breaks out in India, China (perhaps even in the Middle East and other oil and gas producers) and domestic oil and energy use is priced at its global opportunity cost, the energy-intensity of global production and demand will be rising for quite a while. At a horizon of a decade or more, high energy costs may reduce the energy intensity of production, investment and consumption, but total energy demand is still likely to rise even if global real GDP growth averages only 3 or 4 percent per annum. (more…)

A small step forward for humanity: another bastion of sexism has crumbled - the General Synod of the Church of England has decided to allow women bishops, 14 years after ordaining women priests. As a dyed-in-the-wool Protestant, I would have preferred a solution that did away with all priests and bishops, but if we are going to have them at all, let’s have them of either gender or none.

There are reported to be as many as 1333 clergy who have threatened to leave the Church of England if they are not given legal safeguards to set up a network of parishes that would remain under male leadership. I really don’t want these theological sad sacks to leave. They are misguided and deeply offensive in their insistence that women be barred from leadership positions in the Church of England, but the Church should be broad and tolerant enough to accommodate a small Conan-the-Barbarian wing. I actually doubt that very many would leave, even if they did not get their MCP reservation inside the Church, because they are unlikely to be sent on their way with a pro-rated share of the Church assets.

The next step will be a lesbian bishop in a committed relationship. Then a female Archbishop of Canterbury, straight or gay, with or without a beard. DV I will see the day. Progress is made one small step at a time.