In Memoriam: George Kaufman, PhD

Published in Loyola University Chicago.

At a retirement dinner held following the conference, banking leader Alex J. Pollock gave a speech about Kaufman and his contributions to the field entitled “57 Years of Banking Changes and Ideas.” He ended his remarks: “Let us raise our glasses to George Kaufman and 57 years of achievement, acute insights, scholarly contributions, policy guidance and professional leadership, all accompanied by a lively wit. To George!” Read Pollock’s entire speech→

Are Remote Workers More Productive? We Finally Have the Answer

Published in FOND.

Productivity is typically measured by an individual’s output vs. input over a period of time. One example of this is gross domestic product (GDP) per worker, which measures output by person over the course of a year. However, the ways in which we measure productivity today are much more complex.

Comment Letter To OCC, Board of Governors of the Federal Reserve System, and FDIC

Published by the R Street Institute.

Via e-mail to:

Office of the Comptroller of the Currency

Board of Governors of the Federal Reserve System

Federal Deposit Insurance Corporation

         Re.: Comments on the Proposed Joint Rule on “Regulatory Capital Treatment for Investments in  Certain Unsecured Debt Instruments of Global Systemically Important U.S. Bank Holding Companies, Certain Intermediate Holding Companies, and Global Systemically Important Foreign Banking Organizations”

              OCC: Docket ID OCC-2018-0019; RIN 1557-AE38

              Board: Docket No. R-1655; RIN 7100-AF43

              FDIC: RIN 3064-AE79

Dear Sirs and Mesdames:

Thank you for the opportunity to comment on this proposed joint rule.

In my view, the logic of the proposal is impeccable.  Because it is, it should be applied to another, parallel situation, as discussed below.  The proposal’s objective, “to reduce interconnectedness and contagion risk among banks by discouraging banking organizations from investing in the regulatory capital of another financial institution,” makes sense, but might be improved by adding, “or if such investments are made, to ensure that they are adequately capitalized.”

I believe another rule with exactly the same logic and exactly the same objective is required to address a key vulnerability of the U.S. banking system.  That is to apply the logic of the proposed rule to any investments made by U.S. banks in the equity securities of Fannie Mae and Freddie Mac, two of the very largest and most systemically risky of American financial institutions.  As you know, hundreds of American banks took steep losses on their investments in the preferred stock of Fannie and Freddie when those institutions collapsed, and such investments caused a number of banks to fail.  That banks were able to make these investments on a highly leveraged basis was, in my judgment, a serious regulatory, as well as management, mistake.  On top of this, U.S. regulations allowed banks to own Fannie and Freddie securities without limit.

Banks were thus encouraged by regulation to invest in the equity of Fannie and Freddie on a hyper-leveraged basis, using insured deposits to fund the equity securities.  Hundreds of banks owned about $8 billion of Fannie and Freddie’s preferred stock.  For this disastrous investment, national banks had a risk-based capital requirement of a mere 1.6%, since changed to a still inadequate 8%.  In other words, they owned Fannie and Freddie preferred stock on margin, with 98.4%, later 92%, debt. (With due respect, your broker’s margin desk wouldn’t letyou do that.)

In short, the banking system was used to double leverage Fannie and Freddie, just as the investments in TLAC debt addressed by the proposal would otherwise double-leverage big banks.  To analogously correct the systemic risk, when banks own Fannie and Freddie equities, they should have a dollar-for-dollar capital requirement, so that it really would be equity from a consolidated system point of view.

I respectfully recommend, true to the principle and the logic of the proposed joint rule, that any investments by a bank in the preferred or common stock of Fannie and Freddie should be deducted from its Tier 1 regulatory capital.  I believe this should apply to banks of all sizes.

These are my personal views.  It would be a pleasure to provide any further information or comments which might be helpful.

Thank you for your consideration.

                                                                                    Respectfully,

                                                                                    Alex J. Pollock

Financial Goblins

Published by the R Street Institute.

Just in time for Halloween last week, three financial goblins appeared in the Financial Times in the same October 31 issue:

-China Minsheng Investment Group, “the country’s largest private investment company,” with “crushing debt problems,” reportedly is cutting senior and mid-tier salaries by 53% “in a bold decision to save itself.”

-WeWork, the struggling former financial darling, drew a forecast from hedge fund manager Bill Ackman that it has “a high probability of being a zero for the equity as well as for the debt.”

-“South Korea’s biggest hedge fund, Lime Asset Management” is “swamped by investors’ demands to get their money back,” is “forced to sell hard-to-trade assets…at fire-sale prices,” and has “suspended withdrawals.”

The next day, the Wall Street Journal added:

“Depositors swarmed a rural bank here…rushing to pull money out.”

Perhaps these four goblins represent various leaks springing in the global “Everything Bubble” the central banks have inflated?

Will the Federal Reserve have a monopoly in digital currencies?

Published in The Hill.

Cryptocurrencies started out with a libertarian desire to give people an alternative to national money, thereby escaping government power to depreciate their fiat currencies through inflation. Many governments, including the United States, have gone so far as to promise perpetual inflation, a key function of which is to help governments depreciate their own debt. Governments can also completely destroy the value of their currency through hyperinflation, as has happened throughout history.

To create a meaningful alternative to this government money monopoly was a noble intent, consistent with the classic proposal by Friederich Hayek in “Choice in Currency.” He asked, “Why should we not let people choose freely what money they want to use?” He argued, “Practically all governments of history have used their exclusive power to issue money to defraud and plunder the people.” Cryptocurrency enthusiasts agreed. They were, however, too optimistic about how forcefully governments could react, first by imposing regulation and then by realizing that governments themselves could issue digital currency to the public.

The great irony here is that the idea of a digital alternative to national money can morph into an idea to expand and solidify the government money monopoly. According to a survey by the Committee on Payments and Market Infrastructure of the Bank for International Settlements, more than 60 central banks, representing 80 percent of the world population, are researching central bank digital currencies. More than half of them have moved on to actual experiments or more “hands on” activities.

The broadest form of government digital currency would be the central bank offering deposit accounts to the public at large, so individuals, businesses, corporations, nonprofit organizations, and municipal entities could have deposit accounts at the Federal Reserve instead of with a private bank. Then their financial transactions in the digital currency with each other would be settled directly by the accounting entries on the electronic books of the Federal Reserve. Efficient and risk reducing!

Such a centralization has happened before. Paper currency became monopolized by the Federal Reserve in the form of government notes in the early 20th century. Until then, private banks issued their own paper currency. I have a copy of a $3 bill issued in the 1840s by a previous banking employer. Needless to say, no such currency is used today.

Could money in the form of deposits, such as money in the form of paper currency, be monopolized by the central bank, given current technology? In principle that could be the case. Direct deposits at the Federal Reserve would be close to being default and liquidity risk free. No need to worry about whether your bank might fail, whether it might become illiquid or insolvent, or whether your deposit was over the insurance limit. You would have no need to withdraw cash if you were worried about banks in a crisis because you would be holding a direct Federal Reserve obligation. That would no doubt appeal to many holders of money and, in our electronic world, it is quite easy to imagine such a central bank digital currency.

Do we like the idea, however, that deposits would be concentrated in the government instead of spread among 5,000 private banks? How much of the deposit market the central bank could take over depends on whether it would pay interest on the deposits. If it paid zero interest, its market share would be much less. But the Federal Reserve can and does pay interest on deposits. There are $14 trillion in total deposits in the banking system. Suppose 50 percent of them moved to digital deposits with the Federal Reserve compared to the 100 percent market share the Federal Reserve has in paper currency. That would be a towering $7 trillion. The government money monopoly would become bigger and more powerful.

What would the Federal Reserve do with its new $7 trillion? It would have to invest it. It would become an even bigger allocator of credit. It might allocate a lot more credit to the government itself and its favored housing sector. Or it might get into corporate credit, displacing private investors and becoming a state commercial bank. The history of such banks has been generally pathetic because their credit decisions inevitably become politicized. The Federal Reserve could also more readily impose negative interest rates directly on the people, thereby expropriating their savings.

On top of all that, the government would also have financial Big Data extraordinaire. It would know almost everything about our financial lives. Digital currency would then have traveled from libertarian choice to Big Brother. If not strictly limited and controlled, central bank digital currency could turn out to be one of the worst financial ideas of the 21st century.

Should the Fed Be Run by Economists?

Published in Law & Liberty.

Tomorrow, November 2, marks two years since the nomination of Jerome Powell to be Chairman of the Federal Reserve. Leaving aside President Trump’s subsequent expressions of regret at his choice, the nomination represented an important institutional change for the Fed: the first Chairman in 30 years lacking a Ph.D. in economics.

The anniversary of Powell’s appointment offers us an opportunity to reflect: Was this a good thing, or should the Fed always be an “econocracy,” run by economists? Does other expertise matter?

In a 1977 conference at the American Enterprise Institute, Irving Kristol observed: “Most professors of economics genuinely believe they know how to run the economy and would very much like to have the chance to prove it.”

It does seem that inside every macroeconomist is a philosopher-king trying to get out, and that being part of the Federal Reserve is the closest an economist can ever get to being a philosopher-king—or at least an assistant deputy philosopher king.

On the other hand, the will to power is hardly limited to economists. What kind of education and experience, we may wonder, helps us best moderate our natural ambitions, apply wisdom to our actions, and control, in Friedrich Hayek’s terms, the “fatal conceit” of “the pretense of knowledge”?

On the 100th anniversary of the creation of the Federal Reserve, I made a dozen predictions about the Fed’s next 100 years.[1] Among them was this:

An intriguing trend in recent decades is how economists have tended to take over the Fed, including the high office of Chairman of the Board of Governors and the presidencies of the Federal Reserve Banks. But there is no necessity in this, especially once we no longer believe that macro-economics is or can be a science.

I predict the Fed’s next 100 years will again bring a Federal Reserve chairman who is not an economist.

This prediction was fulfilled much more quickly than I thought with the appointment of Chairman Powell, and I think it is a good thing for the Fed to move away from econocracy. Whatever the illusions in the past may have been, we not only no longer believe, but we all ought to know by now that macroeconomics is not a science. Moreover, in my view, it cannot ever be one. Therefore, it is healthy to move the chairmanship of the Fed around among various professional domains.

Chairman Powell was trained as a lawyer and has significant Wall Street experience in investment banking and private equity investing. This is a completely appropriate background, as it seems to me.

Speaking of lawyers, the first Chairman of the Federal Reserve Board was William G. McAdoo, who was at that time the Secretary of the Treasury. Under the original Federal Reserve Act, the Treasury Secretary was automatically the chairman. McAdoo was a lawyer and a businessman, who among other things built two tunnels under the Hudson River between Manhattan and New Jersey. As Treasury Secretary during the cataclysm of the First World War, he set out to and succeeded in helping New York displace London as the world financial center.

But the real power inside the Fed in its early days was Benjamin Strong, the president (they called it “Governor” at the time) of the Federal Reserve Bank of New York from 1914 to 1928. Strong was definitely one of Kristol’s “men of experience.” He went to work in banking right out of public high school—no college, let alone a graduate degree for him. He nonetheless became president of Bankers Trust Company and then took charge of the New York Fed.

If you were President of the United States, whom would you want to pick as chairman of the central bank to the dollar-based world? Here, by principal vocation, are the ones who did get picked in chronological order: Lawyer, banker, lawyer, banker, investment banker, banker, banker, corporate executive, financier, Ph.D. economist (we have reached Arthur Burns), corporate executive, economist without Ph.D. (that is, Paul Volcker), Ph.D. economist, Ph.D. economist, Ph.D. economist, financier (bringing us up to the present).

We may further consider that there are two major Federal Reserve buildings in Washington, DC. The first is the main Fed headquarters. This familiar, impressive temple to the importance of money is the Eccles Building, named for Marriner Eccles, who was chairman of the Fed from 1934 to 1948, and after that stayed on the Federal Reserve Board without being chairman until 1951. About Eccles, we read:

Although he neither attended college nor received any formal training in economics, Marriner S. Eccles became the intellectual force who led the Fed through financial crises during the Depression and World War II.

Eccles was a Salt Lake City banker who controlled two dozen banks, in addition to a number of other companies, and set up one of the first multiple bank holding companies. It is fair to say that this powerful Fed chairman bore little resemblance to an economics Ph.D.

The second main Federal Reserve building in Washington is the Martin Building. It is named for William McChesney Martin, who was chairman of the Fed from 1951 to 1970, which included serving under five U.S. presidents, and represents the record tenure in the job.

Martin’s highest academic degree was a B.A. in English from Yale, where he also studied Classics. Perhaps this prepared him to be, as Peter Conti-Brown has written, the Fed’s greatest creator of language. His most famous metaphor, of course, was “the punchbowl,” which the Fed must take away “just when the party was really warming up.”

Martin did take classes in economics in college, in which “he was astonished,” we are told, that the academic economists believed that his father, who was the president of the St. Louis Federal Reserve Bank, and other Fed bankers were “hopelessly out of date because of their misguided warnings about excessive speculation in the stock market” of the 1920s. Of course, his father and friends turned out to be right.

Among other things, Martin served as the president of the New York Stock Exchange. He did take some graduate classes in economics, too, but through his long tenure at the Fed, he remained highly skeptical of economic models and forecasts.

History does make clear that while having professional education in economics can be a relevant qualification for leading the Federal Reserve, it certainly isn’t the only one or a necessary one.

A very instructive book on whom you might want as Federal Reserve chairman is Donald Kettle’s Leadership at the Fed. Its final chapter, “The Chairman as Political Leader,” draws these insightful conclusions:

The Fed’s policymaking is inevitably political, and no institutional (or even constitutional) fix can change that. History demonstrated the folly of thinking that monetary management can be reduced to a process of technical adjustment, for any monetary policy has political implications and creates political conflicts. The very attempt to shield such inherently political decisions behind “technical” standards and legal “independence” is itself a political strategy.… In framing monetary policy, the chairman operates as a political leader. He seeks to craft a policy for which he can build political support (and deflect attack)… [while enmeshed in] the intricate and complex balance of political forces in the Fed’s constituencies.

These points seem to me correct and to reflect reality. They must make us think of Alan Greenspan, Chairman of the Fed from 1986 to 2006, who earned an economics Ph.D., but was not an academic, and repeatedly demonstrated his skills as a master politician and political leader. This took him all the way to being “The Maestro”—though even he could not sustain that exalted but unrealistic perception.

In sum, are we better off for having had at the Fed an econocracy of Ph.D.s for most of the last three decades? Forty years ago, Kristol mused: “I am not so sure the world has improved much since we began being governed by economic theories rather than by men of experience using some common sense.” As with other counter-factual speculations, we can never know what would otherwise have been.

Turning to the future, it is safe to predict that the Federal Reserve staff will continue to be full of economics Ph.D.s, whose advice and analysis any Fed chairman will want to consider.

But at the top of the Fed, will Chairman Powell be the start of a new phase, which returns to a model of financial experience and practical knowledge—like Eccles, Martin, McAdoo, and Strong? In my view, this would be a good addition to the Fed leadership mix over time. We should certainly not exclude economics Ph.D.s from the office, but they should most definitely not have an exclusive claim on this hugely powerful, globally impactful, systemically important job. The Fed should not be an econocracy.

Eliminating Fannie & Freddie’s Competitive Advantages by Administrative Action

Published in Real Clear Markets.

Among the strategic goals for reform of Fannie Mae and Freddie Mac specified by Treasury Secretary Steven Mnuchin in Congressional testimony on October 22 was: “Legislation could achieve lasting structural reform that…eliminates the GSEs’ competitive advantages over private-sector entities.” A good idea, except legislation won’t happen.

As the Secretary suggests, replacing the current government-dominated, duopolistic secondary housing finance sector with a truly competitive one is an excellent goal. But fortunately, it does not take legislation. It can be achieved with purely administrative actions—three of them, to be exact. These administrative actions are:

1. Set Fannie and Freddie’s capital requirements equal to those of private financial institutions for the same risks.

2. Have Fannie and Freddie pay the same fee to the government for its credit support that other Too Big To Fail financial institutions have to pay.

3. Set Fannie and Freddie’s g-fees at the level that includes the cost of capital required for private financial institutions to take the same risk.

The Same Capital Requirement

The Federal Housing Finance Agency (FHFA), Fannie and Freddie’s regulator, has full authority to set their capital requirements. FHFA simply has to set them in a systemically rational way: namely, so that the same risk requires the same capital across the system: the same for Fannie and Freddie as for private financial institutions.

Running at hyper-leverage was a principal cause of Fannie and Freddie’s failure and bailout. It naturally induced market actors to perform capital arbitrage and send credit exposure to where the capital was least—that is, into Fannie and Freddie—thereby sticking the taxpayers with the risk.

The capital for mortgage credit risk is still the least at Fannie and Freddie and the risk is still sent every day to the taxpayers by way of them. Even with the revised agreement between the FHFA and the Treasury announced on September 30, Fannie and Freddie will be able to in time increase their capital only to $45 billion combined. This is exceptionally small compared to their risk of $5.5 trillion: it would represent a capital ratio of less than 1%, still hyper-leverage.

Something like a 4% capital requirement would be more like the equilibrium standard required to eliminate the capital arbitrage, which would imply a total capital for the two government-backed entities of about $220 billion. I do not insist on the exact numbers, only that the FHFA should implement the right principle: same risk, same capital.

The Same Fee for Government Support

Fannie and Freddie are Too Big To Fail (TBTF). No one doubts or can doubt this. Their business and indeed their existence utterly rely on the certainty of government support. This means their creditors have immense moral hazard: they don’t have to worry about the credit risk of the trillions of Fannie and Freddie fixed income securities they hold. History has proved that the creditors are right to rely on government support—when Fannie and Freddie were deeply insolvent, the bailout assured that the creditors nonetheless received every penny of interest and principal on time.

What is this government support worth? A huge amount. There is widespread agreement that Fannie and Freddie should pay an explicit fee for it, but how much? The right answer is to remove their unfair competitive advantage by having them pay at the same rate as any other Too Big To Fail institution with the same leverage and the same risk to the government.

In other words, have the FDIC determine what the deposit insurance rate for a TBTF bank with Fannie and Freddie’s leverage and risk would be, and require them to pay that to the Treasury. Then they would be on the same competitive basis as private financial institutions.

Setting the right fee in exchange for the ongoing government support is within the power of the FHFA as Conservator and the Treasury, by the two of them amending their Fannie and Freddie Senior Preferred Stock Purchase Agreements accordingly.

The Same Guaranty-Fee Logic

The key action here, which the FHFA is already not only empowered but directed by Congress to take, is already in law—to be specific, in the Temporary Tax Cut Continuation Act of 2011. This statute requires the setting of Fannie and Freddie’s g-fees to include not only the risk of credit losses, but also “the cost of capital allocated to similar assets by other fully private regulated financial institutions.” The FHFA Director is instructed to make this calculation and increase the g-fees accordingly. The FHFA has egregiously not carried out this unambiguous instruction. It should do so now, thereby removing the third distorting competitive advantage which historically allowed Fannie and Freddie to drive out private capital.

Each of these administrative actions by itself would create a serious advance toward the stated goal. To take all three of them would settle the matter: game, set, match. No legislation needed.

Given Enough Time

Published in Barron’s.

Randall W. Forsyth distorts Murphy’s celebrated law with a truncated version of it, writing “whatever can go wrong, will” (“Sometimes Things Can Go Right—and a Lot Did for the Stock Market Last Week,” Up & Down Wall Street, Oct. 11).

Although a common misquotation, this is an incomplete version. The full, correct, and much subtler statement of Murphy’s Law is, “Whatever can go wrong, will go wrong, given enough time.” It is with enough time that structural flaws in a system will necessarily emerge, and that financial vulnerabilities will burst from potential dangers to an actual bust. As properly stated, Murphy’s Law will doubtless prevail once again in finance, as in other domains.

Do you believe central bank assurances?

Published by the R Street Institute.

To reassure savers worried about the safety of their deposits, the Reserve Bank of India (India’s central bank) recently announced it “would like to assure the general public that Indian banking is safe and stable and there is no need to panic.”

The problem is that when government officials issue such assurances, do you believe them?

Governments confronted by the risk of a banking crisis have to say the same thing regardless how severe the risk really is. They must say that the system is safe and you should not panic, because they are afraid that, by sharing any doubts, they would themselves set off the panic they fear. Therefore, their statements of assurance have no informational substance.

“When it becomes serious, you have to lie,” Jean-Claude Juncker, then head of the eurozone finance ministers, with admirable candor said of the European financial crisis of the 2000s.

“We have no plans to insert money into either of those two institutions,” Treasury Secretary Henry Paulson said of Fannie Mae and Freddie Mac in the summer of 2008. One month later, he began inserting into both of them what became $187 billion of bailout money.

Governments and banks in stressed situations are up against Walter Bagehot’s insight into the fragility of credit. “Every banker knows that if he has to prove he is worthy of credit,” Bagehot wrote in 1873, “in fact his credit is gone.” I imagine that will always be true.

The term “credit” comes from credo = “I believe.” In a threatened crisis, you suddenly realize that you have not much ground, if any, for believing in a bank’s soundness or believing the government’s assurances that things are fine.

Actually, Sovereigns Do Go Broke

Published in Law & Liberty.

The ballooning debt of the United States government is an especially large and interesting case of sovereign debt. One chronicler of sovereign debt’s long, global, colorful history, Max Winkler, concluded that “The history of government loans is really a history of government defaults.” More moderately, we may say that at least defaults figure prominently in that history.

In a vivid recent example, the government of Greece, in its 2012 debt restructuring, paid private holders of its defaulted debt 25 cents on the dollar, so these creditors suffered a 75 percent loss from par value. Greek government debt was at the vortex of Europe’s 21st century sovereign debt crisis. Various governments of Greece have defaulted seven times on their debt, which has been in default approximately half the time since the 1820s.

With such a record, how soon would the lenders be back this time?

Pretty soon, as usual. Defaults were the past; new loans proclaim a belief in the future. Thus in July, the print edition of the Financial Times informed us, “Greek debt snapped up as investors seek higher yields”! That’s a headline that would not have been predicted a few years ago—except by students of financial history who have observed the repeating cycles of sovereign borrowing, default, and new borrowing.

“Greece has seen vigorous demand for its latest bond sale,” read the Financial Times article. “The Mediterranean country received orders of more than €13 billion for the seven-year bonds, well above the €2.5 billion on offer.” And the “higher yield”? A not very impressive 1.9 percent. The recently again-defaulting Greek government has succeeded in borrowing at the same interest rate as the United States government was at the same time for the same tenor. Of course the currencies are different, but this is nonetheless remarkable.

Note the common but inaccurate figure of speech used in the article. It talks about the country borrowing, when it is in fact the government of the country that borrows. That these two are not the same is an important credit consideration. Governments can be overthrown and disappear, while the country goes on. Governments can and do default on their debt with historical regularity.

Breaking the Faith

Notorious in this respect is the government of Argentina, which has “broken good faith with its creditors on eight occasions since it declared independence from Spain in 1816,” as James Grant reminds us. That is a default on average about once every 25 years. Obviously the lenders reappeared each time—in 2017, they bought Argentine government bonds with a maturity of 100 years. That is long enough on average to cover four defaults. In August 2019, the Argentine government announced it would seek to restructure its debt once again, and its 100-year bonds at the end of the month were quoted at 41 cents on the dollar.

In contrast to this, an optimistic columnist for Barron’s pronounced in that same August that sovereign bonds “have minimal to no credit risk because they are backstopped by their governments.” This financially uneducated statement is reminiscent of the notorious Walter Wriston line that “countries don’t go bankrupt.” Wriston, then prominent in banking as the innovative chairman of Citicorp, was defending the credit expansion that would shortly lead to the disastrous sovereign debt collapse of the 1980s. While sovereign governments indeed do not go into bankruptcy proceedings, they nevertheless do often default on their debt.

The great philosopher, economist and historian, David Hume, famously argued two and a half centuries ago, “Contracting debt will almost infallibly be abused, in every government.”

Max Winkler shared a realistic appreciation of the risk involved, as he was writing during the sovereign debt collapse of the 1930s. His instructive and entertaining book, Foreign Bonds: An Autopsy (1933), provides a simple but convincing explanation for the recurring defaults. Considering “politicians in the borrowing countries, from Abyssinia to Zanzibar,” Winkler memorably observed:

The position they occupy or the office they hold is ephemeral. Their philosophy of life is carpe diem. . . . Tomorrow they may be swept out of office. Today they can live only by yielding to the multiple undertaking of expenditures, proposed by themselves and their temporary adherents. . . . In order to enjoy the present they cheerfully mortgage the future, and in order to win the favor of the voter they . . . exceed the taxable possibilities of the country.

This sounds familiar indeed. We only need to update Winkler’s A to Z country names—we could make it “from Argentina to Zimbabwe.” Otherwise, the logic of the politicians’ behavior he describes is perpetual. It applies not only to national governments but to the governments of their component states, cities, and territories, like over-indebted Illinois and Chicago; New York City, which went broke in 1975; and Puerto Rico, now in the midst of a giant debt restructuring, among many others.

The observation fits the governments of advanced, as well as emerging, economies. This political pattern includes the expanding debt of the United States government, although it has not defaulted since 1971. In that year, it reneged on its Bretton Woods agreement to pay in gold. The U.S. government also defaulted on its gold bonds in 1933. Then Congress declared that paying these bonds as their terms explicitly provided had become “against public policy.”

The always insightful Chris DeMuth, writing in The American Interest and pondering the long-term trend of rising U.S. government debt, proposes that we have seen “the emergence of a new budget norm.” This is “the borrowed benefits norm.” “Voters and public officials,” he writes, have forged “a new political compact: for the government to pay out benefits considerably in excess of what it collects in taxes, and to borrow the difference.” He points out that the benefits “are mainly present consumption and are not going to generate returns to pay off the borrowed funds. Borrowing for consumption leads to immoderation now, immiseration down the road.”

This scholarly language captures the same behavior Winkler described in more popular terms in 1933.

A Habit of Default that Few Seem to Have Noticed

How frequent are defaults on sovereign debt? In their modern financial classic, This Time Is Different (2009), Carmen Reinhart and Kenneth Rogoff counted 250 government defaults on their external debt between 1800 and 2006, or 12 sovereign defaults per decade on average (of course, there have been more since 2006). In addition, they found 70 defaults on domestic public debt over that period.

A study by the Bank of Canada finds that, since 1960, 145 governments “have defaulted on their obligations—well over half the current universe of 214 sovereigns.” That is on average 24 defaulting governments per decade.

The study considers “a long-held view among some market participants . . . that governments rarely default on local currency sovereign debt [since] governments can service such obligations by printing money.” It points out that “high inflation can be a form of de facto default on local currency debt.” Holders of U.S. Treasury bonds found that out in the Great Inflation of the 1970s, when the bonds became called “certificates of confiscation.” But not counting the inflation argument, the Bank of Canada still finds 31 sovereigns with local currency defaults between 1960 and 2017. “Sovereign defaults on local currency debt are more common than is sometimes supposed,” it concludes.

The Wikipedia “List of sovereign debt crises,” relying heavily on Reinhart and Rogoff, shows 298 sovereign defaults by the governments of 88 countries between 1557 and 2015.

“The regularity of default by countries on their sovereign debt” is how Richard Brown and Timothy Bulman begin their study of the Paris Club and the London Club. These are organizations of governmental and private creditors, respectively, to negotiate with over-indebted governments. The first Paris Club debt rescheduling was in 1956 for Argentina; the London Club’s first was in 1976 for Zaire. (A to Z again.) The clubs have been busy since then. “Reschedulings increased dramatically from 1978 onwards,” Brown and Bulman observed in 2006. The current webpage of the Paris Club reports that in total it has made 433 debt agreements with the governments of 90 debtor countries.

The cycle of sovereign borrowing, default, and new borrowing has a long and continuing history. “Defaults will not be eliminated,” Winkler wrote in 1933. He further predicted that “debts will be scaled down and nations will start anew,” and that “all will at last be forgotten. New loans will once again be offered, and bought as eagerly as ever.” He was entirely right about that, and now we observe once again “Greek debt snapped up.”

How far back in time do government defaults go? Over 2,300 years in Greece. As Sidney Homer, in A History of Interest Rates, tells us: “In 377-373 B.C., thirteen [Greek] states borrowed from the temple at Delos, and only two proved completely faithful; in all, four-fifths of the money was never repaid.”

Shall we expect the fundamental behavior of politicians and governments to change?

Unfunded Pensions: Watch out, bondholders!

Published in Real Clear Markets.

A reorganization plan for the debt of the government of Puerto Rico was submitted to the court Sept. 27 by the Puerto Rico Oversight Board. It covers $35 billion of general obligation and other bonds, which it would reduce to $12 billion.

On average, that is about a 66 percent haircut for the creditors, who thus get 34 cents on the dollar, compared to par. Pretty steep losses for the bondholders, but steep losses were inevitable given the over-borrowing of the Puerto Rican government and the previous over-optimism of the lenders. Proposed haircuts vary by class of bonds, but run up to 87 percent, or a payment of 13 cents on the dollar, for the hapless bondholders of the Puerto Rican Employee Retirement System.

In addition to its defaulted bonds, the Puerto Rican government has about $50 billion in unfunded pension obligations, which are equivalent to unsecured debt. But the pensioners do much better than the bondholders. Larger pensions are subject to a maximum reduction of 8.5 percent, while 74 percent of current and future retirees will have no reduction. Those with a reduction have the chance, if the Puerto Rican government does better than its plan over any of the next 15 years, to have the cuts restored.

The Oversight Board’s statement does not make apparent what the overall haircut to pensions is, but it is obviously far less than for the bondholders. “The result is that retirees get a better deal than almost any other creditor group,” as The New York Times accurately put it. This may be considered good and equitable, or unfair and political, depending on who you are, but it is certainly notable. The Times adds: “Legal challenges await the plan from bondholders who believe the board was far too generous to Puerto Rico’s retired government workers.”

The Puerto Rican debt reorganization plan demonstrates once again, in municipal insolvencies and bankruptcies, unfunded pension obligations are de facto a senior claim compared to any other unsecured debt, including general obligation bonds that pledge the full resources and taxing power of the issuing government. This is not because they are legally senior, but because they are politically senior.

By running up their unfunded pensions, municipalities have not only stressed their own finances, but have effectively subordinated the bondholders. When it comes to unfunded pensions, the Puerto Rico outcome, like that of Detroit and others, announces: Bondholders, Watch Out!

Surprised again

Published by the Housing Finance International Journal.

“Why We’re Always Surprised” is the subtitle of my book, Finance and Philosophy. The reason we are so often surprised by financial developments, I argue in the book, is that “The financial future is marked by fundamental uncertainty. This means we not only do not know the financial future, but cannot know it, and that this limitation of knowledge is ineluctable for everybody.” That certainly includes me!

At the end of last year (in December 2018), interest rates had been rising, and it seemed obvious that they would likely rise to a normal level, at last adjusting out of the abnormally low levels to which central banks had pushed them in reaction to the financial crisis. The crisis began in 2007 with the collapse of the subprime lending sector in the United States and of the Northern Rock bank in the United Kingdom, and ran to 2012, which saw the trough of U.S. house prices and settlement of defaulted Greek sovereign debt at 25 cents on the dollar.

Six years had gone by since then, it seemed that it was high time for normalization. This view was shared during 2018 by the chairman of the Federal Reserve Board and its Open Market Committee. It also seemed that the long period of imposing negative real interest rates on savers, thus transferring wealth from savers to leveraged speculators and other borrowers, needed to end.

What would “normal” be? I thought a normal rate for the 10-year U.S. Treasury note would be about 4 percent and correspondingly for a 30-year U.S. fixed-rate mortgage loan about 6 percent, assuming inflation ran at about 2 percent. I still think those would be normal rates. But obviously, it is not where we are going at this point.

For the final 2018 issue of Housing Finance International, I wrote, “The most important thing about U.S. housing finance is that long-term interest rates are rising.” Surprise! Long-term interest rates have fallen dramatically. The United States does not have the negative interest rates, once considered impossible by many economists, which have become so prevalent in Europe, remarkably spreading in some cases to deposits and even mortgage loans. But the United States does have negative rates in inflation-adjusted terms. The 10-year U.S. Treasury note is, as I write, yielding about 1.5 percent. The year-over-year consumer price index is up 1.8 percent, and “core inflation” running at 2.2 percent, so the investor gets a negative real yield once again, savers are again having their assets effectively expropriated, and we can once again wonder how long this can continue.

What do the new, super-low interest rates mean for U.S. housing finance?

The higher U.S. mortgage loan rates, which reached almost 5 percent for the typical U.S. 30-year fixed-rate loan in late 2018, “would have serious downward implications for the elevated level of U.S. house prices, which already stress buyers’ affordability,” I wrote then. Had those levels been maintained, they definitely would have put downward pressure on prices. But as of now, seven years after the 2012 bottom in house prices, the U.S. long-term mortgage borrowing rate has dropped again to about 3.8 percent. This has set off another American mortgage refinancing cycle and is helping house prices to continue upward.

In the U.S. system, getting a new fixed-rate mortgage to refinance the old one is an expensive transaction for the borrower, with fees and costs which must be weighed against the future savings on interest payments. The fees depend on state laws and regulations; they range among the various states from about $1,900 on the low end to almost $6,900 on the high end, according to recent estimates. On the lender side, the post-crisis increases in regulatory burden had raised the lenders’ cost to originate a mortgage loan to as much as $9,000 per loan – the increased volume from “refis” (as we say) may have reduced this average cost to the lender to about $7,500. It is expensive to move all the paper the American housing finance system requires in order for the borrower to obtain a lower interest rate.

Meanwhile, with the new low interest rates and high house prices, “cash out refis” are again becoming more popular. In these transactions, not only do borrowers increase their debt by borrowing more than they owe on the old mortgage loan, but they reset their amortization of the principal further out to a new 30-year schedule. In both ways, they reduce the buildup of equity in their house, making it more likely that they will still have mortgage debt to pay during their retirement.

In general, there are no mortgage prepayment fees in the United States. The old, higher rate loans are simply settled at par. This continues to make prices of mortgage securities in the U.S. system very sensitive to changes in expected prepayment rates. If investors have bought mortgage loans at a premium to par, which they often do, upon prepayment they have lost and must write off any unamortized premiums they paid.

The most notable American investor in mortgage securities is the central bank, the Federal Reserve. As of Aug. 21, 2019, it had on its books $115 billion (with a B) of unamortized premium, net of unamortized discounts. Not all of this may be for its $1.5 trillion mortgage portfolio; still, a refi boom might be expensive for the Fed.

Speaking of the Federal Reserve, then-Chairman Ben Bernanke wrote in 2010 about his bond buying or “quantitative easing” programs: “Lower mortgage rates will make housing more affordable and allow more homeowners to refinance.” The latter effect of promoting refis is always true, but not the former claim of improved affordability. It ceases to be true when low mortgage rates have induced great increases in house prices, as they have. The high prices obviously make houses less affordable, and obviously mean that more debt is required to buy the same house, often with higher leverage – notably higher debt service-to-income ratios.

U.S. house prices are now significantly above where they were at the peak of the housing bubble in 2006. They have risen since 2012 far more rapidly than average incomes. The Fed’s strategy to induce asset price inflation has succeeded in reducing affordability.

According to the Federal Housing Finance Board’s House Price Index, U.S. house prices increased another 5 percent year-over-year for the second quarter of 2019. “House prices rose in all 50 states…and all 100 of the largest metropolitan areas,” it reports. Its house price index has now gone up for 32 consecutive quarters.

The S&P Case-Shiller National House Price Index has just reported a somewhat lower rate of increase, with house prices on average up 3.1 percent for the year ending in June. There is art as well as science in these indexes – the FHFA’s index notably does not include the very high (“jumbo,” in American terms) end of the market. According to Case-Shiller, in some particularly expensive cities, house price appreciation has distinctly moderated, with year-over-year increases of 1.1 percent for New York, 0.7 percent for San Francisco, and negative 1.3 percent for Seattle.

The AEI Housing Center of the American Enterprise Institute has house price indexes that very usefully divide the market into four price tiers. It finds that at the high end of the market, the rate of increase in prices is now falling, while the most rapid increases are in the lowest-priced houses – just where affordability and high leverage are the biggest issues, and where the U.S. government’s subprime lender, the Federal Housing Administration, is most active.

On a longer-term view, Case-Shiller reports that national U.S. house prices are 57 percent over their 2012 trough, and 14 percent over their bubble peak. When U.S. interest rates rise again, whether to normal levels or something else, these prices are vulnerable. How much might they fall? That may be another surprise.

HUD’s Implementation of the Fair Housing Act’s Disparate Impact Standard

Published by the R Street Institute.

EDWARD J. PINTO and TOBIAS J. PETER                       ALEX J. POLLOCK

AEI Housing Center                                         R Street Institute

September 26, 2019

Department of Housing and Urban Development

Regulations Division

Office of the General Counsel

451 7th Street SW

Washington, DC 20410

Submission via www.regulations.gov

Dear Sir/Madam:

Re.: Docket No. FR-6111-P-02; RIN: 2529-AA98

HUD’s Implementation of the Fair Housing Act’s Disparate Impact Standard

Thank you for the opportunity to comment on this proposed rule on the Disparate Impact Standard. The authors of the comment have many years of experience in housing finance, as operating executives, analysts, and students of housing finance systems and their policy issues.  We believe this rulemaking has the potential to significantly improve the existing standard.

Our fundamental recommendation is that the consideration of disparate impact issues must be able to include credit outcomes, i.e. default rates, not only credit underwriting inputs.  Specifically:

1. Mortgage lenders, including smaller lenders, should have the option to use a credit outcomes-based statistical approach, as defined below, which qualifies as a valid defense under the Disparate Impact rule. This would improve the fairness, operation, and statistical basis of the rule.

2. HUD should develop a credit outcomes-based statistical screening approach that allows it to assess with a high degree of confidence, whether differences in mortgage lending results raise disparate impact questions for further review.

In both cases, the ability to use credit outcomes would enhance clarity and reduce uncertainty.

Problems with the Pure Input Approach

Applying its credit standards in a non-discriminatory way, regardless of demographic group, is exactly what every lender should be doing.  Typically, the question of whether this is being carried out has been approached by looking only at inputs to a lending decision.  This results in a focus on differing credit approval/credit decline rates between protected and non-protected classes.  The argument is then made that the existence of differing credit approval/credit decline rates between classes is evidence of discrimination even if a lender applies exactly the same set of credit underwriting standards to all credit applicants.[1]

Read in full here.

Fund managers are the agents of shareholders

Published in the Financial Times.

“Large institutional shareholders, notably BlackRock, State Street and Vanguard, recognise that companies must serve broader social purposes,” writes Martin Lipton (Opinion, September 18). There is one big problem with this statement: these firms are not shareholders. They are mere agents for the real shareholders whose money is at risk. They are moreover agents that display all the conflicts of classic agency theory. Yet they go about calling themselves “shareholders”, pushing the personal political agendas of their executives.

What they should be doing is finding out what the real shareholders desire and voting shares accordingly as faithful agents, not pontificating about personal ideas, which are irrelevant as far as what shareholders want.

The New Campus Housing Bubble

Published in Forbes, The Independent Institute, Ohio University College of Arts & Sciences Forum, and Catalyst.

My good friend, banker-scholar Alex Pollock of the R Street Institute, has shared with me some startling new data. High priced, comparatively luxury college student housing has been popular, and in this century lots of apartment complexes have been built with many amenities —granite or marble counter-tops, fancy swimming pools or saunas, etc. With unemployment rates below four percent and  low overall real estate delinquency since recovering from the traumas of a decade or more ago, this sector should be booming. But according to a story published by Wolf Street (Wolf Richter), delinquencies are rising dramatically.

Have Fannie and Freddie Paid the Taxpayers Back Yet?

Published in the Real Clear Markets.

The distinguished judges of the U.S. Court of Appeals for the Fifth Circuit have considered how much Fannie Mae and Freddie Mac have paid the Treasury Department to compensate the taxpayers for the giant bailout which kept Fannie and Freddie in existence and business.  The court observed in its September 6 judgment:

“The net worth sweep transferred a fortune from Fannie and Freddie to Treasury.”  Specifically, “Treasury had disbursed $187 billion and recouped $250 billion.”

The “net worth sweep” is the dividend on the senior preferred stock in Fannie and Freddie acquired by the Treasury in the bailout.  Originally set at 10% per year in 2008, the dividend was changed in August 2012—in the “Third Amendment” to the governing agreement—to essentially, “just send in all your profit” each quarter, hence a “sweep.”  The Treasury then owned $187 billion of senior preferred stock acquired for cash, as the court suggested, and another $2 billion in exchange for the original credit support agreement, for a total of $189 billion.  (Now it owns $199 billion.)

Fannie and Freddie should, said the court, “of course…pay back Treasury for [their] draws on the funding commitment.” And “Treasury was also entitled to compensation for the cost of financing.”  No one could disagree.  “But the net worth sweep continues transferring [Fannie and Freddie’s] net worth indefinitely, well after Treasury has been repaid,” it critically points out.  This must make us ask: Have Treasury and the taxpayers been repaid at this point?  The answer is not obvious, as sometimes has been asserted, and requires a little arithmetic.

In short, does having been paid $250 billion vs. a $189 billion principal amount automatically mean full repayment?  As every banker knows, it doesn’t.

Consider a simple analogy.  Suppose you borrowed $1,000 at an interest rate of 10%, under a $5,000 commitment with a commitment fee of 1% per year.  Suppose you pay only the interest and the commitment fee, but never a penny of principal.  After ten years, you will have paid $1,500.   You could truly observe that “You lent me $1,000 and I have paid you $1,500.”  But how much principal do you still owe?  You still owe all $1,000, without a doubt.

We can apply the same logic to Fannie and Freddie and see what happens.

Let us go back to August 2012, and suppose that the Third Amendment and the “net worth sweep” had never happened.  There is outstanding $189 billion of senior preferred stock.  The dividend remains the original 10%.  That is a dividend of $18.9 billion a year.  In addition to the dividend, as the court rightly noted, the original deal provides for Treasury also to charge an ongoing commitment fee. This was to compensate the taxpayers for their continuing credit support, which backed up and continues to back up all Fannie and Freddie’s liabilities.  Nine Fifth Circuit judges in an accompanying opinion call this support “a virtually unlimited line of credit from the Treasury.”  It effectively guarantees liabilities totaling $5.5 trillion—you don’t get that for free.  With vast liabilities and effectively zero capital, Fannie and Freddie could not function for even a minute without taxpayer support.  The Housing Reform Plan just published by the Treasury clearly provides for Fannie and Freddie to pay a commitment fee—and they undoubtedly should.

What would be a fair price for the taxpayers’ credit commitment?  Based on what the FDIC would charge a severely undercapitalized bank for the credit guarantee which is called deposit insurance, I believe 0.18% of total liabilities per year is a good guess.  This credit support fee on $5.5 trillion in liabilities gives an annual fee of $9.9 billion.

Thus, going back to our hypothetical 2012 with no profit sweep, Fannie and Freddie should have been paying Treasury $18.9 billion plus $9.9 billion or a total of $28.8 billion a year.  That was seven years ago.  Had Fannie and Freddie been paying that instead of the profit sweep for seven years the aggregate payment for dividends and commitment fee only, would have been $202 billion.  That payment would provide no reduction of the $189 billion of principal.

But Fannie and Freddie paid $250 billion.  That is $42 billion more than $202 billion, which might fairly be used to retire some of the $189 billion principal.  If we credit Fannie and Freddie with the going rate of interest, say 2%, on this amount, we might make that $45 billion.  That gives us $189 billion less $45 billion, leaving $144 billion of principal still to be repaid.

Suppose you think my suggested commitment fee is too high.  Let us cut it in half, to 0.09 %.  Then by analogous math, Fannie and Freddie’s required payment of 10% dividends plus commitment fees would be $23.9 billion a year, or $167 billion in total for seven years.  That would leave $83 billion, or $88 billion with interest, for principal reduction.  Result: they would have $101 billion still to pay.

Even when we remove by hypothesis Treasury’s claim on the perpetual net worth sweep criticized by the court, it is far from the case that Treasury has been repaid.

These considerations must be taken into account as Treasury and the Federal Housing Finance Agency (as conservator for Fannie and Freddie) revise the Preferred Stock Purchase Agreement as part of the administration’s housing finance reform plan.

Lest We Forget

Published in Law & Liberty.

Fannie Mae and Freddie Mac, then staggering under huge losses from bad loans, were put into government conservatorship on September 6, 2008—eleven years ago today. Once considered financially golden and politically invulnerable, they were the lynchpins of the giant American housing finance market. But in 2008, instead of inspiring the fear and admiration to which they were previously accustomed, they were humiliated. “O what a fall was there, my countrymen!” This was an essential moment in the intensification of the 2007-2009 financial crisis. Naturally, Fannie and Freddie were bailed out by the U.S. Treasury. All the creditors got paid every penny on time, although the common stockholders from peak to trough lost 99%.

On the anniversary of Fannie and Freddie’s arrival in conservatorship, we consider Firefighting, the instructive and often quite personal memoir of the crisis and their own roles in it by three principal government actors—Hank Paulson, then Secretary of the Treasury; Ben Bernanke, Chairman of the Federal Reserve; and Tim Geithner, President of the Federal Reserve Bank of New York (and later, Paulson’s successor as Treasury Secretary).

To paraphrase the opening lines of the famous History of Herodotus from ancient Greece, using first names as they do in the book, “These are the memories of Hank and Ben of Washington and Tim of New York, which they publish in the hope of thereby preserving from decay the remembrance of what they have done, and of preventing the great and wonderful actions of the Treasury and the Federal Reserve from losing their due meed of glory; and withal to put on record what were the grounds of their actions.” This memoir will be able to be read usefully by future generations, if they are smart enough to study financial history.

The personal dimension of this account impresses us with the unavoidable uncertainty and the fog obscuring understanding, not to mention the emotions and then the exhaustion, which surround those who must act in a crisis. As they struggle to update their expectations and make decisions adequate to the threatened collapse, surprising disasters keep emerging in spite of their efforts.

As the authors reflect: “None of us was ever sure what would work, what would backfire, or how much stress the system would be able to handle.” So “We had to feel our way through the fog, sometimes changing our tactics, sometimes changing our minds, with enormous uncertainty.”

The pervasive uncertainty in part reflects the fact that crises “are products of human emotions and perceptions, as well as the inevitable lapses of human regulators and policymakers.” And “regulators and policymakers aren’t immune to those manias. Human beings are inherently susceptible to irrational exuberance as well as irrational fears.” This is not a new thought, to be sure, but certainly an accurate one.

In a crisis, all are faced with “the infinite expandability and total collapsibility of credit.” This wonderful phrase is from Charles Kindleberger, in his classic Manias, Panics, and Crashes. But how can those in responsible positions know when the collapsibility is going to be upon us? It may not be so easy to figure that out in advance.

“In the early phase of any crisis, policymakers have to calibrate how forcefully to respond to a situation they don’t yet entirely understand,” says the book. This seems right, but pretty delicately stated. A more honest wording would have been “have to guess how to respond to a situation they don’t understand.” While guessing, they are faced with this problem: “Governments that routinely ride to the rescue at the first hint of trouble can create. . . reckless speculation. . . . But underreacting can be even costlier and more damaging than overreacting.” Which is it to be? “Unfortunately, crises don’t announce themselves as either idiosyncratic brush fires. . . or systemic nightmares.” So, as the book describes, “Policymakers have to figure it out as they go along.”

As they strove to do so, “The three of us would work together as a team throughout the crisis, talking to one another every day, usually multiple times.” And talking to many financial executives, too: “Sometimes we just needed to hear how much fear was in their voices. Sometimes they professed confidence, sometimes they pleaded for assistance. Often they didn’t know that much about the risks ahead. We had to sort through all the confusion and self-interest.” In general, “Policymakers can’t trust everything they hear from market participants.” Of course.

Indeed, whose word can be trusted? Government officials worry that speaking truly about their fears may set off the very panic they are trying to avoid. “When it becomes serious, you have to lie,” said Jean-Claude Juncker about this aspect of the crisis in Europe. “The mere act of publicly advocating for [the] TARP [bailout] carried some risk,” write our authors. “Excessively alarmist rhetoric could end up inflaming the panic.” There seems to be no way to escape this dilemma.

Here is the authors’ confession: “Even in the months leading up to it, we didn’t foresee how the scenario would unfold”—how it would “unravel” would be a better term. This was not for lack of effort. “All three of us established new risk committees and task forces within our institutions before the crisis to try to focus attention on systemic threats. . . calling for more robust risk management and humility about tail risks.” But “none of us recognized how they were about to spiral out of control. For all our crisis experience, we failed to anticipate the worst crisis of our lifetimes.”

This experience leads the authors to a reasonable conclusion: such a lack of foresight is likely to repeat itself in the future. “For us,” they muse, “the crisis still feels like yesterday,” but “markets have short memories, and as history has demonstrated, long periods of confidence and stability can”—I would say almost certainly do—“produce overconfidence and instability.” So “we remain worried about the next fire.” This is perfectly sensible, although the book’s overuse of the “fire” metaphor becomes tiresome.

Failed foresight and future financial crises and panics are possible or probable. With that expectation and their searing experiences, the authors believe that it is essential to maintain the government’s crisis authorities and bailout powers. This includes the ability to invest equity into the financial system when it would otherwise go broke, and they deplore the Dodd-Frank Act’s having curtailed these powers.

To correct this, “Washington needs to muster the courage to restock the emergency arsenal with the tools which helped end the crisis of 2008—the authority for crisis managers to inject capital into banks, buy their assets, and especially to guarantee their liabilities.” This would hardly be politically popular with either party now, because it would be seen as favoring bailouts of big banks. It would increase moral hazard, but would also reflect the reality that government officials will intervene in future financial crises, just as in past ones. “The current mix of constraints on the emergency policy arsenal is dangerous for the United States,” conclude the most prominent practitioners of emergency financial actions of our time. Thus they end the book with their contribution to the perpetual debate of preparing for government intervention versus creating moral hazard.

In the meantime, they have related a history which, in the spirit of Herodotus, does deserve its due meed of remembrance.

Key points in the Treasury’s paper on Fannie/Freddie reform

Published by the R Street Institute.

The important parts of the Treasury’s new paper on Fannie Mae and Freddie Mac reform are not the legislative recommendations, since legislation is not going to happen. They are the administrative steps that can be taken now, with political will. Of these, the key ones are:

• Increased capital requirements for Fannie and Freddie, under which the same risks, whether taken by private institutions or by Fannie and Freddie, have the same capital protection;

• Removing regulations which especially favor Fannie and Freddie over other competitors;

• An ongoing fee from Fannie and Freddie to the Treasury to pay for the taxpayer credit support, without which Fannie and Freddie could not exist;

• Rewarding the taxpayers for their bailout of Fannie and Freddie by having Treasury exercise its warrants for 79.9 percent of Fannie and Freddie’s common stock. Since the exercise price is one-thousandth of a cent per share, this will be a nice and well-deserved profit for the taxpayers.

The Treasury’s articulated direction of a more competitive mortgage market with less taxpayer risk is certainly correct.

Greenland gambit finds echo in US frontier deals

Published in the Financial Times.

Theo Vermaelen’s ironic letter about the idea of purchasing Greenland (“Trump and Greenland: it’s a winner all around,” August 30) was fun, but ended with a serious point: “The current frontiers of countries are mainly the result of wars.” However, the frontiers of the United States were heavily influenced by purchases: the 1803 Louisiana Purchase of 827,000 square miles, the 1854 Gadsden Purchase of 30,000 square miles, and the 1867 Alaska Purchase of 586,000 square miles. In this context, one cannot help noticing similarities between Alaska and Greenland.

Taxpayers are the GSEs’ true stockholders

Published by the American Enterprise Institute and National Mortgage News.

At a conservative 16 basis points per year, taxpayers would earn some $7 billion annually after taxes, according to one estimate.