Inside The Fed In 2006: A Coming Crisis, And Banter

“We think the fundamentals of the expansion going forward still look good,” Timothy F. Geithner, then president of the Federal Reserve Bank of New York, told his colleagues when they gathered in Washington in December 2006.

And this was the 'must have' guy for Treasury Secretary when Obama took office.

Unbelievable that the economy of our nation is run by these clueless “experts.” We could get better results from a monkey with a dart board.

“The transcripts of the 2006 meetings, released after a standard five-year delay, clearly show some of the nation’s pre-eminent economic minds did not fully understand the basic mechanics of the economy that they were charged with shepherding. The problem was not a lack of information; it was a lack of comprehension, born in part of their deep confidence in economic forecasting models that turned out to be broken.”

Clueless doesn’t even begin to cover it.

Ah, the big layoff and lock against hiring of December 1st, 2007. Are oil prices (freight fuel) way down now? Are foreign product prices down? I didn’t think so. Too bad. So sad. Starve the B.

"The transcripts of the 2006 meetings, released after a standard five-year delay, clearly show some of the nation’s pre-eminent economic minds did not fully understand the basic mechanics of the economy that they were charged with shepherding. The problem was not a lack of information; it was a lack of comprehension, born in part of their deep confidence in economic forecasting models that turned out to be broken.

"'It’s embarrassing for the Fed,' said Justin Wolfers, an economics professor at the University of Pennsylvania. 'You see an awareness that the housing market is starting to crumble, and you see a lack of awareness of the connection between the housing market and financial markets.'"

--snip--

"The general consensus on the board, summarized by Mr. Geithner, was that problems in the housing market had few broader ramifications. 'We just don’t see troubling signs yet of collateral damage, and we are not expecting much,' he said at the September meeting."

"Mr. Bernanke initially agreed, telling colleagues at his first meeting as chairman, in March, 'I think we are unlikely to see growth being derailed by the housing market.'"

"As the year rolled along, however, Mr. Bernanke increasingly took the view that his colleagues were too sanguine."

"'I don’t have quite as much confidence as some people around the table that there will be no spillover effect,' he said."

All these economists seem blissfully unaware of what was feeding the housing bubble - subprime loans mandated from executive branch initiatives that started under Clinton and Cuomo.

“All these economists seem blissfully unaware of what was feeding the housing bubble - subprime loans mandated from executive branch initiatives that started under Clinton and Cuomo.”

That’s the meme around here. Unfortunately for that theory the huge participation of Wall Street investment banks and pure mortgage lenders was done entirely without government pressure.

The initiatives such as the CRA applied to deposit-takers like your local bank. Wall Street gets its capital from investors, not depositors, and was not mandated to do anything.

The world of subprime lending was consciously targeted for development by Wall Street because it offered high yielding paper, and no one had mined that market prior to 2000. The fact that developing the subprime market paralleled the mandates to depository institutions is an interesting historical irony but that’s all that it is.

I'm sure you would have an interesting discussion with Peter Wallison. Weren't JPMorgan Chase, Citibank and Bank of America depository institutions?

What was banks' role? It wasn't until 2002 that Wall Street issued over $100 billion in securities backed by subprime or other weak loans. Recall that by this date, the GSEs had bought over a $1 trillion. The banks' number grew so that, by 2008, there were 7.8 million low quality mortgages backing bank-issued securities - less than 30% of the 27 million (low quality mortgages).

Now I wouldn't say Fannie & Freddie did it all by themselves, but they led the way with subprimes, and the Fed couldn't appreciate that buy keeping interest rates so low that they were also fueling a huge real estate bubble in housing and commercial real estate. The real estate and construction industries have yet to recover, and everybody who supported or supplied them are barely surviving, if that much.

“Weren’t JPMorgan Chase, Citibank and Bank of America depository institutions?”

They are. In comparison the non-depository shadow banking firms were investment banks like Goldman Sachs, Merrill Lynch, Lehman, some pure mortgage lenders like Argent and Ameriquest, and hedge funds. The Implode-O-Meter has a list of former mortgage lenders who didn’t survive the bubble, you can get an idea of the ratio of shadow banks to real ones:

http://ml-implode.com/

The shadow bankers rolled their own CDOs, CMOs, CDOs Squared, and sold that stuff all over the world. The paper they cranked out, including derivatives, was in the trillions. I can assure you that every gov’t mandated CRA loan ever written didn’t come close to that volume of paper.

“the GSEs had bought over a trillion”

It’s not peculiar that Fannie and Freddie had such an enormous amount of mortgage paper- for many decades they had a monopoly on the business.

Fannie was formed by the government in the 1930s to create the secondary mortgage market. No private firm had developed the business. Fannie had it all to themselves until they were sold off to the private sector around 1968. A couple of years later the government created Freddie in order to give Fannie a competitor and it, too, was sold to the private sector.

“Now I wouldn’t say Fannie & Freddie did it all by themselves, but they led the way with subprimes,”

The GSEs didn’t exactly lead subprime. In fact they were late to the party. In the late 1990s one Wall Street firm had been eyeing the hard-money household finance market- the province of Aames Home Loans and Household Finance. They were attracted by the very high returns that these loans produced, but the size of these loans was very small, maybe only a few hundred dollars.

They liked the high returns but needed loans that would be much larger. Eventually they realized that there was a whole universe of people with less than stellar credit who were being rejected for home loans. But maybe they would want a home bad enough to pay a high interest rate if the money was offered to them.... and that would be a market big enough to suit them.

This background is found in the book ‘Chain of Blame’, a good history of the development of the subprime industry. Oddly enough the Wall Street firm that pioneered it didn’t follow up on subprime lending, but everyone else did.

As the bubble progressed into the 2000’s the private market rivals to Fannie & Freddie began eating their lunch, growing market share at a much faster rate than the GSEs. One reason is that the private market firms offered the really exotic loans, the OptionARMs, the NINJAs (no income, no job, no assets), the 120% loans. All that F&F could deal in was conforming paper, even if the loan was subprime.

The big problem with F&F, IIRC, and what attracted the attention of the Bush administration, was the leverage that they were involved in. They had far too many loans versus their capital. Add in their sheer size and there was the potential for disaster. But the GSEs were private, stockholder owned firms, and there was no legal obligation for the taxpayer to save them.

Of course it turned out that every other lender was doing the same thing, so the entire banking and shadow banking systems were disasters waiting to happen.

“The real estate and construction industries have yet to recover, and everybody who supported or supplied them are barely surviving, if that much.”

It will take a decade or more to undo the damage that the bubble generated. Japan had its property bubble in what, 1990, and its still limping along as a result of that bubble popping. The ‘equity’ vanishes, but the debt people owe doesn’t.

But the GSEs were private, stockholder owned firms, and there was no legal obligation for the taxpayer to save them.

The GSEs were not completely private. They were Government Sponsored Entities. As such, they didn't have to be rated. They had the full faith and credit of the United States. So, they took the profits, and the taxpayers took the losses. Heads I win. Tails you lose.

BTW, thanks for supplying some of the other details for those who might read the thread.

Mr. Geithner suggested that Mr. Greenspan’s greatness still was not fully appreciated, an opinion now held by a much smaller number of people.

I figured it out during the Clinton administration when Greenspan had a plunge protection operation which really protected Clinton. Mr. Freemarket and former Austrian School was into market manipulation for political reasons. We should also remember that good ole Greenspan presided over the Dot Com bubble that contributed to the Clinton aura of "success".

It's important to remember just how much of this stuff originated or was made much worse during the Clinton Regime--especially as we may get Her Heinous running as VP for Hussein.

When he signed the Gramm-Leach-Bliley Act, President Clinton said that it, "establishes the principles that, as we expand the powers of banks, we will expand the reach of the [Community Reinvestment] Act".

“The GSEs were not completely private. They were Government Sponsored Entities. As such, they didn’t have to be rated. They had the full faith and credit of the United States. So, they took the profits, and the taxpayers took the losses. Heads I win. Tails you lose.”

You are quite mistaken here. You are equating a GSE with a Government Owned Entity, like Ginnie Mae, and they are not the same. Ginnie Mae is backed by the United States.

Fannie and Freddie began as government creations, that is they were sponsored by the government, as the S in GSE implies. But Fannie ceased being a government agency around 1968 when LBJ wanted it off of the budget, and Freddy never really was one. Once they were sold to private investors F&F were not backed by the government and taxpayers owed their stockholders nothing. Dubya and Paulson decided to bail F&F out. There was zero legal obligation to do so, it was entirely a political decision and not one required by law.

Agree, agree!!

The big investment banks were up to their eyes in coming up with new ways to pedal paper securities to anyone and everyone they could and be damned of the risks or fall out if things didn’t pan out.
They gambled and won, and all their political connections and payoffs did exactly that, guaranteed their survival through TARP and other Fed actions.

Crony capitalism at it best.