Rep. Edolphus Towns

I commend Rep. Edolphus Towns (D-NY), Chairman of the House Committee on Oversight and Government Reform. Rep. Town’s closing statement at yesterday’s Congressional hearing culminated some riveting theatre. That said, this is not a one act play. Rep. Towns highlights the need to dig deeper in exposing what truly happened in the midst of the Bank of America takeover of Merrill Lynch. Towns finished the hearing with this Closing Statement:

At the outset of this hearing, I said that it’s time to shine some light on the events surrounding Bank of America’s acquisition of Merrill Lynch.

At this point, I would say we’ve gotten a peek, but we don’t have full sunshine yet.

I would make three observations:

1. There are significant inconsistencies between what we have been told today, what we were told two weeks ago by Ken Lewis, and what the Fed’s internal emails seem to say.

2. It is still unclear whether Bank of America was forced by the Federal government to go through with the Merrill deal, or whether Ken Lewis pulled off what may have been the greatest financial shakedown of all time; and

3. As a result of this hearing, we have learned that the SEC and FDIC played a role in this transaction.

Former Treasury Secretary Hank Paulson has agreed to appear before this Committee in July and I look forward to that hearing.

But we also need to hear from the FDIC and the SEC, so that we can better understand what happened during the dark days of last December.

Will Congress and the Obama administration look to pursue these ‘inconsistencies?’ Will the parties to these conversations collectively be brought together so these inconsistencies can be addressed? Will the American public once again be subjected to an accusation by one party to a conversation claiming the other party misremembered?

In true Joe Friday fashion, Rep. Ed Towns echoes my sentiments:

The immediate reaction to Bernanke’s testimony is less than positive. The Bank of America-Merrill Lynch ‘play’ could very well be a preview to the Fed as the uber-regulator for systemic risk. Sense on Cents strongly believes the Fed should not occupy that role. Why? Throw any concept of an independent Federal Reserve right out the window. Bloomberg addresses this prospect in, Bernanke Grilling May Weaken Case for Expanded Powers:

Bernanke failed to resolve some lawmakers’ questions on whether the Fed bullied executives and stepped over other regulators in the name of financial stability in a three-hour congressional hearing yesterday.

Criticisms by members of both parties are likely to diminish support for the Obama administration’s plan to make the Fed the single agency responsible for the largest and most interconnected financial institutions.

“There’s something rotten in the cotton here — no ifs, ands or buts about it,” Representative Edolphus Towns, a New York Democrat who chairs the House Oversight Committee, told reporters after the hearing. “There was a forced situation, a shotgun wedding” and “we’re just trying to find out who had the shotgun.”

Will it be business as usual in Washington or will the American public truly learn if Ben Bernanke and possibly Hank Paulson abused their powers.

Don’t recall? Misremembered? Just the facts, please!

LD

Ten Years After The Massacre.  

Prepping for the show Sunday 19, when I speak with Dave Cullen, author of the mesmerizing and appalling “Columbine,” a comprehensive review of the mass murder of children by two sick people ten years ago, April 20, 1999, I was stumped and then gripped by the brief chapter on “Psychopath.”   I read this paragraph with a  fresh chill.

“Researchers are just beginning to understand psychopaths, but they believe psychopaths crave the emotional responses they lack.  They are nearly always thrill seekers.  They love roller coasters and hang gliding, and they seek out high-anxiety  occupations, like ER tech, bond trader, or Marine.  Crime, danger, impoverishment, death — any sort of risk will help.  The chase new sources of excitement because it is so difficult for them to sustain.”  Did you notice?  ”Bond trader.”

And then I put this up against what I read daily about the grotesque risk the big banks and attendant shadow banks sought out and took during the well-known housing bubble of 2002-2008.  AIG’s counterparty bets with CDS is astonishing until you consider there may have been a psychopathology to the behavior.  The risk was the desire, not the money.  All the major banks took part in similar fashion.  Where was the adult supervision?   Anger management?  Were the traders psychopaths?  No.  But perhaps a few, more than a few, and perhaps that behavior was acceptable to the sane.  Or perhaps the psychopaths were very good at disguising their rage and compulsive, reptile-brain risk-taking.  

Another stunning paragraph from the “Psychopath” chapter:  “Psychopaths are distinguished  by two characteristics.  The first is a ruthless disregard for others: they will defraud, maim, or kill for the most trivial personal gain.  The second is an astonishing gift for disguising the first.  It’s the deception that makes them so dangerous.  You never see him coming.  (It’s usually a him– more than 80 percent are male.)  Don’t look for the oddball creeping you out.  Psychopaths don’t act like Hannibal Lecter or Norman Bates.  They come off like Hugh Grant, in his most adorable role.”  Does this sound too much like Jamie Dimon, Tim Geithner, Vikram Pandit, even Lloyd Blankfein?  Is the big banking culture a nest of Eric Harris and Dylan Klebold types?  Impossible!   Are they thrill seekers?    Why are their banks either insolvent or fashioned with an architecture of opacity?  Will JP Morgan Chase, Citigroup and Goldman Sachs pass the stress tests due Monday May 4?   You ask? 

Join us in 10 minutes for LD’s weekly radio show tonight at 8:00 p.m. ET to 9:00 p.m. ET. We’ll discuss a wide array of financial and economic issues from Wall Street and around the world.

You are welcome to call in with questions and comments any time during the show. Dial in to (347) 677-0792 and turn down your computer volume since you can listen to the show for the brief time you’re on hold.

You can also log in to BlogTalkRadio.com, and join the live chat room during the show. (The chat room usually gets going about five minutes before the show.)

Our “very special guest” for our “LD’s Dollars and Sense” is an individual who, in my estimation, has more professional Wall Street relationships than any other individual. Allow me to share the background of the legend that is … Michael Maloney.

Michael started working on Wall Street in the mid-1960s at the tender age of 16 for a specialist firm on the floor of the NYSE. In 1970, Mr. Maloney was an equity block trader for the venerable Stone and Webster. In the late ’70s, Michael moved into the world of financial recruitment and career consulting. He is known as “the man to see” for those looking to move onto or within the world of Wall Street. He has longstanding relationships that would fill the Manhattan directory and has lived to tell about them. From placing chief investment officers to back office assistants, from working with the major investment houses to startups, Michael truly epitomizes the phrase, “it’s not merely what you know but who you know.”

Please join us for a fascinating look back and, simultaneously, a piercing view forward with “the man to see,” Michael Maloney!!

Larry Doyle has continued to track his original investigative report on the nomination of prospective SEC chairwoman Mary Schapiro, “Let’s Really Question Ms. Schapiro.” Larry scoured news and investment sites for any background information on Ms. Schapiro, and also read the 68-page 2008 annual report of FINRA, the Financial Industry Regulatory Authority, which raised a large number of questions about Ms. Schapiro’s abilities as a “watchdog,” as a “cop on the beat.”

We are living through a truly historic and challenging economic period. We want to help you make sense of it all.

Two weeks ago, for example, we were joined by insurance expert Sean D’Arcy of Northwestern Mutual (this show is a must for everyone who has an insurance policy and, since we all do, make sure you catch this important program). LD also wrote up the discussion in this story, “Got Insurance? 529 Plans? Financial Aid?…Read On….”

The week before, Kevin Doyle, founder of 12th Street Capital and former senior executive at Countrywide, joined us from 8:15-8:45pm. We discussed the dynamics and development of the sub-prime mortgage business, the outlook for regulations and the rating agencies, and much more. Fascinating discussion. For those who care the shows are archived.

Larry Johnson’s business partner, John Moynihan, joined us on December 21st. John is an expert in forensic accounting and money laundering. We discussed the Bernie Madoff situation and fraudulent activities in general. Also fascinating.

Get the real “behind the scenes” look from financial experts only here at “No Quarter’s Dollars and Sense with LD.”

:::::::::::::::::::::::
Afterwards, the archived show will be up at BlogTalkRadio or via iTunes/iPod (see our instructions in the right column under No Quarter Radio).)

AND: Check out Larry’s series of “Central Station” posts in which he takes questions from you, and answers them. The latest “Central Station” was yesterday morning, January 24th, from 9 a.m. to noon.

It was only a matter of time before the losses embedded in our banking system caught up and surpassed the capital injected. As such, our politicians and bankers are now forced to be somewhat honest with the public at large.

At long last the “news” is out: there’s another expected $1 trillion in embedded losses in our banking system. I have tried to judiciously, but clearly, highlight that very fact here at NQ over the last three months. In today’s WSJ:

Goldman Sachs economists estimate that financial institutions and investors world-wide will ultimately realize $2 trillion in losses on U.S. loans, but have recognized only half those losses so far. That scares investors who might otherwise give banks needed capital, and makes banks reluctant to make new loans. Regulators say they worry that the only remaining source of capital for banks is the government.

While I know a few readers here at NQ, blogs are generally anonymous communities. Given the nature of my writings, a month or so ago I realized it would be more effective and compelling if I opened myself to public criticism if warranted. For that reason, I went from identifying myself as LD to Larry Doyle. For those who know me, I think they would say that I am a very competitive, honest, and humble individual. I’d like to think that I am. That said, I have plenty of shortcomings. As we look to grow our audience and community, I beg your indulgence as I retrace the posts since I started writing in mid-October in which we wrote about these massive unrealized but embedded losses. We’re all about sharing here, so please pass this along to your friends. We’ll try to stay ahead of the curve for you. ~LD

Without further adieu . . .

The Economy – What Lies Ahead (October 14, 2008)

This injection of capital will not necessarily fully flow through to the economy. The banking system here in the U.S. likely has $1 trillion in embedded losses. This plan is trying to buy time for the system to recognize those losses. The recognition of those losses will curtail future growth for the banking system and the economy as a whole.

Economic/Market Highlights 10/16 (October 16, 2008)

Remember the overall banking system has upwards of $1 trillion in losses that need to be recognized. Both Citi and Merrill know this and have pre-announced that they do not expect to show a profitable quarter in the near future.

McCain/Palin’s Economic Stimulus Plan (October 23, 2008)

. . . what these steps have done is buy time so that the banking system can generate revenues over the next few years to both write down and realize losses that are currently on their books, but which if were currently acknowledged would have rendered certain banks as already bankrupt.

Markets Selloff 10% Overnight (October 24, 2008)

In the midst of all this though, please remember that as I have tried to highlight, that there are likely $1 trillion in embedded losses in the banking system. That bill must be paid.

The Wall St. Model is Broken … and Won’t Soon be Fixed!! (November 12, 2008)

The losses in the banking system alone are upwards of $1 trillion. From there let’s move into insurance companies, hedge funds et al. Paulson, Sheila Baer, Bernanke and others know that any money that goes into the system is purely going to help the banks recapitalize themselves in the face of these losses.

When Barney Frank, Nancy Pelosi, and Barack Obama complain that they need to make sure that credit lines open and remain open, they are not addressing the fact that the banks have an overwhelming amount of non-performing assets already and that those assets are likely going to grow in the face of an unemployment rate headed up by 2% to 4%!!

Economic/Market Highlights 11/12 (November 13, 2008)

Transparency
I had an exchange with a reader as to why the government is not revealing which banks have been participating in certain specific programs launched over the last few months. I made the case that the government is trying to protect the participating banks and in turn the taxpayers by not revealing the names.

The reader responded as to why and how could he ever invest in a bank. That is a very good point, investing in banks now is a much higher risk proposition because one does not know just how deep losses are in individual banks. Who does know?? Hank Paulson knows and he does not want to reveal those figures because they would further spook the markets.

“The Greatest Generation”…… (November 14, 2008)

The TARP bailout/rescue plan proposed to date has not inspired confidence nor generated any real impact for three reasons:

1. the banks have such sizable embedded losses that the funds already injected are being and will be used to recapitalize the balance sheets …

Economic/Market Highlights 11/17 (November 17, 2008)

Markets read this as a further indication that losses are so deeply embedded in the system that only time and “private money” can truly bring needed change. But how does “private money” receive incentive to enter the market?

Economic/Market Highlights 11/19…The Pain Increases!! (November 20, 2008)

Neither Paulson nor Congress nor anybody in Washington or Wall St. will tell you that the system has trillions in embedded losses but they do and our markets know it and are showing it by their prices.

“IT’S EASY TO FIND FAULT…especially if you’re clueless!! (December 11, 2008)

It keeps getting back, though, to the fact that the current situation as well as our future situation under any reasonable economic scenarios highlight the fact that the Wall St. banks are sitting on enormous embedded losses and expected future losses (continued increasing defaults on residential mortgages, credit cards, commercial loans, corporate loans). The money is not flowing through because:
banks need to replenish capital against these losses.

“Where’s The Money??….!!” (December 29, 2008)

In large measure, our mainstream media has done an exceedingly poor job as to highlighting the dynamics at work in the banking system. I will utilize a tape from a high profile financial show to reveal how the media is largely pandering to the public on this topic. Prior to doing that, though, let me get very detailed in answering the question as to “where’s the money?”

The business of banks is to lend money and in so doing they provide the liquidity to keep our economy moving. The banks lend money in a number of sectors but they can be summarized as follows: credit cards, residential mortgages, commercial mortgages, corporate loans. In addition to their lending role, most banks maintain a separate investment portfolio to further augment their revenue.

We have maintained that as a result of these investment activities, banks retained a wide array of what are now qualified as “toxic mortgage assets”. Globally, while banks and investment banks have taken $1 trillion in write-downs on these assets, by my estimation, confirmed by independent research and analytics, there are likely at least another $750 billion in write-downs yet to take on these assets.

Larry Doyle’s (LD’s) Dollars and Sense “Central Station” (January 10, 2009)

Comment by LD | 2009-01-10 10:45:43

Citi will inevitably sell other units at discounted prices.

In summary, it is not outside the realm of possibilities that this institution ends up being nationalized much like has occurred with some banks in the UK.

Against this backdrop, do not expect access to credit to improve anytime soon.

“Market Musings on a Monday . . . “ (January 12, 2009)

We have highlighted extensively why the embedded losses in the banking system would inhibit credit from flowing.

“Where’s The Money?” on December 29th specifically addressed the extent of losses and expected chargeoffs in our banking system. Why do the mainstream media and politicians continue to pander to the public on this topic?

“When Big Ben Speaks . . .” (January 14, 2009)

What does this mean? The banks need more money along with government guarantees against further losses from their deteriorating portfolios. To wit, Citigroup is selling divisions to raise capital. How will those government guarantees be structured? Potentially the nationalization of a banking institution, like Citi, or the splitting of Citi and perhaps other banks into “good banks” and “bad banks”. The “good banks” will house the day to day operations, while the “bad banks” will house the toxic and deteriorating assets and will be capitalized by, you guessed it, “Uncle Sam!”

Couple of observations. First, it doesn’t come off as Presidential as all. Finger pointing in such a hesitant manner looks weak. Second, you are dead wrong. The wheels came off when Democrats controlled the Congress and ignored repeated warnings from Bernake and Paulson about the impending crisis. Try to sell that.

Then there is the matter of the money you, Barack Obama, pocketed over the last four years. When Senators Dodd and Kerry, not exactly newbies on the Hill, are the only legislators who have taken more money than you from Fannie Mae, how do you maintain the lie that you had nothing to do with this? Fannie Mae just gave you money cuz you’re a nice guy?

What about the $600,000 plus from Goldman Sachs or the almost $400,000 from Citi Group? Dude, you’ve only been in the Senate for less than four years and you’ve pulled more money from financial lobbyist fat cats than any other Senator on a per annum basis. How long before the media catch on and ask you to explain?

Fox News has picked up the scent:

And now your buds at ACORN are trying to get their nose into the bailout trough to the tune of $140,000,000.00 Are you shitting me? One of the reasons we are in this mess is because your buds, Dodd and Frank, kept pushing to raise the amount of money that could be loaned to the low income housing efforts advocated by ACORN. I venture to say if ACORN had not been called out in the blogosphere for the corrupt thugs they are you might have pulled this off. But not now. The American people are awakening to the fraud perpetrated on them by the likes of ACORN and others. On this one we are saying no way, now how.

You can’t find a video of the head of Fannie Mae celebrating any Republicans. But Barack, the CEO is praising the Congressional Black Caucus while you are sitting there beaming. Not on your watch?

If you want to read more about ACORN’s complicity in this mess go here (hat tip Nancy).

January 1, 2007 The International Economy

Fannie and Freddie post-election: the significance of the Democratic victories.

BYLINE: Owen Ullman

A decade ago, Fannie Mae and Freddie Mac, the United States’ two mortgage financing behemoths, were flying high. They were among the most profitable companies in the world, had political connections to the White House and Congress, earned enormous bonuses for their corporate chieftains, and did not have to play by the same rules as other corporations. For all that, they could thank their congressional charters, which established them as Government Sponsored Enterprises (GSEs).

Those charters, which remain in place, grant them lines of credit from the Treasury, exempt them from local taxes, allow lower capital requirements than banks must meet, and spare them the mandatory disclosure requirements imposed on other public corporations. Most importantly, the implicit guarantee that Uncle Sam would bail them out in a crisis means a lower risk premium of roughly twenty-five basis pointswhen they borrow money. That quarter-point advantage is the basis oftheir lucrative business of buying and securitizing mortgages in thesecondary market.

As they grew larger and richer, critics warned that their lack of transparency and weak federal oversight would get them in deep trouble. Not a chance, they countered arrogantly. Well guess what? Like Icarus flying to close to the sun, the two companies have fallen far andfast onto their–dare we say–fannies.
It turns out the critics were right on the mark about the abuses that could result from lax accountability. Freddie paid a fine in 2003to settle charges that it misstated prior earnings by nearly $5 billion. Last December, Fannie reported that it overstated past profits by $6.3 billion. Meanwhile, federal regulators are trying to recover bonuses the top executives of each company received during the time earnings were misstated. In a suit filed against Fannie on December 18 to recover $115 million in compensation, the Office of Federal Housing Enterprise Oversight (OFHEO) said former Fannie Mae CEO Franklin D.Raines and other executives used numerous ruses to boost the company’s bottom line, and thus their bonuses.

Yet amid all the turmoil, lawsuits, and financial uncertainty befalling the companies, the current management teams at Fannie and Freddie have something to be thankful for in 2007: Democratic control of Congress.

The Democrats are less likely than Republicans to rein in the two companies’ financial practices. For the most part, Democrats like having leverage over the two GSEs so they can prod them to establish larger funds to make housing more affordable to low-income families. It is one of the top goals that the new House Financial Services Committee Chairman Barney Frank (D-MA) has promised to pursue.
Frank, who has one of the sharpest minds in Congress, also has predicted that Congress will pass a bill in 2007 to tighten regulation of Fannie Mae and Freddie Mac. That may be his intention, but the political reality is that the Democratic Party has many higher prioritiesto pursue after twelve years out of power. Frank’s counterpart in the Senate, Chris Dodd (D-CT) has not expressed any interest in going after the GSEs. So it is likely that any legislation will remain on the backburner.

18 August 2007 The Washington Post

Higher Caps Urged For Fannie, Freddie; Democrats Seek Bigger Role for Firms

BYLINE: David S. Hilzenrath; Washington Post Staff Writer

Leading Democrats pressed their case yesterday to give Fannie Mae and Freddie Mac a larger role in the troubled mortgage markets, arguing that the two companies should be allowed to buy bigger mortgages and more of them.

The market upheaval has shifted a long-running discussion of the government-sponsored finance companies from the esoteric edges of inside-the-Beltway policy arguments to the forefront of the debate over how Washington should respond to a credit crunch. It has given supporters of Fannie Mae and Freddie Mac fresh ammunition to challenge those who think the companies should be kept on a tighter leash.

Christopher J. Dodd (D-Conn.), chairman of the Senate Banking Committee and a candidate for president, told reporters that regulators should raise limits on the companies’ mortgage investments by 5 percent so they can pump more money into the housing finance system. Together, Fannie Mae and Freddie Mac hold about $1.4 trillion of mortgages and securities backed by mortgages.

Dodd was elaborating on a position he staked out days earlier and was firing back at President Bush, who last week said Fannie Mae and Freddie Mac should be reformed before the government considers loosening their restraints.

Dodd said Congress can’t pass a reform bill fast enough to deal with the crisis at hand.

20 September 2007 The New York Times

Fannie Mae to Be Allowed to Expand Its Portfolio

BYLINE: By ERIC DASH

A government regulator gave Fannie Mae permission yesterday to slightly increase the amount of mortgages it can buy for its investment portfolio, a move that analysts say will do little to ease the strain on the housing market.

The moves, along with similar ones for Freddie Mac, should give the nation’s two biggest mortgage buyers a bit more flexibility in managing their portfolios. The changes are also intended to encourage the companies to purchase as much as $20 billion each in subprime loans.

But just two days ago, Ben S. Bernanke, the Federal Reserve chairman, in a letter to Representative Barney Frank of Massachusetts said relaxing the portfolio restrictions on Fannie Mae and Freddie Mac could prove ”ill advised.”

Wall Street analysts said that Ofheo’s changes would do little to ease the pressures on the housing market. And Fannie Mae, which has lobbied to raise the portfolio limit by 10 percent, and several Democratic lawmakers said yesterday that the moves did not go far enough.

In a statement, Senator Christopher J. Dodd of Connecticut, the chairman of the Banking Committee and a Democratic candidate for president, called Ofheo’s decision ”timid and inadequate.” He said the administration was ignoring the severity of the subprime mortgage crisis.

Others, however, suggested it could be a way for Fannie Mae and Freddie Mac to start regaining Ofheo’s trust.

”I actually think this was a smart way of giving the enterprises an opportunity to prove themselves,” said Josh Rosner, a managing director at Graham Fisher & Company who has been critical of Fannie Mae. Under the requirements, Fannie Mae and Freddie Mac must provide more frequent and detailed financial disclosures, including a monthly report that should more clearly parse out their purchases of subprime loans. . . .

It also came just two days after Mr. Bernanke sent a letter to Mr. Frank, the chairman of the House Financial Services Committee, that defended the current portfolio limits and urged Congress to move cautiously if it considers letting Fannie Mae and Freddie Mac buy mortgages over the current $417,000 limit.

16 November 2007 The Investor’s Business Daily

Freddie Mac’s Woes Come As Dems Try To Expand Lender; Sen. Schumer Not Giving Up; $2 bil loss, weak capital makes it harder to argue for larger Freddie, Fannie

BYLINE: SEAN HIGGINS

SECTION: FRONT PAGE NEWS; Pg. A01

LENGTH: 652 words

Freddie Mac on Tuesday declared a $2 billion third-quarter loss and warned it may have to slash its dividend and curb its mortgage buying to meet capital requirements.

A top Senate Democrat stuck to his solution: Let Freddie and Fannie get bigger. But it may be a harder case to make now. . . .

Big Problem, Bigger Solution?

Sen. Chuck Schumer, D-N.Y., said in a statement Tuesday that it should surprise no one that the government-sponsored enterprises have been “negatively impacted” by the credit crunch.

“Today’s news does nothing to lessen the critical role that the GSEs must play in providing much-needed liquidity to a struggling market,” Schumer said.

A spokesman for Schumer confirmed he was referring to his own plan to lift the GSEs’ portfolio caps by 10%, at least temporarily.

Leading Democrats had proposed lifting the GSE caps to alleviate the broader housing crunch.

But that was before GSEs looked like part of the problem, reporting huge third-quarter losses.

To reach its mandated level of capital, Freddie Mac has signaled it may voluntarily limit its growth.

That comes as Democrats were gearing up to push the opposite direction. Schumer, and Rep. Barney Frank, D-Mass., have both introduced bills that would lift the caps by 10%.

Their legislation would take 85% of that increase and use it to help refinance subprime mortgages at risk of foreclosure.

Frank is chairman of the House Financial Services Committee, which has authority over GSEs. Schumer is on the Senate Banking Committee. . . .

Republicans Favor Tight Curbs

Privately, a Senate Democratic aide conceded that enlarging GSEs now will be a “tough row to hoe.”
Senate Banking Chairman Christopher Dodd, D-Conn., didn’t mention expanding GSEs in a statement on Freddie’s losses.

Republicans have long opposed expanding the GSEs, arguing the risk of a financial crisis is too high.
“Because the GSEs are already large enough to pose a risk to the entire housing finance system, we must focus our efforts on making sure they are well-capitalized and well-regulated, rather than discussing ways to expand them,” Sen. Richard Shelby, R-Ala., the ranking Republican on the Senate banking panel, said in a release.

Freddie and Fannie can borrow at lower rates because Wall Street assumes the federal government would bail out them out in a crisis.

Robert Steel, a top adviser to Treasury Secretary Henry Paulson, told the Hill newspaper that Congress should focus on comprehensive GSE reform rather than raising the portfolio caps.

Those fears gained greater currency in 2004 when the GSEs were forced to restate past earnings lower. The scandal resulted in the forced departure of then-Fannie Mae Chairman Franklin Raines.
Congress later passed legislation giving the Office of Federal Housing Enterprise Oversight more authority over the GSEs.

Bottomline–Frank, Schummer, and Dodd, apart from being some of the top recipients of Fannie Mae and Freddie Mac largesse, did little to avert this crisis and in fact appear to have exacerbated it. So count me a sceptic when it comes to trusting these clowns to put together a bailout program. They ignored clear warnings. It is not a matter of opinion, it is a fact of history.

The Paulson Plan is not well understood. It is not a bail-out of failing Wall Street companies. Those companies are being destroyed as we speak. Lehman, Bear Stearns, Merrill Lynch – all are gone now. The problem is that the housing debt they created lives on after them and hangs over the heads of ordinary Americans.

Without establishing a new market for those loans growing default rates could threaten, in fact have already threatened, the real economy. The Paulson Plan enables the federal government to step in and “make a market” for real estate where the broken private sector will not dare tread.

Very few Americans seem to understand what is at stake. If the market for mortgage and other asset backed securities is not stabilized by a very large financially sound player, the risk is that it will cause financial markets that ordinarily are very safe to totter. For example, a key market is the commercial paper market. This is a market for short term loans to very sound large businesses like GE, IBM and GM. They borrow billions through their finance arms to fund their working capital. They sell commercial paper to money market funds.

If those funds sell off their CP or refuse to buy newly issued CP then those large industrial companies lose their working capital. Last week, this was happening to a small group of money market funds. As a result, in one example, IBM’s cost of borrowing tripled in a matter of days. To make this even more clear, one of the large players in commercial paper markets are power plants that use CP to finance their purchases of fuel for power plants.

It is conceivable if the CP market fails that power plants could run out of fuel and the lights would start going out.

Fortunately, we have solved this kind of problem before – in the New Deal that rescued the country from the Great Depression. A key institution was the Reconstruction Finance Corporation that pumped money into a moribund mortgage market to lead the way for private capital, in pension funds and elsewhere, to step back in. By renegotiating mortgage payments, by being willing to stand behind the ability of ordinary Americans to pay their mortgages countless homes and businesses were saved by public intervention where the free market had failed the country.

What Paulson and Bernanke propose is very similar to the efforts of the New Dealers.

Here is a description of how that effort worked from someone who was there, Jesse H. Jones:

Lessons from the New Deal

Reviving the Real Estate Mortgage Market

From Fifty Billion Dollars – My Thirteen Years with the RFC by Jesse H. Jones

What is the largest single type of investment in which the American people put their money? It isn’t the railroads or highways or insurance policies or savings accounts or corporate stocks and bonds. It is the mortgage on real estate. From the ten-acre farm to the tallest skyscraper, almost every piece of property in the country has carried a mortgage at one time or another. Mortgages have financed the construction of nearly every home, factory, store, or office building in this country

During the depression the almost measureless market for mortgages went into total eclipse. The RFC [Reconstruction Finance Corporation] helped to bring it back into the light of day – and also into the light of reason.

That accomplishment required a good many years of hard work. Even after the banking structure had been made sound and agriculture was again moderately prospering, and most of the water had been wrung out of railroad finances, the real estate mortgage market remained immobile, congealed with fear. The part taken by the RFC in its recuperation was accomplished without cost to the taxpayer, although we used millions to put life into it. We got the money back and made a small profit for the government. Better still, we helped restore faith and confidence in the orderly financing of real estate.

When the RFC went directly into the mortgage business in 1934 countless mortgage loans were in default throughout the country. Thousands of costly, useful buildings, such as apartment houses, hotels, offices, stores, warehouses, and factories put up by corporations and covered by mortgage bonds, had gone into receivership. At that time real estate mortgages on urban loans alone – all farm and rural properties being out of consideration – aggregated more than thirty five billion dollars.

Of that sum about nine billion dollars in mortgages was held by commercial banks and trust companies and mutual savings banks, seven billions by building and loan associations, and six billions by life insurance companies. Five more billion dollars was in real estate mortgage bonds held by the public. The remainder was held by trustees, educational and charitable institutions, fire and casualty companies, and individuals.

Many of the properties then in default could have been safely reorganized both in the interest of the bondholders and equity owners and without loss to the new money. But there was no new money available in the real estate field – none for retirement of maturing mortgages, none for new construction except, in spots, from one of the more prosperous life insurance companies….

In the booming 1920’s many of our larger cities had been overbuilt or at least expanded in advance of requirements by optimistic promoters.

The mortgage bond houses which financed these promotions not only charged excessive interest rates but, to make matters worse, required amortization payments much beyond the earning power of the properties even in prosperous times.

But this was not a valid reason for forever condemning real estate or real estate securities….the whole real estate market couldn’t remain in collapse….Having convinced ourselves that there was no mortgage money available to save the situation, we asked Congress in 1934 for authority to buy preferred stocks in mortgage companies, much as we had been doing in banks…But we were never able to get anyone to start a mortgage company. Times were so pessimistic that no one would put up money for common stock in such an enterprise….

So, in the spring of 1935, we started the RFC Mortgage Company with a capital of $10,000,000 which later was raised to $25,000,000. The company did a lot of good, and it made some money for the government.

We bought and sold…mortgages to make a market and encourage financial institutions to buy them. We wanted to prove that the mortgages were good and then withdraw from the field….

We immediately offered to buy…mortgage[s]…at 99 per cent of the face value of the mortgage and to sell it at par. We soon had insurance companies and other big investors interested. Then we raised our price, paying par for the mortgages and selling them at a slight premium. They finally became a popular investment with fiduciaries and trust companies.

[Over time this effort resulted in] profitable enterprises for the government as well as a great help to the public….