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Posts Tagged ‘Freddie Mac’

In my testimony to the Senate Budget Committee the other day, I recommended that Congress set specific fiscal targets for bringing our out-of-control deficits and debt under control. My particular suggestion? Get the publicly-held debt down to 60% of GDP in 2020.

By budgeting  standards, that makes for a great bumper sticker: “60 in 20“.

But as the New York Times points out in two articles today, a measurable target isn’t enough. You also need to make sure that the government doesn’t game the accounting to hide its liabilities.

Exhibit A is Greece. The story was originally broken by Der Spiegel earlier in the week, and is described in the NYT by Louise Story, Landon Thomas Jr., and Nelson D. Schwartz in “Wall St. Helped Greece to Mask Debt Fueling Europe’s Crisis“:

As worries over Greece rattle world markets, records and interviews show that with Wall Street’s help, the nation engaged in a decade-long effort to skirt European debt limits. One deal created by Goldman Sachs helped obscure billions in debt from the budget overseers in Brussels. …

Instruments developed by Goldman Sachs, JPMorgan Chase and a wide range of other banks enabled politicians to mask additional borrowing in Greece, Italy and possibly elsewhere.

In dozens of deals across the Continent, banks provided cash upfront in return for government payments in the future, with those liabilities then left off the books. Greece, for example, traded away the rights to airport fees and lottery proceeds in years to come.

Critics say that such deals, because they are not recorded as loans, mislead investors and regulators about the depth of a country’s liabilities.

The winning quote:

“Politicians want to pass the ball forward, and if a banker can show them a way to pass a problem to the future, they will fall for it,” said Gikas A. Hardouvelis, an economist and former government official who helped write a recent report on Greece’s accounting policies.

Exhibit B are all the contingent liabilities of the United States government, of which Fannie Mae and Freddie Mac have been the most prominent (and expensive). In “Future Bailouts of America,” Gretchen Morgenson interviews budget expert Marvin Phaup (now at George Washington University and previously a colleague of mine at the Congressional Budget Office). She writes:

“If we are extending the safety net, extending the implied guarantee to the debts of a lot of other financial institutions, and we know those guarantees are valuable and costly, then we ought to start budgeting for it,” Mr. Phaup sad in an interview. “We can’t reduce the costs of these subsidies if we can’t recognize them.” …

As the number of firms with implicit government backing has risen because of the crisis, so too have the expected costs of those commitments, Mr. Phaup said. And yet, under current budget policy, those costs will be ignored until the recipient of the guarantee collapses — the precise moment when the guarantee is likely to cost taxpayers the most.

If we are going to set an explicit target for the publicly-held debt–60 in 20!–, we need to think carefully about what politicians may strategically omit from the calculation of the 60.


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Looking Back at Fiscal 2009

A few days ago, CBO released its latest snapshot on the federal budget, documenting the remarkable challenges of fiscal 2009, which ended on September 30. The key phrase in the report is “in over 50 years” as in:

  • At $1.4 trillion, the budget deficit was 9.9% of gross domestic product, the largest, relative to the economy, in over 50 years.
  • At $3.5 trillion, spending was almost 25% of GDP, the largest, relative to the economy, in over 50 years.
  • At $2.1 trillion, tax revenues were about 15% of GDP,  the lowest, relative to the economy, in over 50 years. (I get the sense that this point is less well-known than the other two.)

Other highlights from the report:

  • As expected, CBO estimates that the 2009 deficit was about $1.4 trillion, below the $1.58 trillion estimate in the Administration’s August budget forecasts. Assuming CBO is right, that means that next week, when the official Treasury figures are released, the Administration will be able to put a good news spin on the results, saying the deficit was less than it anticipated.  (As noted in an earlier post, CBO’s summer update, released on the same day as the Administration’s, predicted a $1.4 trillion full-year deficit, when calculated on an apples-to-apples basis. The report was a bit complicated to interpret, however, because its headline deficit estimate used different accounting for Fannie Mae and Freddie Mac, which resulted in a higher figure of about $1.6 trillion.)
  • As shown in the following chart, the deficit exploded in 2009 for three main reasons:

Budget Deficit Fiscal 2009

  • Tax revenues fell off a cliff (down 17% or $419 billion relative to fiscal 2008). The sharpest declines were in corporate income taxes (down 54%) and individual income taxes (down 20%). The declines reflect both the weak economy and, to a lesser extent, efforts to provide stimulus.
  • The financial rescue required $245 billion in new spending. TARP accounted for $154 billion, while cash injections into Fannie Mae and Freddie Mac accounted for $91 billion.
  • Other spending increased (up 13% or $347 billion relative to last year). These increases were spread across many spending programs, but were most pronounced for unemployment insurance (up 156%) and Medicaid (up 25%).

In addition:

  • Interest payments provided a sliver of good news. Interest payments fell by 23% (or $61 billion) thanks to low interest rates and small inflation adjustments on indexed bonds.
  • CBO estimates that the budget impact of the stimulus totaled about $200 billion by the end of September.

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As you have undoubtedly noticed, this week marks the one-year anniversary of the fall of Lehman Brothers–the moment at which the financial crisis became a severe economic crisis.

I did an interview on Fox Business on Tuesday to discuss some of the lessons learned. (My wife’s comment  on the interview: “You need to straighten your collar next time.”)

Going in, I had two basic points I wanted to make:

  • First, the fall of Lehman Brothers was the moment that the abstract threat of “systemic risk” became tangible to many policy makers and the public. As we progressed from propping up Bear Stearns to taking over Fannie Mae and Freddie Mac, many observers began to suffer from policy fatigue, and, in some circles, there was concern that the scale of the government actions might be disproportionate to the alleged, but little-seen, risk of a systemic crisis. That changed when Lehman fell, and the dominoes started toppling.
  • Second, we still have our work cut out for us. The major items on our to do list include:

(1) Taking steps to avoid such enormous shocks in the future (e.g., by increasing capital requirements and reducing allowed leverage for financial firms).

(2) Fixing the problem of too-big-to-fail (or, if you prefer, too-interconnected-to-fail). Unfortunately, this problem has worsened, in many ways, since the crisis began. Some gigantic firms have grown even larger. And the necessary interventions to prop up the financial sector have reinforced the idea that the government will prevent these firms from failing in the future.

(3) Disentangling the government from private firms, so that it can again act as a referee, not as a player. That will take time given the enormous investment portfolio that the government has amassed in financial firms and the auto companies. It is heartening, however, that even Citigroup is beginning to ponder how to raise outside capital and reduce the government stake.

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A front page story in today’s Washington Post (“In Shift, Wall Street Goes to Washington“) documents the Capital’s rising importance in the financial world:

J.P. Morgan Chase for the first time convened its board in Washington this summer, calling the directors to a meeting at the downtown Hay-Adams hotel, then dispatching them to Capitol Hill for meet-and-greets.

Last month, a firm run by the billionaire investor Wilbur Ross hired the head of Washington’s top mortgage regulator to pick through the wreckage of the housing bust looking for bargains.

And the world’s largest bond fund, Pimco, which has traditionally assessed the risk of any new investment according to five financial criteria, recently added one more: the impact of any change in federal policy.

“In the old days, Washington was refereeing from the sideline,” said Mohamed A. el-Erian, chief executive officer of Pimco. “In the new world we’re going toward, not only is Washington refereeing from the field, but it is also in some respects a player as well. . . . And that changes the dynamics significantly.”

The Ross example doesn’t tell us much — the financial world has always recruited government officials. The J.P. Morgan and Pimco examples, however, highlight how much the playing field has changed over the past two years. Washington is not just a more aggressive regulator. Given the stresses on the system, it has become a serial intervener — stepping in to prop up specific firms or credit channels that appear too important to fail. And it is now a major investor, with a burgeoning portfolio of investments in financial firms, auto companies, and mortgage backed securities.

As we commemorate the first anniversary of the fall of Lehman, it appears that the worst of the financial and economic crisis is behind us. And the policy conversation should increasingly focus on exit strategies. Not just the narrow question of how the Federal Reserve eventually unwinds the extraordinary expansion of its programs. But also how the Treasury eventually unwinds it TARP investments. How the FDIC walks back from offering guarantees on bank debt. How the government restructures Fannie Mae and Freddie Mac.

And, perhaps most importantly, how policymakers recalibrate their relationship with financial markets. To paraphrase Mohamed A. el-Arian: can Washington return to being a referee on the sidelines or will it continue to be a player?

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Earlier today, CBO released its latest monthly snapshot on the federal budget. The key things you should know are:

  • CBO estimates that the government ran a deficit of almost $1.4 trillion during the first eleven months of the fiscal year (up from $501 billion at this point last year).
  • CBO reiterated its forecast that the full year’s deficit will also come in around $1.4 trillion (September is usually a month of surplus because of strong tax receipts, but CBO apparently thinks this September will be close to break-even.)
  • CBO’s estimate is noticeably lower than the administration’s most recent deficit forecast of $1.58 trillion. If the final numbers next month are in line with CBO’s projections, some commentators will thus spin the full year deficit as good news (“the deficit came in lower than the administration expected”), while others will spin it as bad news (“yikes, the deficit was $1.4 trillion”). (As noted in an earlier post, CBO’s summer update was a bit complicated to interpret because its headline deficit estimate used different accounting for Fannie Mae and Freddie Mac than the administration used; on an apples-to-apples basis, however, CBO then forecast a deficit of $1.41 trillion.)
  • As shown in the following chart, the deficit has exploded for three main reasons:

Budget Deficit August

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Can anyone explain the stock prices of Fannie Mae and Freddie Mac, the two government-sponsored enterprises that are supporting our mortgage market?

On Friday, Fannie’s common stock closed at $2.04 per share, up 250% since the start of August. That values the company–to be precise, the privately-owned common shares in the company–at more than $2 billion.

Freddie Mac’s common shares closed at $2.40 per share, up almost 300% since the start of August. That values Freddie’s privately-owned common shares at more than $1.5 billion.

Collectively, then, the common stock of these two wards of the state totals almost $4 billion.

This seems a trifle high, however, since most observers think their common stock is worthless (see, for example, this AP story).

I think those observers are right.

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As expected, the new budget projections from the Office of Management and Budget show an estimated deficit of $1.58 trillion in the current year (which ends on September 30).

In their coverage of the dueling budget releases, many members of the media are noting that this estimate is almost identical to the $1.59 trillion estimate released by the Congressional Budget Office. Thus, it may appear that OMB and CBO reached similar conclusions about this year’s deficit.

That is not correct.

OMB and CBO use different accounting for a growing part of the budget — the federal take-over of Fannie Mae and Freddie Mac.  If you adjust for those accounting differences, an apples-to-apples comparison shows that OMB’s projection of a $1.58 trillion deficit should be compared to a CBO estimate of $1.41 trillion. (For details, see the table on p. 2 and the box on pp. 8-9 of CBO’s report.)

In other words, using identical accounting, CBO is projecting a deficit that is almost $200 billion less than projected by OMB.

Here’s how it works:

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