Wall Street Goes to Washington

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?

The Exploding Deficit Reaches $1.4 Trillion

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

Continue reading “The Exploding Deficit Reaches $1.4 Trillion”

The Fannie and Freddie Anomaly

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.

Continue reading “The Fannie and Freddie Anomaly”

OMB’s 2009 Deficit Estimate Is Likely Too High

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:

Continue reading “OMB’s 2009 Deficit Estimate Is Likely Too High”