Deleveraging Denial

Another day, another bailout, another $800 billion and in the end I’m left scratching my head asking why?, what is the grand plan here?, is there a plan at all?  The full press release from the Fed can be seen below. Let’s take it apart a bit.

The Fed is going to lend up to $200 billion to holders of recently issued asset-backed securities collateralized by student loans, auto loans, credit card loans and SBA guaranteed loans. This new facility is to be known as TALF. The rationale for the program as enunciated by the Fed goes like this:

 New issuance of ABS declined precipitously in September and came to a halt in October. At the same time, interest rate spreads on AAA-rated tranches of ABS soared to levels well outside the range of historical experience, reflecting unusually high risk premiums. The ABS markets historically have funded a substantial share of consumer credit and SBA-guaranteed small business loans. Continued disruption of these markets could significantly limit the availability of credit to households and small businesses and thereby contribute to further weakening of U.S. economic activity. The TALF is designed to increase credit availability and support economic activity by facilitating renewed issuance of consumer and small business ABS at more normal interest rate spreads.

There are a couple of things in the statement that really sort of grind on me.

First, it states that interest rate spreads have risen to ranges outside the norm of historical experience due to disruptions in the ABS market. Note that they neglect to go into any detail as to what period was used to establish the “normal risk premium”. Is it a range that was calculated over a 10, 20 or 30 year period or is it one that was derived over the past five or six years of unusually low interest rates? Could it be that current interest rate spreads just reflect a new view of appropriate risk pricing on the part of buyers of asset-backed securities? Or is the Fed arbitrarily determining what the cost of a particular type of credit should be?

Second, the statement clearly expresses dissatisfaction with the current amount of credit being delivered by the market to these sectors. It seeks to blame the perceived shortfall as resulting from a dysfunctional market. Maybe, but I thought that there was general agreement that the nation as a whole was over leveraged. The statement gives the impression that the government wants to roll back the clock. If the economy is being starved due to an absence of credit then fine, something probably needs to be done. If, on the other hand, we are seeing a restriction of available credit due to tighter, saner underwriting then I fail to see the point.  

Moving on, the second part of the press release says that the Fed will buy $100 billion of direct obligations of Fannie, Freddie and Ginnie Mae and launch a program to purchase up to $500 billion of their mortgage backed securities. Once again old Mr. Market is being blamed for not working right and the goal is to reduce the cost of credit and increase the availability.

I don’t want to beat a dead horse here, but underwriting standards are mostly to blame for fewer home loans. Yeah, the spreads are historically higher, but if I were an investor in mortgage backed securities listening to Barney Frank and Chuck Schumer promising to let the bankruptcy courts cram down my debt, I’d be demanding a higher interest rate too.

Let’s cut to the chase here. The latest move to shore up the mortgage market is just a circular way of providing direct federal government financing of mortgages. The artifice is that Fannie, Freddie and FHA are making the loans, while in fact they are simply conduits to the Treasury. The complete nationalization of the mortgage business in America is complete.

Deleveraging is going to happen whether the government likes it or not. The recent moves are simply the machinations of tired men who are starting to run out of options. I’ve said that before and each one of these new programs just reinforces the concept. Let’s hope a new administration recognizes the pain that the country has to endure. Let’s also hope that they respect the market a bit more and recognize that sometimes the signals it sends may represent a new paradigm not a malfunctioning market.

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