Fed bond-buying decision keeps mortgage rates at record lows

-Housingwire

The Federal Reserve's plan to reinvest principal payments on some bonds into mortgage-backed securities is already contributing to the nation's record low mortgage interest rates, Bankrate said Thursday.

Bankrate said the Federal Open Market Committee seems to be taking direct aim at mortgage rates by shifting $400 billion from short-term holdings into long-term government bonds. The program, which begins Oct. 3 and runs through June, will involve longer-term Treasury securities with remaining maturities of six years to 30 years, and will be financed through the sale of shorter-term Treasurys with maturities of three years or less.

"This program should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative," the FOMC said in a statement following its two-day meeting.

Analysts also said anemic economic growth and European debt fears are keeping investors on the sidelines.

Rates are unlikely to increase until mortgage refinancing and purchasing activity picks up, Bankrate said.

"In order to get the most economic impact out of low mortgage rates, the pool of prospective refinancers needs to be expanded. Deeply upside-down homeowners, those with second liens or mortgage insurance, and lender concerns about buyback liability are all formidable impediments to refinancing," according to the firm, which aggregates rate data from across the country.

The Freddie Mac primary mortgage market survey showed the average rate for a 30-year, fixed-rate mortgage remained unchanged this week at 4.09%, while the 15-year, fixed rate dropped one basis point to a new record low of 3.29%.

Meanwhile, the five-year, Treasury-indexed hybrid adjustable-rate mortgage averaged 3.02%, up from 2.99% last week and down from 3.54% a year ago.

The one-year, Treasury-indexed ARM averaged 2.82% this week, up from 2.81% a week earlier and down from 3.46% last year.

"A sluggish economy and investor concerns over the European debt markets left mortgage rates largely unchanged this week," said Frank Nothaft, vice president and chief economist for Freddie Mac.

"Manufacturing activity in both the New York and Philadelphia regions contracted in September," he said. "Moreover, the Federal Reserve board reported that households lost nearly $150 billion in net worth in the second quarter, representing the first quarterly decline in a year."

Bankrate data show the 30-year FRM at record lows for the fifth consecutive week. The average rate for a traditional mortgage fell to 4.29%, from 4.32% last week, while the 15-year FRM declined to 3.42% from 3.44%.

In addition, the 5/1 ARM decreased to 3.05% from 3.07% last week.

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G.O.P. Urges No Further Fed Stimulus

-The New York Times

Even though the financial markets have been counting on the Federal Reserve to take action, Republican Congressional leadership sent a letter to the Federal Reserve chairman on Tuesday evening urging it not to engage in further stimulus.

The letter was sent in the midst of a two-day meeting in which Fed officials are widely expected to undertake policies to lower long-term interest rates. That move would be intended to loosen up credit in hopes of promoting growth. The meeting ends Wednesday, and the Fed is expected to release a statement Wednesday at 2:15 p.m.

“We have serious concerns that further intervention by the Federal Reserve could exacerbate current problems or further harm the U.S. economy,” said the letter, signed by four of the top Republicans in Congress: Mitch McConnell of Kentucky, the Senate Republican leader; Jon Kyl of Arizona, the Senate Republican whip; House Speaker John Boehner of Ohio and House Majority Leader Eric Cantor of Virginia.

The Fed’s chairman, Ben S. Bernanke, has not said further stimulus was in the works, but economists and analysts have repeatedly asserted that they believe the central bank will announce more easing.

“I just don’t think the Fed will sit idly as momentum fizzles in this recovery,” said Dana Saporta, a United States economist at Credit Suisse.

Minutes from the Fed’s latest meeting revealed sharp dissent within the group of policy makers, so further stimulus is not necessarily a sure bet.

As the Republican letter notes, economists are divided on how much the move would help the stalled recovery. The Fed, after all, has tried several rounds of monetary stimulus in the last four years.

Republican Congressional leaders expressed not only skepticism that further easing would improve the recovery, but also concerns that such actions might be damaging.

“Such steps may erode the already weakened U.S. dollar or promote more borrowing by overleveraged consumers,” the letter from Republicans said.

Many economists, however, are unconvinced by these risks and argue that a weakened dollar would be good for the country because it would make American exports more attractive.

With unemployment at 9.1 percent and Congress unable to agree on fiscal policies that might encourage job creation, many advisers have been calling on the Fed to continue using whatever ammunition it has left.

The Federal Reserve is an independent body whose decisions do not have to be ratified by the president or Congress, and efforts to influence monetary policy are discouraged to maintain its credibility.

“Even if I agreed” with the Republican letter, Tony Fratto, a former adviser to President George W. Bush, wrote in a Twitter post, “I’d still disagree with the effort to put public political pressure on Bernanke.”

Over the years, there have been many efforts by members of both parties, from both the White House and Congress, to influence Fed policies, according to Allan H. Meltzer, a political economy historian at Carnegie Mellon.

Less than a year ago Michele Bachmann, a Minnesota congresswoman who is running as a Republican presidential candidate, sent a letter to Mr. Bernanke urging him to refrain from the last round of stimulus, which the Fed ultimately decided to do.

In recent months other Republican presidential candidates have stepped up their attacks on Fed policy, with Rick Perry, the governor of Texas, calling further easing “treasonous.”

Fed critics have said they are merely trying to counter pressure from Democrats for the Fed to do more.

“This is the most politicized Fed we’ve ever had,” Mr. Meltzer said. “They’ve been doing the Treasury’s work for quite some time, buying things like Treasuries and bonds. It’s no surprise that there’s political pressure coming from the other direction.”

The Federal Reserve was meant to be independent so that it would be shielded from short-term political interests, and Fed officials have repeatedly said they are unmoved by external political pressures. A Fed spokeswoman acknowledged receiving the letter on Tuesday evening but she declined to comment further.

Appearing to cave to political interests — on the left or the right — could compromise the Fed’s authority and jolt markets even more than a popular or unpopular policy decision.

If anything, Federal Reserve members seem to be trying show their ability to exert their own influence. Traditionally, Fed officials have refrained from commenting on fiscal policy except in the vaguest of terms, but in an August speech Mr. Bernanke called on Congress to avoid steep spending cuts in the near future. He also gave specific recommendations for fiscal measures to promote long-term growth.

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Fed Runs Risk of Doing Less Than Investors Expect

-The New York Times

Investors have concluded that the Federal Reserve will announce new measures to promote economic growth after a meeting of its policy-making committee ends Wednesday. Long-term interest rates have moved as if the Fed had already spoken.

The central bank is often described as facing the choice of whether to do more to improve the economy. But the anticipatory behavior of investors means the Fed really faces a slightly different choice, one it has confronted often in recent years: whether to risk doing less than expected.

The overriding argument for action is the persistent weakness of the American economy, which has left more than 25 million Americans unable to find full-time work.

The Federal Reserve chairman, Ben S. Bernanke, who has made a series of unusual efforts to revive growth, has not discouraged speculation that he is ready to try again.

“I think the Fed has no choice but to act,” said Krishna Memani, director of fixed income at Oppenheimer Funds. “If the Fed were not to do anything having built market expectations to a pretty decent level, I think the markets would react quite negatively to that.”

But the Fed also faces mounting pressure against additional action, including strident criticism from Republican presidential candidates and divisions in the policy-making committee. Moreover, the options available to the central bank have less power to generate growth, a greater chance of negative consequences, or both, than those it has already tried.

Some close watchers of the central bank say investors’ behavior could let the Fed offer a token gesture now, postponing any larger move at least until its next meeting in November. After all, the Fed is reaping the benefits of action without the costs.

“There is no reason for the Fed to rush,” Lou Crandall, chief economist at Wrightson/ICAP, wrote in a recent note to clients predicting such an outcome. “It is in the Fed’s interest to milk the anticipation effect as long as possible.”

The move markets are anticipating is a new effort to reduce long-term interest rates, which would allow businesses and consumers to borrow more cheaply. Yields on the benchmark 10-year Treasury note fell to a record low of 1.88 percent at the start of last week, reflecting the Fed’s earlier efforts to lower rates and investors’ pessimism about the economy.

The hope is that an additional reduction in rates will provide a little more encouragement for companies to build factories and hire workers and for consumers to buy cars and dishwashers.

The Fed has held short-term rates near zero since December 2008, by increasing the supply of money.

To further reduce long-term rates, the Fed bought more than $2 trillion in government debt and mortgage-backed securities, reducing the supply available to investors and thereby forcing them to pay higher prices — that is, to accept lower interest rates.

The Fed could seek to amplify that effect by adjusting the composition of its portfolio, selling short-term securities and using the proceeds to buy long-term securities, which it predicts would further reduce rates.

An analysis by the forecasting firm Macroeconomic Advisers estimated that such an effort by the Fed could raise gross domestic product by 0.4 of a percentage point over the next two years, and create about 350,000 jobs. That is comparable to estimates of the impact of the central bank’s most recent aid campaign, the QE2, or quantitative easing, purchases of $600 billion in Treasury securities, which concluded in June.

Mr. Bernanke announced in August that the Federal Open Market Committee, the policy-making board, would meet for two days, extending its scheduled one-day meeting this week to include both Tuesday and Wednesday, to consider that and other options.

The Fed could take smaller steps, like promising to maintain current efforts longer. It may also consider options that could deliver a more powerful jolt to the economy, like increasing the size of its investment portfolio again. But more aggressive measures have little internal support.

The Fed, Mr. Bernanke said, is “prepared to employ these tools as appropriate to promote a stronger economic recovery in a context of price stability.”

He still commands a solid majority of his 10-member board despite the emergence of the largest bloc of internal dissent in two decades. Three members voted against the decision last month to declare an intention to hold short-term interest rates near zero for at least two more years, replacing a stated intention to maintain the policy for an “extended period.”

The central bank has also become a target of conservative politicians, with several Republican presidential candidates denouncing its efforts to increase growth. But even Mr. Bernanke’s internal critics dismiss these attacks.

“I don’t spend a lot of time worrying about what any one candidate says about us,” Richard W. Fisher, president of the Federal Reserve Bank of Dallas, told Fox Business Network in a recent interview. “The issue is to get it right.”

Of greater concern is the possibility that the Fed is nearing the limits of its powers. Interest rates are already depressed and, like a board mounted on a spring, pushing down gets harder as the floor gets closer.

Studies also have found the Fed’s success in reducing rates has not yielded the full measure of predicted benefits. Mortgages and small business loans may be cheap, but because lenders remain cautious, they are not easy to get.

The research firm Capital Economics said recently any renewed effort by the central bank would be unlikely to overcome those obstacles.

“We don’t expect it to have any dramatic impact on the wider economy because many households will still not qualify for loans at those lower rates,” it said.

The Fed also would face an increased risk of losing money on its investments.

And only so many Treasuries are available for sale. If the Fed sold all of its securities maturing in the next four years and bought only securities maturing in more than 17 years, maximizing its impact, it would end up with 70 percent of the available long-term inventory. That could interfere with the normal operations of insurance companies and other traditional buyers.

Laurence H. Meyer, a former Federal Reserve governor who now leads Macroeconomic Advisers, said he expected the Fed to conclude that the potential benefits outweighed these issues, but that it needed more time to hammer out details.

“We expect them to come out of the committee meeting feeling that they’ve decided and have a consensus to move in November,” he said.

Mr. Meyer suggested that the Fed could mollify the markets by announcing what amounts to a preview, by investing the proceeds of maturing securities — about $20 billion each month — in longer-term debt.

Such a move might not do much to move the economic needle, because the amounts involved would be minute by the standards of monetary policy, but it could be enough to preserve the valuable conviction that the Fed will do more soon.

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Bank regulators to unveil "living will" plan

-Reuters

U.S. regulators are set to vote next week on a final rule governing the plans large banks must draft on how they can be liquidated if they are heading toward failure.

The 2010 Dodd-Frank financial oversight law requires these "living wills," which are part of the government's new power to seize and break up large, failing firms.

The Federal Deposit Insurance Corp announced plans on Thursday for its board to vote on the final rule on Tuesday. It is drafting the rule with the Federal Reserve.

Regulators have to approve the plans once banks submit them. They can force changes to the structure of banks or other large financial companies if they believe the institution could not easily be liquidated once in trouble.

Former FDIC Chairman Sheila Bair, who left her post in July, had stressed the need for regulators to force banks to simplify their operations, such as by creating more subsidiaries, if the plans could not be easily executed.

The rule applies to banks with more than $50 billion in assets and to other large financial companies whose sudden failure could roil financial markets.

Proponents of this new power to seize and liquidate firms argue it will curb taxpayer bailouts and limit the sort of market turmoil caused by the 2008 bankruptcy of Lehman Brothers.

But analysts and market participants have expressed skepticism, saying the government would not let a large bank fail out of fear it would wreak havoc on the economy.

The banking industry raised some concerns about the earlier proposed version of the living will rule, which was released in April.

Banks such as Wells Fargo have said regulators need to do more to ensure that the plans remain confidential and not subject to disclosure through lawsuits or Freedom of Information Act requests.

Banking groups have also asked regulators to start off with a pilot program rather than subject all eligible institutions to the requirement right away.

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Bernanke’s big Jackson Hole speech could rattle the markets

-MSNBC

Whether the Federal Reserve likes it or not, its unprecedented monetary polices over the last few years have conditioned the financial markets to expect a helping hand when the going gets tough.

That's why all eyes will be on Ben Bernanke, the central bank's chairman, when he speaks Friday at the Fed's annual symposium in Jackson Hole, Wyoming.

With the stock market mired in a month-long slump and both the U.S. and euro zone economies in danger of sliding into recession, investors are bracing for a possible repeat of last year's performance, when Bernanke hinted the Fed would act if conditions deteriorated.

Two months later, the central bank began pumping $600 billion into the financial system through direct purchases of Treasury debt, a second round of stimulus that markets dubbed "QE2."

While the jury's still out on how effective these purchases have been, few are ready to rule out QE3 entirely.

Wyoming may conjure up images of the American Wild West, but markets aren't expecting Bernanke to ride into the mountain resort with guns blazing -- at least not yet.

While the economy has taken a turn for the worse -- growth ground to a halt in the second quarter and nearly flat-lined in the first -- there's a sense that the Fed will want to wait a bit longer to assess the impact of its past stimulus.

Other Fed policymakers have sought to downplay expectations of an imminent QE3 announcement. St. Louis Fed President James Bullard was quoted in Japan's Nikkei newspaper saying that while the Fed could buy more bonds if the economy weakened, the time was not right for such a move.

"Going into Bernanke's speech at Jackson Hole, people are positioned for a significant shift in policy. (But) we think financial market conditions have to deteriorate even further for more QE3," said Simon Derrick, head of currency research at Bank of New York Mellon.

Nonetheless, traders are still expecting Bernanke to signal in some shape or form that he hasn't run out of bullets and could start shooting again if need be.

"Based on our conversations with clients, we believe investors would be very surprised if the speech did not include a discussion of asset purchases," strategists at Goldman Sachs wrote in a note to clients.

They said this could involve the Fed reinvesting proceeds from maturing assets into 10- and 30-year Treasuries to hold long-term interest rates low.

"I think we'll see (QE3) because America needs growth, but I don't think we'll necessarily get it on Friday," said Neil Dwane, chief investment officer for Europe at RCM.

Current market moves reflect this. While still down about 15 percent from late July, the S&P 500 rallied smartly Tuesday and the dollar has struggled against major currencies.

More stock market gains could be in store if Bernanke gives a strong hint of future action. After Bernanke's speech last August, the S&P 500 began a rally that took it up nearly 25 percent by May 2011.

Pulling the trigger now would have the element of surprise going for it and might spark the most aggressive market moves.

There's been some talk in bond market circles that the 10-year yield's dip below 2 percent reflected a pricing in of QE3, though those moves probably had more to do with recent dismal jobs, manufacturing and growth data.

Still, there are impediments to launching QE3.

For one thing, Bernanke already caught investors off guard earlier this month and slowed a market rout when the Fed pledged to keep interest rates near zero until at least 2013.

Steven Bell, director of GLC Ltd, a global macro hedge fund in London with $1 billion in assets, also noted that higher inflation may make the Fed cautious. "We have core inflation going up," he said. "It may be low but it's still going up."

Political opposition is also on the rise. Texas Governor Rick Perry, a candidate for president, even said he would consider it "treasonous" if Bernanke "prints more money between now and the election" in 2012.

That populist anger stems partly from the fact that Fed policies have done little to increase hiring or spark a housing market recovery.

"The history is $600 billion (in bond purchases) hasn't really made any difference to the U.S. economy," Dwane said. "It's still where it was when he was talking about it last August: nearly in recession."

If QE3 fails to boost growth or stokes inflation, markets may wish the Fed had done nothing.

"Investors are becoming more cynical," said Jack Ablin, chief investment officer at Harris Private Bank in Chicago. "Central bankers and governments seem to playing the role of the Dutch boy trying to plug holes in the dike."

A humdrum speech that neither announces plans for QE3 or even hints at the Fed's willingness to act is probably the most unlikely scenario, as far as markets are concerned.

If Bernanke did go that way, it could signal that the hawks were gaining the upper hand. Three Fed policymakers voted against extending the zero interest rate pledge to 2013 and have argued that the Fed cannot do much more to boost growth.

Fred Dickson, market strategist at D.A. Davidson & Co, noted that policy remains very loose even without QE3. In addition to holding rates near zero, the Fed has said it will reinvest the proceeds of maturing assets on its "extraordinarily large" $2.8 trillion balance sheet.

"So they have a stealth QE3 policy in place already," he said.

No mention of future easing would likely hurt stocks but should spark a short-term dollar rally. Treasuries would likely fall as expectations of more Fed support faded.

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Former Ginnie Mae execs submit GSE reform plans

-Housingwire

Former Ginnie Mae presidents Robert Couch and Joseph Murin said the future structure of Fannie Mae and Freddie Mac should be based on the agency they used to lead, according to a letter they sent to Republican lawmakers last week.

In the letter sent to Sen. Richard Shelby (R-Ala.), and Reps. Spencer Bachus (R-Ala.) and Scott Garrett (R-N.J.), the former Ginnie chiefs expressed concern over the health of the secondary mortgage market and its weight on the economic recovery.

"Any effort to replace Fannie Mae and Freddie Mac with a new framework must be designed to provide a steady flow of mortgage finance to consumers in all economic cycles while protecting taxpayers from undue risk," Couch and Murin wrote. "We believe the Ginnie Mae guarantee program provides an effective model to achieve these objectives."

Outside of fringe and sometimes duplicitous reforms, Congress has yet to take up meaningful legislation to revamp the future housing finance system. Even though the Obama administration submitted three options for winding down Fannie and Freddie in February, news reports surfaced last week that some within the administration may be opting to maintain a large government role.

The Treasury Department maintains its commitment to the original options.

Regardless, it grows increasingly unlikely that Congress will pass GSE reform before 2013, leaving plenty of time for proposed plans.

Couch and Murin said an ideal solution would be remove the federal government altogether but the current financial market could not fill the void and support long-held features of the housing finance system such as the 30-year, fixed-rate mortgage.

"Until financial markets settle down, federal credit backing is required," they write. "In the meantime, based upon our experience, we believe that it is possible to design a guarantee that sustains the long-term mortgage market while protecting taxpayers from undue risk."

All this they said can be borrowed from Ginnie Mae, which guarantees the timely payment on securities backed by Federal Housing Administration and Department of Veterans Affairs loans.

They suggested placing a guarantee only on securities backed by the safest loans. They said shareholders and credits in the private replacements of Fannie and Freddie should be wiped out before the guarantee is triggered.

The guarantee pricing would also be increased to protect against a possible 20% to 25% drop in home prices as opposed to what Fannie and Freddie charged, which covered a 10% decline.

In many areas, the housing downturn cut prices in half since 2007.

Couch and Murin suggested also including a "recoupment" provision requiring other firms to step in and repay taxpayers should catastrophe strike.

"Without properly protected private investors, we would not have a reliable market for long-term financing of mortgages," Couch and Murin write. "As the Ginnie Mae example continues to show, a limited federal guarantee would ensure a steady flow of mortgage finance and can be designed and priced to shield taxpayers from undue risk."

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Fed's Low-Rate Pledge Is 'Inappropriate': Plosser

-CNBC

The Federal Reserve's recent promise to keep rates low for another two years was "inappropriate policy at an inappropriate time," while its statement on the economy was excessively negative, a top Fed policymaker said Wednesday.

Philadelphia Federal Reserve President Charles Plosser said he dissented from the Fed's statement  because policy should be determined by what the economy is doing rather than by a fixed timeline.

"It was inappropriate policy at an inappropriate time," Plosser told Bloomberg Radio.

"Policy shouldn't be dependent on the calendar, it should be dependent on the economy," he later added.

The Fed in a statement last week pledged to keep interest rates low for at least two more years and said it would consider further steps to help growth.

Plosser was one of three dissenters from the Fed's decision, who wanted to avoid any specific time reference on the low-rates pledge.

At the same time, the central bank gave a gloomy picture of the economy, saying that growth was proving considerably weaker than expected, inflation should remain contained for the foreseeable future and U.S. unemployment, currently at 9.1 percent, would come down only gradually.

"I thought the statement that described the state of the economy was excessively negative. Confidence is not strong ... a very downbeat description of the economy would not do much to engender confidence in the business community or the consumer community," Plosser said .

The noted policy hawk said that although U.S. economic data had been weak in the first half of the year, reports in the last part of July contained good signals, including a recent decrease in first-time weekly claims for jobless benefits.

In an hour-long interview, Plosser said that while inflation expectations were still contained, the Fed needs to guard against the possibility of a sudden shift upward.

"Personally, I believe we're going to have to raise rates well before mid-2013," Plosser said. "I don't know when that date will be, but it's unlikely to be two years from now, at least from my perspective."

The Fed cut overnight interest rates to near-zero in December 2008 and has bought $2.3 trillion in government and mortgage-related bonds to help the economy.

There is plenty of doubt as to what more the Fed can do to stimulate the economy with rates already so low. Plosser noted it is not the Fed's role to act if fiscal policy is unable to.

"I think it's a big mistake for policymakers, either inside the Fed or other places, to believe that if fiscal policy is hamstrung for one reason or another, the Fed has to act," he said. "We run the risk of not being able to deliver on the things people want us to do because we can't, and then when we try, we fail and our credibility is at risk."

Slower economic growth in 2011 so far has raised speculation the Fed will embark on another round of bond buying to shore up the recovery. Known as quantitative easing  , such a move would likely meet political opposition both domestically and abroad.

Indeed, Texas Governor and presidential candidate Rick Perry said earlier in the week he would consider it "treasonous" if Fed Chairman Ben Bernanke "prints more money between now and the election".

Asked about Perry's comments, Plosser said it was important for the Fed to maintain its independence and for the public to know about the internal debate that goes on.

"We are asking often times the same question the public is asking. We're struggling with exactly the same questions and making that known is an important part of being transparent and building confidence in the institution."

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With Bank Failures Mounting, Some Complain of Harsh Exams

-New York Times

Financial regulators have taken a public thrashing for going easy on banks before the financial crisis hit, allowing institutions big and small to dole out dubious loans. Now, according to some community bankers, regulators have abandoned their light touch for a heavy hand at a time when the industry is struggling to recover.

The Federal Reserve, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency have dispatched on-site examiners to scour banks for minuscule problems, bankers said in Congressional testimony on Tuesday. While regulators say they are trying to prevent further bank failures, bankers complain that the examinations amount to nitpicking.

“We have found the field examiners less willing to disclose conclusions and very guarded in acknowledging progress in those areas where we may have been performing well,” Chuck Copeland, the chief executive of First National Bank of Griffin, Ga., said at a House Financial Services subcommittee hearing in Newnan, Ga.

Since the crisis hit, Georgia has had 67 institutions fail, more than any other state. Community banks, those with $10 billion or less in assets, make up the bulk of those now-shuttered institutions.

For all the talk of Bank of America’s beleaguered stock price and Goldman Sachs’s disappointing earnings, small banks are faring far worse than their large Wall Street counterparts. More than 380 banks have failed since early 2008; 326 of which were community banks, according to the F.D.I.C.

“The F.D.I.C. is keenly aware of the significant hardship of bank failures on communities in Georgia and across the country,” Bret D. Edwards, the head of the agency’s division that oversees bank failures, said in prepared testimony before the financial services committee.

But some bankers say their regulators are making matters worse by misunderstanding the cause of the industry’s woes. Mounting losses at small banks are not owed to reckless risk-taking, community bankers say, but the unforeseen collapse of the commercial real estate market in the Southeast.

“Did we have a role setting ourselves up to become victims? No doubt,” said Mr. Copeland of First National Bank of Griffin, a nationally registered bank that is overseen by the Office of the Comptroller of the Currency. “But did we recklessly pursue growth and earnings at all cost with no regard to the other elements of our mission? Never.”

That message is lost on regulators, he said. “We understand that it is not a personal affront; it is simply this environment of second-guessing and weariness in which we are all operating.”

In testimony before the subcommittee, regulators said they were taking steps to address the perception that their examiners are overly strict.

“The Federal Reserve takes seriously its responsibility to address these concerns,” Kevin M. Bertsch, an associate director of the Fed told the subcommittee. The Fed, he said, has created training programs for its examiners and conducts occasional reviews of their examinations.

For its part, the F.D.I.C. said it was reaching out to bankers for guidance on the examination process. In 2009, the agency created the Advisory Committee on Community Banking, made up of small bankers from across the country, according to Mr. Edwards of the F.D.I.C.

“The F.D.I.C. takes great care to ensure national consistency in our examinations,” Mr. Edwards said.

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On mortgage rates, Obama wants proposal for how government can keep big role

-Washington Post

President Obama has directed a small team of advisers to develop a proposal that would keep the government playing a major role in the nation’s mortgage market, extending a federal loan subsidy for most home buyers, according to people familiar with the matter.

The decision follows the advice of his senior economic and housing advisers, who favor maintaining the government’s role as an insurer of mortgages for most borrowers. The approach could even preserve Fannie Mae and Freddie Mac, the mortgage finance giants owned by the government, although under different names and with significant new constraints, said people knowledgeable about the discussions.

A decision to preserve a major government role would mark a big milestone in the effort to craft a new housing policy from the wreckage of the mortgage meltdown and could mean a larger part for Fannie and Freddie than administration officials had signaled.

In a statement, the White House said it is premature to say that senior officials have agreed on any of the three main options outlined earlier this year in an administration white paper on reforming the housing finance system.

“It is simply false that there has been a decision to move forward with any particular option,” said Matt Vogel, a White House spokesman. “All three options remain under active consideration and we are deepening our analysis around how each would potentially be implemented.  No recommendation has been made to the president by his economic advisers.”

The proposal is likely to draw criticism from many Republicans, who blame the financial crisis on policies they say overly encouraged the housing market. And many economists, including some who have worked in the White House under Obama, consider the federal role harmful to the free market.

But if this approach became law, it probably would keep in place the kind of popular home loans that have been around for decades — 30-year fixed-rate mortgages with relatively low interest rates.

Officials have not determined whether to advance a final proposal before the 2012 presidential election. Officials from the White House, the Treasury Department and the Department of Housing and Urban Development are working out the details.

The government could maintain a substantial role in various ways. These include restructuring Fannie and Freddie as public utilities overseen by a government regulator. The government would no longer guarantee their financial health, as in the past, but would continue to backstop the mortgage-backed securities they issue using loans made by private banks.

Or the two companies could be shut down and replaced with several successors that, likewise, would have their mortgage-backed securities guaranteed by the government in exchange for a fee. A federal guarantee, by reducing the risk to investors, can make it cheaper for firms to raise money for making home loans, in turn reducing mortgage rates.

For years, Fannie and Freddie — shareholder-owned companies chartered by Congress to support the housing market — owned or insured trillions of dollars in home loans. When the housing market crashed, the government seized the firms, and it has spent more than $150 billion propping them up.

Since then, Fannie and Freddie have played a key role in ensuring the availability of mortgages amid the market upheaval. But the Obama administration has said it wants to scale back the federal role.

In weighing whether to preserve Fannie and Freddie, administration officials have several concerns, said people familiar with the discussions. They spoke on the condition of anonymity because the talks are still preliminary.

The firms spent decades developing a market in which investors worldwide can buy and sell securities backed by U.S. home loans, and administration officials don’t want to jeopardize it.

In addition, officials don’t want to punish the thousands of Fannie and Freddie employees who have specialized knowledge about the mortgage market and had nothing to do with the poor business decisions top executives made in the run-up to the financial crisis.

But some critics warn that nearly any government role could leave taxpayers on the hook.

“The long-term consequence is that the taxpayers ultimately have to bail out the government’s losses,” said Peter Wallison, a fellow at the American Enterprise Institute. He added, “There is only one legitimate role for government in guaranteeing mortgages: That is mortgages for low-income people, to enable them to buy homes.”

Under the approach Obama endorsed, the government would seek to limit the exposure of taxpayers. Fannie, Freddie or other successor firms would charge a fee to mortgage lenders and banks and use the money to create an insurance pool to cover losses on mortgage securities caused by defaults on the underlying loans. The government would be the last line of defense in case of another housing market meltdown, using taxpayer money to cover losses only if the insurance pool ran dry.

Some special advantages awarded to Fannie and Freddie would be eliminated, according to people familiar with the matter. For example, the two companies were allowed for decades to do business while holding a fraction of the reserves — essentially, rainy-day money — that banks and other financial firms were required to hold. This advantage allowed Fannie and Freddie to grow very large. The companies, or the firms that replace them, would have to start holding much more in reserve.

The administration’s strategy also would require Fannie and Freddie, if they remain in some form, to shed many of the mortgages they own. Their loan portfolios, which have ballooned recently, would shrink greatly over coming years and perhaps be eliminated. Private firms would have to fill the void.

“We remain committed to winding down Fannie and Freddie, though such significant measures would need to be done gradually and with care,” said Vogel, the White House spokesman. “We believe that it is essential to bring private capital back to the center of a reformed housing system.”

Although banks would be able to make any home loans they wanted, only those that met federal standards would be eligible to be included in securities assembled by Fannie, Freddie or successor companies. And only those securities would have a government guarantee.

Any effort to remake the nation’s housing finance system would be phased in over five to 10 years.

Since early in his tenure, Obama has promised to offer a proposal to overhaul the nation’s housing finance system.

In February, the administration released a long-awaited white paper discussing an overhaul of the housing finance system. The paper called for the end of Fannie and Freddie but did not say what should replace them.

Three options were presented. The first two called for greatly reducing the federal role in the mortgage market, perhaps eliminating it. A third option called for largely maintaining the government’s footprint but introducing several changes to reduce the chances that another taxpayer bailout would be needed. 

(All of the options preserved the Federal Housing Administration, a government agency that helps low- and middle-income and minority home buyers.)

The administration’s decision in February to release a series of options — and not make a formal recommendation — reflected a political calculation and a disagreement among Obama’s advisers.

Two top Obama advisers, HUD Secretary Shaun Donovan and Treasury Secretary Timothy F. Geithner, think the government should maintain an outsize role in the housing market, administration officials said.

Donovan thinks federal support for housing fulfills a public service, while Geithner has been focused on the need for the government to have a way to keep the mortgage market operating during a financial crisis.

Other advisers, however, opposed a continued government role over the long run. Austan Goolsbee, who this month left his job as chairman of Obama’s Council of Economic Advisers, argued that the federal role in housing distorts the free market. By subsidizing mortgage investments, he argued, the government drives capital away from other types of investments — for example, those in companies developing environmentally friendly technology. He also warned that the government is putting enormous sums of taxpayer money on the line while conveying little actual benefit to home buyers.

In a meeting with the president, Goolsbee said that the government had finally brought Fannie and Freddie’s excesses to heel by taking over the companies and that it would be a mistake to let them loose in the market again, said a person familiar with the meeting. Goolsbee likened the companies to a villain held in a special prison who shouldn’t be freed just because he promises to help the poor, the source recounted.

Lawrence H. Summers, who was director of the National Economic Council until early this year, argued that, over the long term, it didn’t make sense to have a government-backed agency providing guarantees to the mortgage market but that Fannie and Freddie still play a crucial role.

“My position was that we needed to maximize activity in the short run to support the housing market,” Summers said in an interview. “Discussions of scaling down Fannie and Freddie were vastly premature under the circumstances of a collapsing housing market.”

After a decade or so, he added, the government role might be phased out. He cautioned that models similar to Fannie and Freddie “were problematic because they were likely to lead to the same type of abuses” that Fannie and Freddie engendered.

Gene Sperling, who became director of the National Economic Council this year, shepherded the release of the white paper. He agreed that a continued government guarantee made sense.

In the end, Obama signaled agreement. The White House, however, says the president has not made a final decision.

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What is Fed weighing as it mulls more easing?

-CNBC

The Federal Reserve is considering renewed efforts to boost growth should the weak U.S. economic recovery and high unemployment take a turn for the worse.

Even though employers added a surprisingly hefty 117,000 jobs in July and the jobless rate slipped a tenth of a percentage point, no one argues the job market is robust. Officials will remain vigilant for signs subpar growth is entrenched or is at risk of petering out altogether.

The possibility that financial market strains from the ongoing debt crisis in Europe and jitters following Standard & Poor's downgrade of U.S. debt boost chances the Fed may consider actions to buttress recovery.

The Fed has already mounted one of the most aggressive central bank easy money campaigns in history: it cut interest rates to near zero in December 2008 and has since bought $2.3 trillion in assets to provide an additional prod to economic activity.

Yet officials maintain the Fed still has arrows in its quiver -- should conditions warrant firing them.

WHAT COULD THE FED DO?

* It could return what appears to have been its most potent conventional tool, another round of large-scale asset purchases.

* It could make a smaller move, such as deliberately restocking its balance sheet to emphasize longer maturities, pushing down longer-term interest rates.

* Cement commitments to low rates and easy money in ways that might free up buying, building and hiring. One such initiative might be to bolster its promise to maintain rates low for an extended period; a second might be to promise to keep its much-expanded balance sheet large for an extended period.

Most analysts believe a communications measure or rebalancing of the Fed's portfolio is the most likely first step and that more bond buying would only occur if conditions worsened significantly.

* Setting explicit targets for inflation or price levels. A firm inflation target would strengthen confidence that the Fed won't let inflation get out of hand; a price level target would give the Fed more leeway to spur growth while keeping inflation in check.

* The Fed could lower the interest rate it pays banks on excess reserves, forcing banks to lend the money to obtain higher rates of return.

WHAT PREVENTS THE FED FROM ACTING?

* Inflation worries: after the Fed's $600 billion second round of quantitative easing, or QE2 as it became known, commodity and energy prices soared worldwide. The Fed was blamed for fueling inflation although Chairman Ben Bernanke and other economists argued rising demand around the world was the principal cause of rising prices.

Even so, U.S. inflation is now near the Fed's preferred level of 2 percent or a bit below, depending on the gauge. When the Fed launched QE2, inflation was near record lows.

Bernanke has said that higher U.S. inflation is one restraint on Fed willingness to ease policy.

* Political pressures: the Fed was savaged at home as well as abroad for QE2. U.S. lawmakers took the Fed to task for risking inflation and proposed narrowing its mandate to focus only on price stability, not on growth.

While the central bank has over the years established a reputation for political independence, the risk of stoking further anti-Fed sentiment on Capitol Hill could give policymakers pause.

* Effectiveness questions: although a study by Fed economists said large-scale asset programs lowered rates on 10-year Treasury bills by between .30 of a percentage point and 1 percentage point, impact is a subject of heated debate.

Detractors point to the continued struggles of the economy -- which grew at less than a 1 percent annualized rate in the first half of the year -- as signs of quantitative easing's limitations. Supporters counter that without the bond buying, things would have been worse.

* Policy fatigue: after Fed purchases of near $1.4 trillion worth of mortgage-related debt and $900 billion of Treasury securities, many wonder whether additional bond buying would have diminished effect.

Furthermore, some Fed officials believe that despite stumbles, the recovery is on track and that the Fed's next step should be tightening, not further easing.

* Difficult exit: critics worry that when the recovery begins to gain traction, the Fed will have difficulty shrinking its balance sheet from its current $2.9 trillion size, let alone a larger one. Failure to reverse easy money policies in time could ignite inflation and plunge the economy into a fresh crisis.

Fed officials say they have the tools in place to tighten monetary policy even with a bloated balance sheet. However the reversal of quantitative easing on such a large scale has never been undertaken before.

WHAT WOULD THE FED HOPE TO ACCOMPLISH WITH MORE STEPS?

* Quick response: although the Fed was criticized for being slow to react initially to the financial meltdown that began in mid-2007, Fed Chair Bernanke's track record reflects a willingness to take bold steps quickly in response to deteriorating conditions.

* Emphasize growth: even a smaller step such as a commitment to maintaining a large balance sheet would signal to markets that the Fed sees weak growth, and not rising inflation, as the main risk to the recovery, but would do so without the potentially controversial step of committing to another sequence of bond buying.

* Encourage risk-taking: moving to longer maturities could push down interest rates for longer-dated securities and push investors to take on riskier assets, such as stocks.

* Lower interest rates: by weighting the Fed's portfolio to longer-dated maturities, buying more bonds, the Fed would be pushing down longer term rates even more, thus encouraging borrowing and hopefully, spending, investing, and hiring.

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If Fed Is Out of Bullets, Are Tax Cuts Only Option?

-CNBC

The U.S. Federal Reserve managed to spark a stock rally on Tuesday, but some economists are now left wondering if it will take tax cuts to inject real life into the broader US economy.

The Fed  told investors it will keep rates at zero until 2013, and said it would consider further moves to boost growth. Following the news, stocks on Wall Street surged higher and ended the session up more than 4 percent, helping to erase some of the losses made over the last 7 days.

Despite the rally, the Fed’s statement did not reflect well on the health of the economy. Growth is weaker than expected, and unemployment is set to remain stubbornly high. The fact that the Fed will keep rates at zero for another two years is hardly a vote of confidence.

So what to do? Among many economists, there remain big doubts over the effectiveness of further quantitative easing (QE) .

“QE pumps money into the system and helps the economy via the wealth effect, but you need something to push demand,” Hans Redeker, the global head of foreign exchange strategy at Morgan Stanley, told CNBC on Wednesday.

Demand was underpinned by fiscal policy after the 2008 financial crisis, but Redeker said that government debt in the US and Europe have removed fiscal policy as a viable option now.

Ian Shepherdson, chief US economist at High Frequency Economics, sees no way that governments will be able to spend their way out of broad economic malaise.

“On the fiscal front, it is clear that the chance of stimulus via government spending is nil,” Shepherdson said.

“But on the other side of the accounts, things are different," he said. "We wonder if President Obama might be bold enough to propose that taxes be cut substantially for a while. It seems to us that Mr. Obama has a prime opportunity to call the Republicans' bluff,” Shepherdson said.

“They say they want tax cuts, Republicans exist to cut taxes, so why not offer them tax cuts and dare the GOP to vote against them?” he asked.

Redeker does not agree that tax cuts would be the only option on the table to boost demand, but thinks instead that the answer lies with the G20.

“The G7 is not going to boost demand via fiscal policy. The only countries that can are China" and elsewhere in Asia, said Redeker, who believes a deal could be in the cards in which the U.S. rules out further QE in return for China and others to use their fiscal muscle to boost global demand.

The big effect from the Fed’s statement was on the bond market, according to Dennis Gartman, the Founder of The Gartman Letter. He told CNBC that Bernanke had effectively restructured the bond market, making 2-year paper into an overnight lending facility with very low yields  .

“He made the world say I might as well own Johnson & Johnson [JNJ 60.17 -2.03 (-3.26%) ], as the yields in the bond market are so low,” Gartman told CNBC.

Seeing nothing that would point to a prolonged appetite for risk among investors, Redeker said the Fed meeting had at least turned around the conversation.

“A few weeks ago if you got weak data, it meant 'risk off.' Following the last few days, if we get weak data, it will be 'risk on' as we get closer to a tipping point on QE3,” Redeker said.

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Fed’s Elusive Prescriptions for an Erratic Ailment

-The New York Times

The Federal Reserve is back in the spotlight, with investors anxiously wondering if the central bank will end a two-month hiatus and announce new measures to support the economy on Tuesday.

Under its chairman, Ben S. Bernanke, the Fed has pushed the boundaries of its authority and defied opposition during its unprecedented four-year-old campaign to rescue the financial system and revive the economy.

As the Fed’s policy-making board convenes Tuesday, with the gains of the last two years slipping away and the government focused on getting smaller, the looming question is whether Mr. Bernanke and his lieutenants are willing to press deeper into uncharted waters.

Mr. Bernanke has held the Fed steady since June, saying that he wanted to judge the health of the economy for several months before considering any additional measures.

But the news since then has been uniformly grim. The government reported that the economy grew at an annual rate of only 0.8 percent in the first half of the year. The number of people with jobs is shrinking. Governments at all levels are slashing spending. The stock market has plunged, evaporating vast amounts of household wealth. And investors once again are fleeing Bank of America and Citigroup, rescued at such a heavy toll only two years ago.

Close watchers of the central bank had expected that this meeting in August would pass quietly, with difficult decisions deferred until the autumn. But just as happened last summer, the moment is rising to meet the Fed.

“I think that they should reconsider their judgment” to wait, said Joseph E. Gagnon, a former Federal Reserve official and now a scholar at the Peterson Institute for International Economics. Mr. Gagnon said that Mr. Bernanke, who has said publicly that he is reluctant to act, was right to fear the consequences. “He is expressing the angst of a sailor in uncharted waters, in which he’s right,” he said, “but you have to weigh that against the very real cost in unemployment.”

The Fed keeps its eyes on the medium term, like a driver steering a car down a highway, because its actions only gradually affect the economy. Donald L. Kohn, who stepped down as the Fed’s vice chairman last year, said the recent setbacks were nonetheless significant, because they reduced the trajectory of growth, making it more likely that the Fed would need to act.

“To the extent that you thought fiscal policy was in a tightening mode, you’d factor that into your forecast,” said Mr. Kohn, now a fellow at the Brookings Institution. “And to the extent that you thought the stock market was reducing the country’s wealth, the cost of credit for marginal borrowers was rising, you would want to factor those into your forecast and into your monetary policy decisions.”

The Fed has held its benchmark short-term interest rate near zero since December 2008, flooding the financial system with the nearest thing to free money. The central bank also has amassed a portfolio of $2.9 trillion in Treasuries and mortgage-backed securities, driving down long-term interest rates by accepting low rates, and pushing investors into stocks and other riskier assets.

A number of independent studies have concluded that the asset purchases gave the economy a modest but meaningful boost by reducing rates, an argument that can be summarized in the simple observation that stocks climbed after the most recent round of purchases was announced last August; the purchase of $600 billion in securities was completed at the end of June; and now the market is falling.

Most public attention has focused on the possibility that the Fed will renew its asset purchases, the most drastic option available to the central bank, but also the one it has said is the most unlikely.

There are even reasons to think a new round of asset purchases could be more potent. Because rates already are low, a similar reduction in rates would be larger in percentage terms. Also, the first round of purchases presumably plucked Treasuries from the hands of those most willing to sell. The remaining holders are likely to demand a better deal, driving down rates more.

But some members of the Federal Open Markets Committee have said that they do not support additional purchases, expressing concern that the extensive portfolio will interfere with the central bank’s ability to control inflation when the economy strengthens.

Instead, the Fed is more likely to begin any renewed aid campaign with smaller gestures.

The most basic measure available to the Fed is to promise that it will keep interest rates near zero for at least six months, or a year, or some other specified period of time. The central bank has promised after each of its meetings since late 2008 to keep interest rates near zero “for an extended period.” Earlier this year, Mr. Bernanke said that each renewal of that promise meant there would be no changes for at least a few months. A promise with a more distant expiration date would reduce uncertainty about at least one aspect of the economy.

The Fed also could make a similar commitment for the first time regarding its huge investment portfolio. Selling assets removes money from circulation, tightening monetary conditions, so a promise to maintain the portfolio for a certain number of months would have a similar effect. Moreover, the Fed has said it will start to sell assets before raising interest rates, so a promise about the portfolio also would extend the Fed’s commitment to maintain low rates.

Another available option would be to maintain the size of the portfolio, but to shift its composition toward bonds with longer terms. The Fed initially was reluctant to do this because those bonds would take longer to disappear naturally, but that concern may have been eased by the board’s affirmative decision eventually to shrink its portfolio through asset sales.

None of these options is likely to spur growth significantly. Economists generally agree that the economy is suffering from a lack of demand. The Fed can provide lots of money at low cost, but it can’t convince companies to build new factories unless they think there will be a market for their products. And it can’t convince consumers to spend money on those products if they don’t have jobs, or they’ve already borrowed more money than they can afford to repay.

“I don’t think any of these things would have a huge effect on rates,” Mr. Kohn said. “Could they help to reduce the cost of capital and ease financial conditions? Sure, and that would help encourage spending. But I think the major problem here is that people don’t want to spend, and that’s about confidence in the economy and the government.”

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GSEs suspend Republic Mortgage Insurance

-Housingwire

Freddie Mac and Fannie Mae will no longer purchase for securitization most mortgages insured by Republic Mortgage Insurance and its affiliate RMIC of North Carolina.

RMIC, a subsidiary of Old Republic International (ORI: 9.95 -2.26%), a Chicago-based insurance underwriting company with a market capitalization of $2.6 billion, had been showing signs of financial stress since at least last fall.

The company breached its regulatory risk-to-capital limits as of Sept. 30, 2010, said Fannie Mae in its statement announcing the company’s suspension as an approved mortgage insurer.

While North Carolina regulators had temporarily allowed the company to keep selling insurance, the state’s waivers were due to expire Aug. 31 and there was no sign they would be renewed, said Fannie in explaining its move. Calls to Fannie Mae and Old Republic for comment were not immediately returned.

Fitch Ratings shined a spotlight on the insurer’s financial woes earlier this year, putting the company on a negative ratings watch in March and then downgrading it from a double B rating to double B- with a negative outlook a month later.

The downgrade "is driven primarily by RMIC’s comparatively weak capital levels, continued operating losses and uncertain business prospects," said Fitch in a statement. "At year-end 2010, RMIC’s total capital resources represented just 78% of its delinquent risk-in-force, the lowest ratio among the six active U.S. mortgage insurers."

Fitch also cited Old Republic’s failure to inject more capital into its subsidiary as a negative sign for the company’s financial health. "Although RMIC’s delinquencies have started to show positive trends, Fitch expects the company to experience operating losses for the foreseeable future," said analyst Ilya Ivashkov in his report on the downgrade.

RMIC was the fifth-largest U.S. mortgage insurer as of year-end, said Fitch, with $18 billion of risk-in-force.

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Bernanke says home price stabilization necessary to woo buyers

-Housingwire

Federal Reserve Chairman Ben Bernanke said home price stabilization and a faster foreclosure process are needed to restore confidence in housing, unleashing a recovery in the sector.

He also said the central bank expects the unemployment rate to slip to 8.6% by the latter part of 2011 and decrease to 7.5% by 2013.

High unemployment continues to weigh down the economy and remains a significant contributor to the stalled housing recovery, Bernanke said Wednesday in the Fed's second press conference following a committee meeting.

Despite projecting the economic recovery will pick up in coming quarters, Bernanke told reporters the economy is expected to grow at a slower pace than the Fed originally projected.

He is advocating for congressional budget cuts that will occur over a longer, 10-year period as opposed to rapid budget reductions currently in play that could derail attempts to achieve maximum employment growth before a full recovery is reached.

Bernanke, who continues to balance inflationary concerns against unemployment gains, said the inflation rate, which picked up in recent months, is expected to eventually fall back to a level of 2% or lower by 2012.

He told reporters the Fed has not taken any action as far as additional asset purchases, but said that would be a committee decision at a later date.

When asked about the risk Greece poses to the overall financial system, Bernanke said the banks that U.S. regulators oversee are not significantly exposed to the European countries facing debt crises. While he did note a direct tie to other European countries, Bernanke said, "We have asked the banks to do a stress test, looking at their positions and hedges and the effect on their capital if Greece defaults, and the answer is the effects would be very small."

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Accountability needed

-Centredaily.com

The recent release of documents showing that the Federal Reserve lent tens and possibly hundreds of billions of dollars to foreign banks in 2008 and 2009 has raised more questions about Ben Bernanke’s chairmanship of the Federal Reserve

The lending may or may not have been the right thing to do at the time, given the financial crisis. But it was done in secret, and the only reason that we have the information now is because Bloomberg News and Fox Business News won a two-year court battle, using the Freedom of Information Act, to get the documents released.

The official excuse for such secrecy at the time of lending is that the borrowing institutions could suffer “bank runs” if their loans were made public. That is debatable, but there is no excuse for keeping the information secret for years after the crisis has passed.

This kind of secrecy is maintained to avoid political accountability, not for reasons of financial stability. Such practices are what we would expect from authoritarian governments, not the government of a democratic republic.

Accountability is really the main problem at the Fed. If there were any significant accountability, Ben Bernanke would never have become chairman of the Fed in 2006 and certainly wouldn’t have kept his job after the economy collapsed.

Bernanke was a governor of the Federal Reserve in 2002, when the housing bubble was already identified by my colleague Dean Baker. Bernanke was oblivious to the bubble as it continued to expand to $8 trillion in 2006, before bursting and causing our worst recession since the Great Depression.

Bernanke should have been aware of Baker’s analysis, which looked at home prices during the post-World-War II era, and especially the record run-up of 70 percent —after adjusting for inflation — from 1996 to 2006.

Before the bubble burst, Baker became the most cited source on the housing market for The New York Times. Economist Robert Schiller followed with an analysis of a century of home price data and came to the same conclusion — that this was a bubble that would inevitably burst. He was also frequently cited in the major media.

Baker showed clearly that this price run-up could only be explained by an asset bubble — that other explanations attributing it to demographics, building restrictions, or other changes in demand or supply were not consistent with the data. This was not rocket science for an economist of Bernanke’s skill level. He is well-versed in economic history, including that of the Great Depression.

Yet as late as July 2005 Bernanke was asked directly if there was a housing bubble, and he replied: “I don’t know whether prices are exactly where they should be, but I think it’s fair to say that much of what’s happened is supported by the strength of the economy.”

In May 2007, just seven months before the Great Recession began, Bernanke stated: “We do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system. The vast majority of mortgages, including even subprime mortgages, continue to perform well.”

Bernanke therefore missed the biggest asset bubble in U.S. history, and then failed to anticipate the inevitable destruction that its bursting would cause in the overall economy. This is analogous to Japan’s nuclear regulators’ determination that the Fukushima Daiichi nuclear power plant was safe from any tsunami.

The problem with rewarding incompetence and failure in high places is that even a well-regulated financial system — which we are still very far from achieving — cannot serve the public interest if the chief regulators don’t do their jobs. Secrecy, lack of accountability and incompetence — these are weapons of mass destruction for America’s economy.

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Is the Fed setting America up for another economic crisis?

-AG Beat

Do you remember the “too big to fail” crisis? Remember the talking heads on cable news debating whether or not the banking system in America should be bailed out or allowed to fail and rebuild? Well guess what? Here comes round two, according to economists Gretchen Morgensen and Josh Rosner on the Daily Ticker as featured in the video above.

It seems that since the banks have been bailed out, everything is on the right track, but Morgensen and Rosner look back in time and see parallels to today, pointing to the continued “incestuous relationship” between the Fed and Wall Street which enabled the first crisis which resulted in a bailout.

The Fed “failed to oversee” the banks and we’re just now learning about a secret $80 billion fund for banks back in the spring of 2008 with some suspecting that more details will leak this year about the bailout.

Former Federal Reserve Chairman Alan Greenspan has already publicly admitted that the “fatal flaw” that required bank bailouts was self regulation and Morgenson and Rosner say nothing has changed.

They note that originally, we grew “too big to fail,” so the government consolidated the banks and the belief was that they shouldn’t be too closely regulated not only because profitability was being misinterpreted as the banks being sound and that if they were punished for misdeeds, they would fall and the entire economy would be destabilized.

The authors say the psychology is now that the Fed is pretending there isn’t a problem in the name of economic stability. Because of this, they predict the banks will go back to taking more risks because of a lack of oversight and the cycle starts all over again.

 

What’s next?

So they say we’re back in the exact same situation, so what’s next? Will the Fed go back to Congress asking for another bailout in the name of economic stability or will the President keep his promise that no more bank bailouts will happen and let them fail on their own merit and rebuild?

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Economists predict no immediate end to government debt purchases

-HousingWire

The latest incarnation of quantitative easing is ending at the end of June. However, economists say the Federal Reserve's $600 billion Treasury debt buying program, called QE2, may not be the last federal liquidity injection into the nation's monetary supply.

Further, they say the removal of QE2 is not necessarily going to be a dramatic turning event.

Economist Roger Meiners, a professor with the University of Texas at Arlington, says the day of reckoning has already come in a sense and some economists believe the government will have to continue buying debt regardless of whether or not it is referred to as quantitative easing. Several market observers say they expect a third round of government debt purchases.

In an interview with HousingWire, Princeton economist Paul Krugman said he believes there should be a QE3, and that it should focus on private market debt purchases. "I'm in the boat the Fed isn't doing remotely enough," Krugman said.

Both Krugman and Meiners expect any new government debt program to likely be much larger than previously seen.

"It may be that the Fed is going to be buying up less than before, but that is doubtful because of government deficits," Meiners said. "I don't think there is going to be any choice but for the Fed to continue buying government debt."

Earlier this month, the Fed released minutes from its latest open market committee meeting, which showed the FOMC beginning to contemplate a move away from expansionary policies like QE2. However, no exact timelines were given for the transition.

After reviewing the minutes, analysts with Capital Economics estimated it will take more than a year before the Fed actually tightens its policies.

Meiners also doesn't see a dramatic shift at the end of the month when it comes to the Fed buying government debt.

"I would guess for the rest of the year, the Federal Reserve will continue to do exactly what they have been doing," he said. "I think the bigger problem is the long-term uncertainty that a lot of people feel — rightly or wrongly — that this is a house of cards, so we see many businesses holding off on making commitments because tax policies are up in the air."

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DeMarco criticizes Republican GSE bills

-HousingWire

In a subcommittee hearing Wednesday the chief regulator for Fannie Mae and Freddie Mac punched holes in the latest seven reform bills sponsored by House Republicans.

After the Treasury Department released its white paper on the future of housing finance, Republicans on the House Financial Services Committee announced 15 bills regarding how to wind down Fannie and Freddie. Since conservatorship in 2008, the two companies have drawn roughly $164 billion from the Treasury.

Edward DeMarco, acting director of the Federal Housing Finance Agency, addressed drafts of the latest seven introduced in mid-May, pointing out redundancies in some and the potential dangers in others.

The first bill drafted by Rep. Don Manzullo (R-Ill.) would prevent the Treasury from lowering the 10% dividend payment the GSEs are required to make each quarter.

DeMarco said the bill is consistent with the current conservatorship agreements, and the GSEs have been making quarterly payments at this rate.

The mortgage finance giants "frequently have had to draw additional funds from Treasury in order to 'pay' the dividend to Treasury," according to DeMarco. He said fixing the rate at 10% would limit resolution options and would hurt the ability of the GSEs to build up reserves and exit conservatorship. However, when responding to questions during the hearing, DeMarco said the bill is consistent with what Fannie and Freddie are doing, and there is no plan to change the dividend.

DeMarco said the GSEs still face "a significant number of hurdles" before getting out of conservatorship even if the rate is reduced.

Another bill from Rep. Michael Fitzpatrick (R-Pa.) would cap any federal funds used for GSE bailouts at $200 billion plus any deficiency amounts the companies owe. DeMarco said the cap is already consistent with the conservatorship agreement.

A third bill introduced by Rep. Ed Royce (R-Calif.) would abolish the Affordable Housing Trust, but DeMarco said the GSEs have not contributed to the trust since entering conservatorship in 2008, and it would be inappropriate for them to do so.

Rep. Jason Chaffetz (R-Utah) sponsored one bill that would subject Fannie and Freddie to Freedom of Information Act requests. DeMarco reiterated these are still private companies working in conservatorship. The two companies, he claimed, would incur significant costs responding to such requests, including "significant litigation requests."

A bill sponsored by Rep. Robert Hurt (R-Va.) would require Fannie and Freddie to dispose of all "nonmission critical assets." DeMarco asked the lawmakers for regulatory discretion to preserve and conserve the GSE's assets to the FHFA's best judgment.

"Moreover, FHFA has already begun to fulfill the intent of Mr. Hurt’s draft bill regarding the sale of nonmission critical assets," DeMarco said.

A bill drafted by Rep. Randy Neugebauer (R-Texas) would prohibit taxpayer dollars from funding legal fees for former Fannie and Freddie employees.

DeMarco said the companies have a serious challenge attracting and retaining employees. Neugebauer's proposal would require the FHFA to establish a process for setting the standard of "reasonableness" for these fees. If an employee is subjected to these lawsuits, they could be rendered bankrupt by the escalating legal cost even if they are found innocent, DeMarco said.

"Further, the proposal would have to be prospective in nature to avoid undermining the status of current employees," he said. "The language currently would cover conduct occurring before the effective date of a regulation and that would make it retrospective in nature."

DeMarco plans to work with the lawmakers on the ongoing drafts and help them move toward a final resolution.

"I also recognize the critical and contemporaneous need to provide market participants with greater clarity and assurance about the ultimate role of the government in housing finance beyond the issues surrounding the enterprises," DeMarco said.

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Fed hasn't decided exit strategy yet: Lockhart

-The Wall Street Journal

The Federal Reserve hasn't decided on an exit strategy from ultra low interest rates and its $600 billion bond buying program, Atlanta Fed President Dennis Lockhart said Sunday, according to a transcript of his remarks. "Some of my colleagues have already begun to weigh in on the details of exit. I will not do so today, but I think it would be a mistake to assume that these public conversations on exit are much more than an open discussion of the options the central bank should consider," he said.

The Fed will communicate an exit strategy once it's clear the economic rebound is secure. "Once the expansion becomes more clearly sustainable, it will be appropriate to begin the process of normalization of interest rate policy and the Fed's balance sheet. The exact timing remains to be determined by the FOMC. I am confident that the committee will provide guidance when we have enough certainty that the guidance will provide more signal than noise to financial markets and the public," he said.

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The Politics of Mortgage Reform

-CNBC

A few months ago the Obama administration put out a "white paper" on potential outcomes for the demise of Fannie Mae and Freddie Mac.

There was much debate about it at the time, but since then there's been something of a calm after the storm.

Republicans made it clear they want government out of the mortgage business, and democrats just the opposite; hence the quiet.

Now comes a bi-partisan bill from a California Republican and a Michigan Democrat, that could be the first to get some real traction.

Rep. John Campbell (R-California) and Rep. Gary Peters (D-Michigan) are looking to keep the government as a backstop to the mortgage market, an a very measured and limited way. Their bill (HR 1859) does away with Fannie and Freddie and replaces them with no fewer than five "government-chartered" entities. These would securitize mortgages, as Fannie and Freddie do, with a government guarantee. To pay for that guarantee, the entities would pay the government a fee, as well as be required to follow certain strict standards of underwriting and loan size. The entities would also have to hold on to far more capital than Fannie and Freddie do.

The idea is to get private capital back into the mortgage market.Currently about 90 percent of all loans are backed by the government through Fannie, Freddie and the FHA. This as Fannie and Freddie continue to build a tab with taxpayers that now stands at $138 billion.

The first reaction from the mortgage bankers was, dare I say, safe: "The bipartisan legislation introduced by Congressmen Campbell and Peters to reform our secondary markets closely mirrors the proposal of MBA's Council on Ensuring Mortgage Liquidity, which was the first to put forward a comprehensive blueprint for the future of our housing finance system," wrote Michael Berman, Chairman of the Mortgage Bankers Association.

But let us not forget that reforming the mortgage market is as political as it is financial, and so I found the reaction from Washington policy analyst Jaret Seiberg of MF Global particularly pertinent. He argues that this type of legislation is exactly what could eventually emerge from Congress because it appeases the industry and the general home buying public. It produces revenue for the government in the form of the fees the entities would pay, preserves the 30-year fixed mortgage, helps the Realtors, the home builders and the mid-sized banks and even gives mortgage insurers a role for borrowers with less than 20 percent to put down.

But…

For us, the problem here is that the bill is too early in the political fight.

In effect, this legislation preserves Fannie and Freddie as we will have government-sponsored enterprises issuing MBS with government backing.

We do not believe the political environment is favorable for such a vote. Put another way, it will be hard for many Republicans to support this approach. That is why it may be several years before this type of legislation can garner sufficient support. In addition, we do not believe that House GOP leaders are willing to support this type of legislation. That means there is little chance of it getting a vote on the House floor.

In other words, you can discuss it all you want…and I hope you will here on the blog…but until the housing market stabilizes and consumers and politicians alike feel confident that home ownership will rise again, nobody is going to make a move, or at least a move that will result in substantive change.

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