THE FED

The Fed and the Mortgage 'Crisis'

By WILLIAM M. ISAAC

The meltdown in the subprime mortgage market has caused a great deal of turmoil in the financial markets and hardship for individual homeowners and financial institutions. It prompted the Federal Reserve to take unprecedented actions to support the markets, one of which raises very difficult public policy issues.

I will return to the Federal Reserve, but first I will make some general comments. I believe that too much is being made of the current problems in the financial and real estate markets. This is probably due to three things: 1) a 24/7 news cycle; 2) a hotly contested presidential election in which roughly half of the population wants us to feel angst; and 3) we are spoiled by 25 years of unprecedented prosperity.

Martin Kozlowski

We have been told in headlines that we are in the midst of the worst banking crisis since the Great Depression. If there is a banking crisis, I have seen no evidence of it.

I can count on my fingers and toes every sizable bank about which I have had any concern during the past year. In the early 1980s, when I was chairman of the Federal Deposit Insurance Corp., it was far easier to count the major banks that were not in trouble. Virtually every major bank in the country would have failed in 1984 had a couple of developing countries renounced their debts, which the FDIC considered a distinct possibility.

The U.S. suffered through more than 3,000 bank and thrift failures during the 1980s and early 1990s, and still had 1,430 banks on the problem list at year-end 1991. I'm sure the problem bank list will grow during the next year, but it totaled only 76 at last count. Banks continue to have incredible access to the capital markets, and over 99% of all banks are considered "well capitalized" by the regulators.

When the headlines are not focused on the "banking crisis," they are fixated on the dramatic decline in home prices – more than 20% from peak levels in some major markets. At the risk of being politically incorrect, I'm not sure why we are upset about a 20%-off sale in housing.

After years of double-digit increases, housing prices in the city in which I live, Sarasota, Fla., jumped an astonishing 35% in 2005 – an unsustainable rate of increase that was pushing housing prices beyond the reach of far too many people. We really needed our housing markets to cool down quite substantially.

Millions of people – particularly the young – will benefit from a significant reduction in housing prices. While those who purchased homes in the past couple of years are unhappy if their investment is under water, the housing markets will be back for those who are able to hang on – with help from their lenders where appropriate. Congress's $300 billion "rescue" plan notwithstanding, the good news is that we have a lot of housing stock at more affordable prices for our growing population.

I don't mean to minimize the economic devastation for individuals or firms caught up in declining asset values if they don't have the financial resources to weather the storm. The last time it happened in a major way was in 2000 when the Nasdaq average took a breathtaking plunge from 5,000 to just over 1,000. That had a terrible impact on a lot of people, but we made it through it as a nation with little disruption.

This brings me back to the Federal Reserve. We had a major crisis of confidence in the financial markets, due in significant part to a loss of faith in the rating agencies and others, especially with respect to mortgage-backed securities. No one knew how big the problems were or even where they resided, so the mortgage securitization markets closed down, and financial firms stopped lending to each other.

The problems were exacerbated greatly by "mark-to-market" accounting, which required financial firms to write down their assets to fire-sale prices in the absence of a functioning market. Bank balance sheets ballooned due to the inability to sell assets at the same time accounting rules drained capital. This required banks to slow lending when loans were most needed.

The Fed displayed ingenuity and persistence on a variety of fronts in its efforts to help end the crisis in confidence. While some argue it waited too long, the Fed cut rates aggressively. It also developed and refined a unique auction process to put tens of billions of dollars of cash into the hands of the banks.

A seminal moment for the Fed came on March 14 when it extended a $30 billion nonrecourse loan to JPMorgan Chase so that it could in turn lend the money to investment bank Bear Stearns, which was suffering a liquidity crisis. Two days later JPMorgan Chase purchased Bear Stearns with considerable financial assistance from the Fed.

The rescue of Bear Stearns was a strong statement by the government that it would do everything in its power to restore sanity to the markets. Having been at the helm of the FDIC when Continental Illinois was rescued in 1984 by a very unusual and high profile transaction, I can appreciate what the Fed did. As part of an interim rescue package, the FDIC made a $2 billion subordinated loan to Continental Illinois. The Fed and the largest banks in the country also agreed to provide close to $20 billion of liquidity to the bank to prevent it from failing.

Now we are left with the aftermath of the Bear Stearns rescue. The transaction marks a vast expansion of the federal safety net. The safety net (i.e., the Fed discount window and the FDIC fund) has been paid for exclusively by insured banks, which are highly regulated. Among the questions raised by the Bear Stearns rescue is whether investment banks will now be required to support the safety net and be regulated like banks. If so, will they be able to maintain their creativity and competitiveness?

Bear Stearns also marks the first time the Fed has taken meaningful financial risk in facilitating a takeover. This is by far the most troubling aspect of the Fed's rescue effort. If the Fed had simply provided liquidity to Bear Stearns through JPMorgan Chase, I suspect there would be fewer critics of the transaction.

Do we want the Fed underwriting takeovers of failing firms? Are we willing to allow that to happen without a competitive bidding process, which is routinely used when insured banks fail? Would we want the Fed to rescue an insurance company? How about an auto company? In short, what are the rules going forward?

I'm delighted the liquidity crisis has eased, and I believe the Fed had a big hand in that. But I'm deeply troubled by the precedent that has been set and the implications for our financial system.

It might be possible to stuff the genie back into the bottle by restricting the Fed's powers to engage in Bear Stearns-type transactions. Under current law, the FDIC cannot engage in an open-bank rescue package like the one that saved Continental Illinois without receiving a recommendation from the secretary of the Treasury (after consultation with the president), and without receiving approval from two-thirds of the FDIC's board and the board of governors of the Federal Reserve.

It's time for a good debate about the authority and role of our central bank, just as we had about the FDIC in the wake of the Continental Illinois rescue.

Mr. Isaac, chairman of the Federal Deposit Insurance Corp. from 1981-1985, is chairman of the Washington financial services consulting firm The Secura Group of LECG.

Hillary's Concession Speech

For those who can't handle the suspense, we fast-forward the campaign to June 2, in Sioux Falls, South Dakota. A wire-service reporter, who has covered the Clinton campaign for 17 months, files this story:

Sen. Hillary Clinton of New York has decided to end her historic quest for the Democratic presidential nomination. The decision comes one day before the South Dakota and Montana primaries, and a day after she received an extraordinary petition from senior members of the Democratic Party.

Wonder Land columnist Dan Henninger speaks to Kelsey Hubbard about Hillary Clinton's inevitable concession speech, as well as her future in the Democratic Party. (May 22)

The petition, asking her to withdraw, was signed by every Democratic member of Congress, every Democratic governor, all current and former elected Democratic officials still living, the trustees of the estate of Martin Luther King Jr., and all but one member of the New York Times editorial board. The superdelegates remained undecided.

A draft of Mrs. Clinton's concession speech was obtained from persons close to the campaign. It is to be delivered tomorrow evening in South Dakota at the Sheraton Sioux Falls convention center.

Text of draft:

Thank you, thank you very much. (Pause). Thank you! Yes. Oh, yes! Thank you all so much!

Let me just begin by congratulating Sen. Obama (pause for screams of "No!") on obtaining the presidential nomination of the Democratic Party. For the past six months, Sen. Obama and I have traveled to every state of this great country. He will be the party's standard-bearer in November. I wish him only the best.

This has been the most gratifying experience of my life. Together, we sent a message into this political system that will not be forgotten. (Pause for cheers.) That's right. You will not be forgotten. Your hopes, your needs, your dreams. [Shout this line]: They know about them now, don't they? (Pause for cheers.)

Wherever we went – at an auto factory in Lordstown, Ohio; at Bronko's Bar in Indiana (yup Crown Royal!); at a day-care center for single moms in Altoona – wherever we went, you told me how politics was failing you, and I ran to see that the American system would finally work for you. Some day it will! That's my promise. Some day it will!

AP

We came up a little short. (Pause for booing.) But boy, we came close. Or should I say: Boys and girls, we came close! (Pause to smile.)

Let me take this final opportunity in 2008 to thank the great states whose wonderful people voted to support my candidacy.

Our victories began in the legendary primary state of New Hampshire. Then the voters supported this Democrat in Nevada, Tennessee and Oklahoma. Then Super Tuesday arrived, and oh what a day to remember it was: New York, California, New Jersey, Massachusetts – what an honor to win the support of states that carry so much weight in the history of our party's presidential successes.

The media said we were losing, which – let's be honest – meant You were losing. But as I traveled this great land, I listened to you, and what I heard you say was: Keep going! Keep fighting! And we did!

We took our fight to Ohio, a state so vital to the Democratic cause. And we won. (Cheers.) To Texas. And we won. To Rhode Island! To Pennsylvania! I will never forget Pennsylvania! And we won! (Pause for crowd to begin chant: "And we won!")

In Indiana, the industrial heartland took us to their heart, and we won't forget that. West Virginia – a state I will always associate with the historic primary victory of John F. Kennedy – honored me with 67% of its vote. In Puerto Rico we deepened our ties to the Hispanic community, as in New Mexico. Kentucky – the media wrote you off as "meaningless." You will never be meaningless to me. We will not forget you. Ever!

And yes, that includes Florida and Michigan. You will always count with me. You know, there's a reason they call them battleground states. You need a fighter to win them, and together we battled to victory! (Pause/cheers.)

Politics can be hard on lifelong relationships. We understand that. But let me thank just a few old friends who stood by me: the American Federation of State, County and Municipal Employees, the Painters and Allied Trades Union, the Amalgamated Transit Union, the International Association of Machinists and Aerospace Workers, the International Bricklayers Union. My friends, we will not forget you. (Don't smile.)

I'm proud to be the first woman to almost win a presidential nomination. I think women belong in the Democratic Party. Don't you?

Some in the media said our primary victories were divisive. Really? We remember when these voters were called Reagan Democrats and voted Republican. I guess now they'd have to be called Hillary Democrats! My hope this fall is that they'll be Obama Democrats.

Some will ask if I think Sen. Obama can win. It is my honest intention to attend the inauguration of President Barack Obama in January 2009 (pause for scattered boos). He's going to make us proud this November. It will also forever be my intention to stand and fight for the future of the Democratic Party and the people of America. Your hopes. Your needs. Your dreams. Thank you, thank you, thank you!

Huelga! Argentine Farmers Back on Strike

Call it populism that isn't particularly, well, po-pu-lar. While India has decided to shut down futures trading of in-demand agricultural commodities to show the public it is "doing something" about the high prices of food at home, the Peronist government of Argentinian President Cristina Fernandez de Kirchner has raised export tariffs in a bid to keep the locals well-supplied with increasingly scarce agricultural produce. The problem is that the farmers whose livelihoods have been adversely affected by this tariff are none to happy, as are many middle class folks who Kirchner needs the support of. The decision to raise tariffs was accompanied by massive rioting in Argentina by affected farmers. As is usually the case in Argentina, large-scale disturbances ensued. In this instance, routes were cut off to neighbouring countries which are usually destinations of Argentinean produce until the elevated tariffs were put into effect. If you want more of a background, consult this TIME article, from which I draw the snippet below:

At the core of the discontent was a decision by Fernandez three weeks ago to raise export taxes for soy from 35% to 44% though a sliding scale of tariffs. Other observers have called the soy tax and efforts to ban exports of some farm products as misguided attempts to retain the supply of basic goods in Argentina. The government's argument is that the large-scale export of products like soy cause local shortages and drive up the price of food in Argentina.

The protesting farmers (the organizers claim as many as 150,000 took part) blocked international routes used for trade with neighboring Brazil, Paraguay and Chile, leading the government to threaten police action to clear the roads if necessary. The strike forced many supermarkets and butchers to close their meat counters, a dramatic move in a land famous for its abundant and tasty beef. Fruit and vegetable prices rose and exports of cereals and oils have also been affected.

A 30-day truce ended at the start of the month. With more than half of all export revenues coming from agricultural exports which are now at a standstill, things aren't looking up for Argentina's economy. The main agricultural producers in the country want nothing less than the removal of the additional tariffs, but Kirchner won't back down from the redistributive ploy. The result is that the farmers have gone back to good ol' "industrial action," as per the British euphemism. From Reuters:

Thousands of farmers lined Argentina's highways on Thursday in fresh protests to disrupt key grains exports and pressure the government to cut agricultural taxes. Farmers launched the eight-day strike after breaking off weeks of talks with the government, complaining that President Cristina Fernandez had refused to modify a new system of export taxes that triggered a three-week strike in March.

"They wanted to trample all over us, but they couldn't do it," said Alfredo De Angeli, a farm leader in Entre Rios province who became well-known for his fiery speeches during the first strike. The Entre Rios town of Gualeguaychu, some 125 miles (200 km) from Buenos Aires, has become the focus of farm protests. Argentina is one of the world's top suppliers of corn, wheat and soy, and the protests have pushed up soy prices on world markets.

Argentina's peso currency slipped as investors concerned over a prolonged conflict sought refuge in dollars [!], and the local currency is now languishing close to a five-year low. Bonds and stocks were also jittery.

Traders at Argentina's main grains market in Rosario said they had no orders. Farmers plan to hold back products from soy crushers and exporters through May 15. But they have ruled out a repeat of the roadblocks that caused food shortages during March's strike, when the government accused them of trying to hurt ordinary Argentines.

Fernandez's leftist government has offered a tax rebate and transportation subsidies for small producers to cushion the effect of the new taxes, but farmers said they will not go back to negotiations unless she suspends the measure. The sliding-scale tax system pins export taxes to international prices, raising levies on soybeans to about 40 percent at current prices from the previous fixed rate of 35 percent. "When they don't have any more cash from exports, that's when they'll have to sit down to talk," said one farmer in Gualeguaychu who declined to give his name.

Argentina's vast fertile farmlands make it the world's No. 2 corn exporter, the third-biggest soy supplier and the No. 4 provider of wheat and beef. The conflict with the farming community has landed Fernandez with her biggest challenge since taking office five months ago. Top officials criticized the new wave of protests. "It's a hugely irresponsible decision that makes no sense at all. It's just about defending the interests of one sector and not about the general interest," said Interior Minister Florencio Randazzo.

Fernandez has refused to scrap the sliding-scale tax system and she defends high export taxes on farm goods as a way to redistribute wealth and combat inflation in a country where a quarter of the population lives in poverty. Soy exports earned the country $13.47 billion last year while sales of farm goods abroad accounted for 52 percent of total Argentine exports, totaling $29.13 billion.

What are these farmer doing with all that agricultural produce in the meantime now that they are unwilling to cooperate? Socialists would say they are "hoarding"; these farmers would say they are "protecting their interests." Mercopress has an interesting article on how farmers are using ginormous silos to keep the non-exported grains away from unwelcome parties. Will they succeed in starving the government of revenues from export tariffs? It will be interesting to watch, to say the least:

The extended Argentine farmers/government conflict, which was triggered in early March when the new sliding export taxes system was announced, and its renewed eight days of protest, have left an estimated 44 million tons of grains and oil seeds unsold, valued in approximately 12 billion US dollars, according to market analysts interviewed by the Buenos Aires press. The 44 million unsold tons are equivalent to 45% of the 2007/08 harvest which is forecasted to be Argentina’s second record with 96.8 million tons equivalent to 25 billion US dollars.

Non exported grains will inevitably have an impact for the Argentine government coffers since it will have limited access to collecting the controversial export tax if farmers hold on to their crops. This is particularly true since farmers apparently with the help of plastic silos can store such huge volumes of grains.

According to Gustavo Lopez from Agritrend, of the 44 million tons, 75% is soy. Argentina still has to ship overseas an estimated 32 million tons of soy, (some of it already sold but with no price agreed) which at current local prices is equivalent to 9 billion US dollars. The country’s total soy crop is expected to reach 48 million tons of which 14 million still are waiting to be harvested.

Ricardo Baccarin from Panagricola argues that given the current uncertainty in the grains market, and situation, farmers are holding on to their soy crops “which is the most valuable.They’ve decided to sell what they need to face current expenditures and the rest they are holding on to; we could be facing a historic year in so far as crop retention is concerned”, added Baccarin.

Normally at this time of the year daily transactions in the area of Rosario (Argentina’s main soy bean hub) “are in the range of 100 to 200.000 tons of soy, but currently it’s down to 10 to 30.000 tons”. Lopez revealed that an estimated 51 million tons of the current crop have been commercialized, and even when soy beans retention is as high as 75%, “most of corn and wheat has been traded. Of the 16 million tons of wheat possibly 4.2 million tons remain unsold”.

Regarding corn, of a crop of 21 million tons, 10.4 million tons have been traded and exporters have registered sales for 10.7 million tons. Argentina’s domestic consumption is 7.8 million tons. Nevertheless grain traders are fearful because last year the Kirchner administration clamped exports when the overseas registry reached 10.5 million tons. Lopez says that 25 million tons, (14 million of soy and 11 million of corn, sorghum and others) still have to be harvested.

And how do farmers store such huge volumes? Apparently plastic portable silos with minimum units of 200 tons and which can stand a whole year has become the most common resource in current circumstances. “The plastic silos are a good strategy for tough moments and uncertainty” said representatives from a company which specializes in selling these products. Apparently business has been booming and sales of plastic silos could store well above 40 million tons. “That’s where most of the crop should be now”, added Lopez.

This also means a huge improvement from the 2003/04 harvest when plastic silos helped store 12 million tons. Companies admitted this has become a “90 million US dollars business per crop”. Provincial authorities’ sources from Cordoba estimated that Argentine farmers could be holding on to grains and oil seeds valued at almost 20 billion US dollars [!]