For decades, William Isaac’s insights on the U.S. financial system have been featured in leading news publications. Now, you can browse them all in one location.

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The ‘interest rate comet’ is about to slam into the U.S. economy by Peter Tanous published by CNBC

The ‘interest rate comet’ is about to slam into the U.S. economy by Peter Tanous published by CNBC

February 11, 2022

Adam McKay’s recent movie, “Don’t Look Up,” was a timely example of how our elected leaders react to crises. In the film, a comet is about to destroy all civilization, but the country’s leaders don’t pay much attention until it is too late and we are all doomed.

Welcome to our next major debt crisis.

In just a few years, over half of every dollar we pay in income taxes will go to pay the interest on our national debt owned by the public. And it will get worse.

When that financial comet strikes, what will our politicians say or do?

First, let’s have a look at how we got here.

Most informed Americans are aware that the national debt and interest rates are both rising. Americans will soon wake up to the fact that the interest on our national debt is costing taxpayers a frightening percentage of our national income and wealth.

The comet is about to hit.

According to the U.S. Treasury, in fiscal 2021, the amount of interest paid on the national debt was $562 billion including government transfers. The amount actually paid out to holders of U.S. securities was $413 billion.

That figure alone, which is over 20% of what we paid in income taxes in FY 2021, should be alarming when compared to other government expenditures.

Compare the $413 billion we pay in interest to holders of these securities to the annual budgets of other parts of the government. The State Department annual budget is “only” $35 billion and the Justice Department $39 billion.

But this interest rate crisis will soon get worse, a lot worse.

Cost of debt is on the rise

Here’s why: According to the Congressional Budget Office, the average interest rate paid on the national debt in FY 2021 was approximately 1.5%, historically a very low figure.

Most experts agree that interest rate increases are coming, and a consensus expectation is that there will be three or four rate hikes by the Federal Reserve in 2022. The central bank on Wednesday strongly hinted that the first rate hike will happen in March, and the market is now pricing in as many as five increases this year alone.

As interest rates rise, which they have in dramatic fashion in January, so will the interest rate paid on newly issued Treasury securities. While this is happening, our national debt is exploding.

In 2017, the national debt was $20 trillion. Just four years later, that amount is approaching $30 trillion. The recent stimulus programs brought on by the Covid crisis helped add a staggering $6 trillion to the total.

The math is easy.

Interest rates are still near an all-time low. According to the Monthly Treasury Statement, in 2001, interest paid on the national debt was an average of 5.4%, about 3½ times what it is now.

If we get back to that rate, which is far from inconceivable, interest on the debt would cost American taxpayers $1.4 trillion, based on our present level of national debt. That is twice the budget of the Defense Department.

In FY 2021, the total amount of personal income taxes collected was $1.9 trillion. Moreover, the future budget deficits projected by economists will add over a trillion dollars a year to the overall debt, adding substantially to the rising interest cost.

The interest rate comet is now visible on the horizon.

Americans will not stand for a situation where most of the income taxes we pay go to pay interest to holders of our national debt who live in Japan, China, the U.K. along with others here who own Treasury securities.

How will Congress react to this crisis? We won’t have to wait too long to find out.

The Fed’s Doomsday Prophet Has a Dire Warning About Where We’re Headed by Christopher Leonard published by Politico

The Fed’s Doomsday Prophet Has a Dire Warning About Where We’re Headed by Christopher Leonard published by Politico

December 29, 2021

Tom Hoenig is a remarkable public servant who reminds me, in more than a few ways, of another hero on mine, the late and truly honorable Paul Volcker. Hoenig, like Volcker, devoted most of his life to serving the public, and both are or were brilliant, blunt and unwilling to suffer fools gladly. Tom Hoenig is most well known for his long and storied service as President of the Federal Reserve Bank of Kansas City from 1991 through 2011 and later as Vice Chairman of the FDIC from 2012 through 2018. Volcker was most well known for his service as President of the Federal Reserve Bank of New York before being appointed by President Carter as Chairman of the Board of Governors of the Federal Reserve in 1979 and serving for two terms under both Presidents Carter and Reagan. I knew Volcker better than Hoenig because we served side by side at the Fed and the FDIC during the massive battles against inflation during the 1970s through the early 1990s. I have nothing but respect for their unwavering service to our country and particularly for their determination to rid our country of the scourge of inflation. Hoenig has been fighting this battle for at least a decade with almost no one in power listening to him, until now. The recent article about Hoenig by Politico is must reading by anyone who cares about the future of our great country and wants the best possible life for the generations who follow us. We are on an extremely dangerous road and very much need another Hoenig or Volcker to help us get turned around as soon as possible. Volcker showed us the path, now we just need the courage to follow it. Bill Isaac, Former Chairman, FDIC

Thomas Hoenig doesn’t look like a rebel. He is a conservative man, soft-spoken, now happily retired at the age of 75. He acts like someone who has spent the vast majority of his career, as he has, working at one of the stuffiest and powerful institutions in America: the Federal Reserve Bank. Hoenig has all the fiery disposition that one might expect from a central banker, which is to say none at all. He unspools sentences methodically, in a measured way, never letting his words race ahead of his intended message. When Hoenig gets really agitated he repeats the phrase “lookit” a lot, but that’s about as salty as it gets.

This makes it all the more surprising that Tom Hoenig is, in fact, one of America’s least-understood dissidents.

In 2010, Hoenig was president of the Federal Reserve regional bank in Kansas City. As part of his job, Hoenig had a seat on the Fed’s most powerful policy committee, and that’s where he lodged one of the longest-running string of “no” votes in the bank’s history.

Hoenig’s dissents are striking because the Fed’s top policy committee — called the Federal Open Market Committee, or FOMC — doesn’t just prize consensus; it nearly demands it. The committee likes to present a unified front to the public because it is arguably the most powerful governing body in American economic affairs. Hoenig’s string of dissents shattered that appearance of unanimity at a critically important time, when the Fed was expanding its interventions in the American economy to an unprecedented degree. It was a hinge point in American history, and the economy has never been the same since.

Between 2008 and 2014, the Federal Reserve printed more than $3.5 trillion in new bills. To put that in perspective, it’s roughly triple the amount of money that the Fed created in its first 95 years of existence. Three centuries’ worth of growth in the money supply was crammed into a few short years. The money poured through the veins of the financial system and stoked demand for assets like stocks, corporate debt and commercial real estate bonds, driving up prices across markets. Hoenig was the one Fed leader who voted consistently against this course of action, starting in 2010. In doing so, he pitted himself against the Fed’s powerful chair at the time, Ben Bernanke, who was widely regarded as a hero for the ambitious rescue plans he designed and oversaw.

Hoenig lost his fight. Throughout 2010, the FOMC votes were routinely 11 against one, with Hoenig being the one. He retired from the Fed in late 2011, and after that, a reputation hardened around Hoenig as the man who got it wrong. He is remembered as something like a cranky Old Testament prophet who warned incessantly, and incorrectly, about one thing: the threat of coming inflation.

But this version of history isn’t true. While Hoenig was concerned about inflation, that isn’t what solely what drove him to lodge his string of dissents. The historical record shows that Hoenig was worried primarily that the Fed was taking a risky path that would deepen income inequality, stoke dangerous asset bubbles and enrich the biggest banks over everyone else. He also warned that it would suck the Fed into a money-printing quagmire that the central bank would not be able to escape without destabilizing the entire financial system.

On all of these points, Hoenig was correct. And on all of these points, he was ignored. We are now living in a world that Hoenig warned about.

The Fed is now in a vise. Inflation is rising faster than the Fed believed it would even a few months ago, with higher prices for gas, goods and automobiles being fueled by the Fed’s unprecedented money printing programs. This comes after years of the Fed steadily pumping up the price of assets like stocks and bonds through its zero-percent interest rates and quantitative easing during and after Hoenig’s time on the FOMC. To respond to rising inflation, the Fed has signaled that it will start hiking interest rates next year. But if that happens, there is every reason to expect that it will cause stock and bond markets to fall, perhaps precipitously, or even cause a recession.

“There is no painless solution,” Hoenig said in a recent interview. “It’s going to be difficult. And the longer you wait the more painful it will end up being.”

To be clear, the kind of pain that Hoenig is talking about involves high unemployment, social instability and potentially years of economic malaise. Hoenig knows this because he has seen it before. He saw it during his long career at the Fed, and he saw it most acutely during the Great Inflation of the 1970s. That episode in history, which bears eerie parallels with the situation today, is the lodestar that ended up guiding so much of Hoenig’s thinking as a Fed official. It explains why he was willing to throw away his reputation as a team player in 2010, why he was willing to go down in history as a crank and why he was willing to accept the scorn of his colleagues and people like Bernanke.

Hoenig voted no because he’d seen firsthand what the consequences were when the Fed got things wrong, and kept money too easy for too long.

The last time America suffered a long and uncontrolled period of inflation, Thomas Hoenig was given the miserable job of cleaning up the mess it left behind. This was the period that has come to be known as the Great Inflation, a period in the 1970s characterized by long lines at gas stations and price hikes at grocery stores that came so fast price tags were replaced midday. Hoeing came to realize that the institution he worked for, the Federal Reserve, wasn’t just a bystander to this inflation. It had helped create it.

As a bank examiner, Hoenig spent the 1970s watching as the Fed’s policies helped pile on the inflationary tinder that would later ignite. These policies are known as “easy money” policies, meaning that the Fed was keeping interest rates so low that borrowing was cheap and easy. The Fed had kept interest rates so low during the 1960s that they were effectively negative when accounting for inflation by the late 1970s. When rates are effectively negative, that might be called a super-easy money policy. This kind of environment fuels inflation because all that easy money is looking for a place to go. Economists call this phenomenon “too many dollars chasing too few goods,” meaning that everybody is spending the easy money, which drives up the prices of the things they are buying because demand is high.

Importantly, the Fed creates these conditions by creating more and more dollars, or increasing the monetary supply, as the economists say.

As a bank examiner, Hoenig realized another very important thing. Easy money policies don’t just drive up the price of consumer goods, like bread and cars. The money also drives up price of assets like stocks, bonds and real estate. During the 1970s, low interest rates fueled demand for assets, which eventually inflated asset bubbles across the Midwest, including in heavy farming states, such as Kansas and Nebraska, and in the energy-producing state of Oklahoma. When asset prices like this rise quickly, it creates that dreaded thing called an asset bubble.

The self-reinforcing logic of asset bubbles was painfully evident in farming, and it reflected the dynamics that would later play out in the housing bubble and the over-heated asset markets of 2021.

When the Fed kept interest rates low during the 1970s, it encouraged farmers around Kansas City to take on more cheap debt and buy more land. As cheap loans boosted demand for land, it pushed up land prices — something that might be expected to cool off demand.

But the logic of asset bubbles has the opposite effect. Rising land prices actually enticed more people to borrow money and buy yet more land because the borrowers expected the land value to only increase, producing a handsome payoff down the road. Higher prices led to more borrowing, which led to higher prices and more borrowing still. The wheel continued to spin as long as debt was cheap compared to the expected payoff of rising asset prices.

The bankers’ logic followed a similar path. The bankers saw farmland as collateral on the loans, and they believed the collateral would only rise in value. This gave bankers the confidence to keep extending loans because they believed the farmers would be able to repay them as land prices increased. This is how asset bubbles escalate in a loop that intensifies with each rotation, with the reality of today’s higher asset prices driving the value of tomorrow’s asset prices ever higher, increasing the momentum even further.

The bubbles weren’t just confined to farmland. The same thing was happening in the oil and natural gas business. Rising oil prices and cheap debt encouraged oil companies to borrow money and drill more wells. The banks built a whole side business dedicated to risky energy loans to pay for these wells and related mineral leases, all based on the value of the oil they’d produce. In commercial real estate, it was the same thing.

It all came to an end in 1979, with a severity that has never been repeated. Paul Volcker became chair of the Federal Reserve and he was intent on beating inflation by hiking interest rates. Under Volcker, the Fed raised short-term interest rates from 10 percent in 1979 to 20 percent in 1981, the highest they have ever been. This unleashed massive economic havoc, pushing the unemployment rate to 10 percent and forcing homeowners to take out mortgages with 17 percent interest rates or higher. Volcker recognized that when he was fighting inflation, he was actually fighting two kinds: asset inflation and price inflation. He called them “cousins,” and acknowledged that they had been created by the Fed.

“The real danger comes from [the Fed] encouraging or inadvertently tolerating rising inflation and its close cousin of extreme speculation and risk taking, in effect standing by while bubbles and excesses threaten financial markets,” Volcker later wrote in his memoir.

When the Fed doubled the cost of borrowing, the demand for loans slowed down, which in turn depressed the demand for assets like farmland and oil wells. The price of assets collapsed, with farmland prices falling by 27 percent in the early 1980s and oil prices falling from more than $120 to $25 by 1986. This, in turn, created a cascading effect within the banking system. Assets like farmland and oil reserves had been used to underpin the value of bank loans, and those loans were themselves considered “assets” on the banks’ balance sheets. When the loans started failing, the banks had to write down the value of those loans, which made some banks appear insolvent because they suddenly didn’t have enough assets on hand to cover their liabilities. When land and oil prices fell, the entire system fell apart.

“You could see that no one anticipated that adjustment, even after Volcker began to address inflation. They didn’t think it would happen to them,” Hoenig recalled. Overall, more than 1,600 banks failed between 1980 and 1994, the worst failure rate since Depression.

This was the period when Hoenig traveled around the Midwest, auditing banks to determine if they were still solvent during the recession. Not surprisingly, Hoenig ended up arguing with a lot of bankers when his team declared that the value of the banks’ assets were not sufficient to meet their liabilities.

“They could become quite stressed and quite vocal in their objections,” Hoenig later recalled of the bankers. “You could empathize with them enormously. You could understand the anguish. Lives were destroyed in this environment, people lost everything in this environment. I didn’t blame them for yelling or being distraught.”

John Yorke, a former senior vice president at the Kansas City Fed, observed a stubbornness in Hoenig during that period that persisted through his entire career. Shutting down community banks wasn’t easy, but Hoenig didn’t seem to flinch from the responsibility. “Tom’s German,” Yorke said, referring to the ethnic origin of Hoenig’s name. “He’s strict. There’s rules.”

It would have been easy enough for Hoenig to blame the bankers for making so many risky loans after the bubble burst. Examples of banking grotesquery were abundant. But Hoenig didn’t think the stupidity in lending was entirely the bankers’ fault. The Fed had encouraged the asset bubbles through its easy money policies.

“The fact is, [bankers] made the loans,” Hoenig said. “They made them in an environment of incredible optimism in terms of asset values.” By “optimism,” Hoenig was referring to something called “inflation expectations.” The bankers expected asset prices would continue rising indefinitely, and that very expectation fueled demand for loans, which in turn caused the price to rise. “And that, really, was in part the fault of a decade of too-accommodative monetary policy.”

There were many counterarguments to explain inflation that didn’t blame the Fed. These arguments rested on the idea of “cost push” inflation, meaning that all kinds of forces outside the Fed were pushing price higher. Middle Eastern cartels were boosting the price of oil, for example, while labor unions were pushing up the price of labor. The federal government spent years trying to fight inflation under this theory, even going to far as to impose wage and price controls. It didn’t work.

There is strong evidence to support Hoenig’s view that the Fed was fueling inflation the whole time. In a 2004 report, the Fed economist Edward Nelson wrote that the most likely cause of inflation during the ’70s was something he called “monetary policy neglect.” Basically, the Fed kept its foot on the money pedal through most of the decade because it didn’t understand that more money was creating more inflation. This kind of inflation is called “demand pull” inflation, meaning that the Fed stokes demand, which causes prices to increase.

The author and economist Allan Meltzer, who reconstructed the Fed’s decision-making during the 1970s in his 2,100-page history of the central bank, delivered a stark verdict. It was monetary policy, set by the Fed, that primarily created the problem. “The Great Inflation resulted from policy choices that placed much more weight on maintaining high or full employment than on preventing or reducing inflation,” Meltzer wrote. “For much of the period, this choice reflected both political pressures and popular opinion as expressed in polls.”

Hoenig carried these lessons with him. He was promoted to become the president of the Kansas City Fed, in 1991, which gave him a voting seat on the FOMC. He served there during the long tenure of Fed Chair Alan Greenspan, and then Greenspan’s successor Ben Bernanke. Between 1991 and 2009, Hoenig rarely dissented.

Then came 2010, when he believed the Fed was repeating many of the same mistakes it made in the 1970s.

The FOMC faced a terrible dilemma after the crash of 2008. The central bank had kept interest rates pegged at zero in the wake of the banking crisis, but it didn’t seem to be enough to stoke strong growth. The unemployment rate was still 9.6 percent, close to the levels that characterize a deep recession. While members of the FOMC generally agreed that another recession was unlikely, the committee began considering new and experimental ways to exercise its power.

Hoenig began voting no in 2010 when it became clear that Bernanke wanted to keep interest rates at zero for an extended period of time. A review of Hoenig’s comments during the 2010 FOMC meetings (the transcripts of which become public five years after the fact), along with his speeches and interviews at the time, show that he rarely mentioned inflation. Hoenig was warning about even deeper dangers that might be stoked by keeping interest rates pegged at zero. But his warnings were also very hard to understand for people who didn’t closely follow the politics of money.

Hoenig, for instance, liked to talk a lot about something called the “allocative effect” of keeping interest rates at zero. The allocative effect wasn’t something that people debated at the barbershop, but it was something that affected everyone. Hoenig was talking about the allocation of money and the ways in which the Fed shifted money from one part of the economy to another. This is what he’d witnessed during the 1970s. The Fed’s policies encouraged or discouraged things like Wall Street speculation that could lead to ruinous financial crashes.

But it also did more than that — encouraging speculation and rising asset prices also shifts money between the rich and the poor because the rich own the vast majority of assets in the United States. Hoenig was worried that a decade of zero-percent interest rates would have the same effect.

Bernanke was unpersuaded by these arguments. When Bernanke published a memoir in 2015, he entitled it The Courage to Act. This captured the theory of Bernankeism, which holds that central bank intervention is not only necessary, but even courageous and noble (Bernanke declined to answer questions about Hoenig’s dissents that were sent to Bernanke in June).

Bernanke pushed the FOMC to keep rates at zero throughout 2010. Then, in August of 2010, with unemployment high and growth sluggish, he publicly unveiled the plan to create $600 billion new bills through an experimental program called “quantitative easing.” This program had been used once before, during the financial crash. But it had never been used in the way that Bernanke proposed it be used in 2010, as an economic stimulus plan to be employed outside of an emergency.

If Hoenig had learned one thing during his decades at the Fed, it was that keeping money too easy for too long could create disastrous side effects that only manifested years later. That’s what happened during the 1970s, and again in the mid-2000s, when low rates fueled the housing bubble. Now Hoenig was being asked to vote for quantitative easing, a super-easy money policy that would encourage risky lending and asset bubbles.

The basic mechanics and goals of quantitative easing are pretty simple. The goal is to pump massive amounts of cash into the banking system at the very moment when there is almost no incentive for banks to save the money, because rates are so low. (When rates are low, banks don’t earn much from saving cash because the cash earns meager interest.) The Fed creates the money as it always has, by using its own team of financial traders who work at the Fed’s regional bank in New York.

These traders buy and sell assets from a select group of 24 financial firms called “primary dealers,” an ultra-exclusive club that includes the likes of JPMorgan Chase and Goldman Sachs. The primary dealers have special bank vaults at the Fed, called reserve accounts. To execute quantitative easing, a trader at the New York Fed would call up one of the primary dealers, like JPMorgan Chase, and offer to buy $8 billion worth of Treasury bonds from the bank. JPMorgan would sell the Treasury bonds to the Fed trader. Then the Fed trader would hit a few keys and tell the Morgan banker to look inside their reserve account. Voila. The Fed had instantly created $8 billion out of thin air, in the reserve account, to complete the purchase.

Morgan could, in turn, use this money to buy assets in the wider marketplace.Bernanke planned to do such transactions over and over again until the Fed had purchased $600 billion worth of assets. In other words, the Fed would buy things using money it created until it had filled the Wall Street reserve accounts with 600 billion new dollars.

Inside the closed-door FOMC meetings, quantitative easing was debated during 2010 for being what it was — a large-scale experiment that carried unclear benefits and risks. There was more opposition to the plan than was publicly known at the time. Hoenig wasn’t the only FOMC member with strong objections to the plan. The regional bank presidents Charles Plosser, Richard Fisher and Jeffrey Lacker expressed concerns about it, as did a Fed governor named Kevin Warsh.

The Fed’s own research on quantitative easing was surprisingly discouraging. If the Fed pumped $600 billion into the banking system in roughly eight months, it was expected to cut the unemployment rate by just .03 percent. While that wasn’t much, it was something. The plan could create 750,000 new jobs by the end of 2012, a small change to the unemployment rate but a big deal to those 750,000 people.

There were many downsides to the plan, but the risks all played out over the long term. The primary worries were the ones Hoenig pointed out, about risky lending and asset bubbles. But there was also concern that quantitative easing could create price inflation, encourage more government borrowing (because the plan worked by purchasing government debt) and that it would be very difficult to end once it began because markets would become addicted to the flow of new money.

The final vote on quantitative easing was set on Nov. 3, 2010, and opposition was still strong. Lacker, president of the Richmond Fed, said the justifications for quantitative easing were thin and the risks were large and uncertain. “Please count me in the nervous camp,” Lacker said at the time.

Plosser, the Philadelphia Fed president, was blunter. “I do not support another round of asset purchases at this time,” he said. “Again, given these very small anticipated benefits, we should be even more focused on the downside risks of this program.”

Fisher, the Dallas Fed president, said he was “deeply concerned” about the plan. “I see considerable risk in conducting policy with the consequence of transferring income from the poor, those most dependent on fixed income, and the saver, to the rich,” he said at the time.

According to transcripts of internal FOMC debates, Bernanke defended the plan with an argument that he would use repeatedly in coming years, saying that the Fed faced risks if it didn’t intervene. Bernanke also knew he had the votes to pass quantitative easing. Due to a quirk in the FOMC voting rotation, the critics Fisher, Lacker and Plosser didn’t have a vote that day. Bernanke had personally lobbied Warsh, the Fed governor, who came to an agreement that he’d support quantitative easing, according to Bernanke’s memoir, although he would write an op-ed expressing his concerns about it.

Hoenig believed that there would likely be no going back if the Fed unleashed quantitative easing in late 2008. Just like the 1970s, the Fed might end up keeping money too easy for too long as it tried to juice the job market, chasing short-term gains as it piled up long-term risks.

If Hoenig had voted to support quantitative easing on Nov. 3, he would have almost certainly been praised by his peers. By breaking his long string of dissents that year, he would have allowed the Fed to appear united in the decision to embark on a new and experimental course. But something held him back.

Hoenig has a stubborn streak when it comes to such decision, and it traces back to his long history of working with serious numbers. During his childhood in Fort Madison, Iowa, Hoenig spent his holiday breaks working at his dad’s small plumbing shop. Hoenig was sent to the back room with a clipboard so he could record the inventory of plumbing parts. If he made a mistake, his dad could find himself short of supplies. After graduating high school, Hoenig served as an artillery officer in Vietnam, where he calculated the firing range of mortar shells to ensure they landed near enemy positions rather than on his fellow U.S. soldiers. Hoenig’s upbringing taught him that getting numbers right was a deadly serious job. And he felt a sense of duty to get it right. When he enlisted to fight in Vietnam, he had explained the decision in simple terms to his sister, Kathleen Kelley.

“I remember him saying: ‘You know, I’m an American citizen and I hope to be able to enjoy all the benefits this country offers, so it’s my responsibility,’” Kelley recalled. He would later characterize his string of dissents in this language. He called it his “duty.”

There were 10 votes in favor of quantitative easing. When it was Hoenig’s turn to vote, he answered: “Respectfully, no.”

Hoenig retired from the Fed in late 2011. As he predicted, the round of quantitative easing he voted against was just the beginning. By 2012, economic growth was still tepid enough that Bernanke argued that more quantitative easing was in order. This time, the Fed printed roughly $1.6 trillion. The Fed also kept interest rates remained pegged at zero for roughly seven years, by far the longest stretch in history (rates had touched near-zero in the late ‘50s and early ‘60s, but stayed there only briefly).

The Fed tried mightily to reverse its easy money programs, but largely failed to do so. The central bank tried to raise interest rates slowly, while withdrawing some of the excess cash it had injected through years of quantitative easing. When the Fed tried to withdraw this stimulus, markets reacted negatively. In late 2018, for example, the stock and bond markets fell sharply after the Fed had been steadily raising rates and reversing quantitative easing by selling off the assets it purchased (a maneuver it dubbed “quantitative tightening”). Fed Chair Jay Powell quickly halted those efforts in a move that traders dubbed the “Powell Pivot.”

For Hoenig, the most dispiriting part seems to be that zero-percent rates and quantitative easing have had exactly the kind of “allocative effects” that he warned about. Quantitative easing stoked asset prices, which primarily benefited the very rich. By making money so cheap and available, it also encouraged riskier lending and financial engineering tactics like debt-fueled stock buybacks and mergers, which did virtually nothing to improve the lot of millions of people who earned a living through their paychecks.

In May of 2020, Hoenig published a paper that spelled out his grim verdict on the age of easy money, from 2010 until now. He compared two periods of economic growth: The period between 1992 and 2000 and the one between 2010 and 2018. These periods were comparable because they were both long periods of economic stability after a recession, he argued. The biggest difference was the Federal Reserve’s extraordinary experiments in money printing during the latter period, during which time productivity, earnings and growth were weak. During the 1990s, labor productivity increased at an annual average rate of 2.3 percent, about twice as much as during the age of easy money. Real median weekly earnings for wage and salary employees rose by 0.7 percent on average annually during the 1990s, compared to only 0.26 percent during the 2010s. Average real gross domestic product growth — a measure of the overall economy — rose an average of 3.8 percent annually during the 1990s, but by only 2.3 percent during the recent decade.

The only part of the economy that seemed to benefit under quantitative easing and zero-percent interest rates was the market for assets. The stock market more than doubled in value during the 2010s. Even after the crash of 2020, the markets continued their stellar growth and returns. Corporate debt was another super-hot market, stoked by the Fed, rising from about $6 trillion in 2010 to a record $10 trillion at the end of 2019.

And now, for the first time since the Great Inflation of the 1970s, consumer prices are rising quickly along with asset prices. Strained supply chains are to blame for that, but so is the very strong demand created by central banks, Hoenig said. The Fed has been encouraging government spending by purchasing billions of Treasury bonds each month while pumping new money into the banks. Just like the 1970s, there are now a whole lot of dollars chasing a limited amount of goods. “That’s a big demand pull on the economy,” Hoenig said. “The Fed is facilitating that.”

Hoenig’s 2020 paper didn’t get much attention. After his retirement from the Fed, he served as stint as vice chairman of the FDIC, where he pushed an unsuccessful proposal to break up the big banks. Now he lives in Kansas City, publishing papers and giving the occasional media interview. He is still issuing warnings about the dangers of runaway money printing, and he is still being mostly ignored.

Hoenig isn’t optimistic about what American life might look like after another decade of weak growth, wage stagnation and booming asset values that primarily benefited the rich. This was something he talked about a lot, both publicly and privately. In his mind, economics and the banking system were tightly intertwined with American society. One thing affected the other. When the financial system benefited only a handful of people, average people started to lose faith in society as a whole.

“Do you think that we would have had the political, shall we say turmoil, revolution, we had in 2016, had we not had this great divide created? Had we not had the effects of the zero interest rates that benefited some far more than others?” Hoenig asked. “I don’t know. It’s a counterfactual. But it’s a question I would like to pose.”

Federal Housing Regulators Have Learned and Forgotten Everything by Alex J. Pollock and Edward J. Pinto

Federal Housing Regulators Have Learned and Forgotten Everything by Alex J. Pollock and Edward J. Pinto

December 23, 2021

Should the government subsidize buying houses that cost $1.2 million? The answer is obviously no. But the government is going to do it anyway through Fannie Mae and Freddie Mac. The Federal Housing Finance Authority (FHFA) has just increased the size of mortgage loans Fannie and Freddie can buy (the “conforming loan limit”) to $970,080 in “high cost areas.” With a 20% down payment, that means loans for the purchase of houses with a price up to $1,212,600.

Similarly, the Federal Housing Administration (FHA) will be subsidizing houses costing up to $1,011,250. That’s the house price with a FHA mortgage at its increased “high cost” limit of $970,800 and a 4% down payment.

The regular Fannie and Freddie loan limit will become $647,200, which with a 20% down payment means a house costing $809,000. The median U.S. price sold in June 2021 was $310,000. A house selling for $809,000 is in the top 7% in the country. One selling for $1,212,600 is in the top 3%. To take North Carolina for example, where house prices are less exaggerated, an $809,000 house is in the top 2%. For FHA loans, the regular limit will become $420,680, or a house costing over $438,000 with a 4% down payment—41% above the national median sales price.

Average citizens who own ordinary houses may think it makes no sense for the government to support people who buy, lenders that lend on, and builders that build such high-priced houses, not to mention the Wall Street firms that deal in the resulting government-backed mortgage securities. They’re right.

Fannie and Freddie, which continue to enjoy an effective guarantee from the U.S. Treasury, will now be putting the taxpayers on the hook for the risks of financing these houses. Through clever financial lawyering, it’s not legally a guarantee, but everyone involved knows it really is a guarantee, and the taxpayers really are on the hook for Fannie and Freddie, whose massive $7 trillion in assets have only 1% capital to back them. FHA, which is fully guaranteed by the Treasury, has in addition well over a trillion dollars in loans it has insured.

By pushing more government-sponsored loans, Fannie, Freddie, its government conservator, the FHFA, and sister agency, the FHA, are feeding the already runaway house price inflation. House prices are now 48% over their 2006 Housing Bubble peak. In October, they were up 15.8% from the year before. As the government helps push house prices up, houses grow less and less affordable for new families, and low-income families in particular, who are trying to climb onto the rungs of the homeownership ladder.

As distinguished housing economist Ernest Fisher pointed out in 1975:

[T]he tendency for costs and prices to absorb the amounts made available to prospective purchasers or renters has plagued government programs since…1934. Close examination of these tendencies indicates that promises of extending the loan-to-value ratio of the mortgage and extending its term so as to make home purchase ‘possible for lower income prospective purchasers’ may bring greater profits and wages to builders, building suppliers, and building labor rather than assisting lower-income households.

The reason the FHFA is raising the Fannie and Freddie loan-size limits by 18%, is that its House Price Index is up 18% over the last year. FHA’s limit automatically goes up in lock step with these changes. These increases are procyclical acts. They feed the house price increases, rather than acting to moderate them, as a countercyclical policy would do. Procyclical government policies by definition make financial cycles worse and hurt low-income families, the originally intended beneficiaries.

The contrasting countercyclical objective was memorably expressed by William McChesney Martin, the longest-serving Chairman of the Federal Reserve Board. In office from 1951 to 1970, under five U.S. presidents, Martin gave us the most famous of all central banking metaphors. The Federal Reserve, he said in 1955, “is in the position of the chaperone who has ordered the punch bowl removed just when the party was really warming up.”

Long after the current housing price party has gotten not only warmed up, but positively tipsy, the Federal Reserve of 2021 has, instead of removing the punch bowl, been spiking the punch. It has done this by, in addition to keeping short term rates at historically low levels, buying hundreds of billions of dollars of mortgage securities, thus keeping mortgage rates abnormally low, and continuing to heat up the party further.

In general, what a robust housing finance system needs is less government subsidy and distortion, not more.

In fact, the government has been spiking the housing party punch in three ways. First is the Federal Reserve’s purchases of mortgage securities, which have bloated its mortgage portfolio to a massive $2.6 trillion, or about 24% of all U.S. residential mortgages outstanding.

Second, the government through Fannie and Freddie runs up the leverage in the housing finance system, making it riskier. This is true of both leverage of income and leverage of the asset price. It is also true of FHA lending. Graph 1 shows how Fannie and Freddie’s large loans have a much higher proportion of high debt-to-income (DTI) ratios than large private sector loans do. In other words, Fannie and Freddie tend to lend more against income, a key risk factor.

Graph 1: Percent of loans over 43% DTI ratio

Source: Fisher, Lynn M., et al. “Jumbo rates below conforming rates: When did this happen and why?.” Real Estate Economics 49.S2 (2021): 461-489.

Fannie and Freddie also make a greater proportion of large loans with low down payments, or high loan-to-value (LTV) ratios, than do corresponding private markets. Graph 2 shows the percent of their large loans with LTVs of 90% or more—that is, with down payments of 10% or less—another key risk factor.

Graph 2: Share of loans with LTV ratios over 90%

Source: Fisher, Lynn M., et al. “Jumbo rates below conforming rates: When did this happen and why?.” Real Estate Economics 49.S2 (2021): 461-489.

Now—on top of all that– the FHFA, by upping the loan sizes for Fannie and Freddie, is bringing to the party a bigger punch bowl. That the size limit for Fannie and Freddie is very important in mortgage loan behavior, we can see from how their large loans bunch right at the limit, as shown by Graph 3.

Graph 3: Distribution of loans relative to limit

Note: The right-most bar contains the GSE loans with amounts greater than 98% of the applicable conforming loan limit.
Source: Fisher, Lynn M., et al. “Jumbo rates below conforming rates: When did this happen and why?.” Real Estate Economics 49.S2 (2021): 461-489.

The third spiking of the house price punch bowl consists of the government’s huge payments and subsidies in reaction to the pandemic. A portion of this poorly targeted deficit spending money made its way into housing markets to bid up prices.

A key housing finance issue is the differential impact of house price inflation on lower-income households. AEI Housing Center research has demonstrated how the spiked punch bowl has inflated the cost of lower-priced houses more than others. This research shows that rapid price increases crowd out low-income potential home buyers in housing markets. Thus, as Ernest Fisher observed nearly 50 years ago, government policies that make for rapid house price inflation constrain the ability to become homeowners of the very group the government professes to help.

In general, what a robust housing finance system needs is less government subsidy and distortion, not more. The question of upping the size of Fannie and Freddie loans, and correspondingly those of the FHA, is part of a larger picture of what the overall policy for them should be. Should we favor making their subsidized, market distorting, taxpayer guaranteed activities even bigger than the combined $8 trillion they are already? Should they become even more dominant than they are now? Or should the government’s dominance of the sector and its risk be systematically reduced? That would be a movement toward a mortgage sector that is more like a market and less like a political machine.

In short, what about the future of the government mortgage complex, especially Fannie and Freddie: Should they be even bigger or smaller? We vote for smaller.

How might this be done? As a good example, Senator Patrick Toomey, the Ranking Member of the Senate Banking Committee, has introduced a bill that would eliminate Fannie and Freddie’s ability to subsidize loans on investment properties, a very apt proposal. It will not advance with the current configuration of the Congress, but it’s the right idea. Similarly, it would make sense to stop Fannie and Freddie from subsidizing cash-out refis, mortgages that increase the debt on the house. Another basic idea, often proposed historically, but of course never implemented, would be to reduce, not increase, the maximum size of the loans Fannie and Freddie can buy, and by extension, FHA can insure.

In the meantime, the house price party rolls on. How will it end after all the spiked punch? Doubtless with a hangover.

Crypto and the insecure internet by Thomas P. Vartanian published by The Hill on December 15, 2021

Crypto and the insecure internet by Thomas P. Vartanian published by The Hill on December 15, 2021

December 16, 2021

Crypto, Bitcoin and other forms of digital technology that store value and/or make payments are the rage these days, particularly among younger folks not brought up on bank accounts, check books, and credit cards. The newer forms of storing value or making payments clearly offer value and solve some problems, but it is also clear they pose very substantial risks that must be addressed very soon by policy makers throughout the world. The last thing we need right now is another economic meltdown or blowup similar to what we experienced in the 1980s and 2008-2100. My longtime friend and colleague, Tom Vartanian has written another article on this subject which I urge you to read.

Crypto mania is in full swing. Some people just can’t get their heads around it, and others can’t get enough of it.

Watching the testimony last week of six innovative leaders of crypto-asset firms before the House Financial Services Committee was an educational experience. They explained the crypto phenomena like astrophysicists talking about the dark matter in the universe that we don’t yet understand. But I found myself wondering about the questions that went unasked, particularly what long-term risks crypto assets may pose to national and global economies.

There is already about $3 trillion of cryptocurrency trading throughout the world. Those crypto products are being used and sliced and diced into another $2.7 trillion of derivative crypto-securities traded on traditional markets and crypto exchanges.

Assuming that some of these financial instruments are purchased on margin or otherwise leveraged, we are talking about a potential crypto global footprint approaching $10 trillion. Except for stablecoins, those are financial instruments supported by little if any intrinsic value beyond the decentralized networks that create and transmit them.

Some take solace in the fact that if a crypto market collapsed due to some form of cyberattack, for example, no taxpayer would directly lose money. After all, crypto is not insured by the FDIC or SIPIC, and many investors are just that — investors. But that ignores how smaller financial issues can cascade into global panics as confidence dissipates.

Digital money has been around for quite a while in wholesale form. The Federal Reserve, banks, clearinghouses and exchanges have traditionally “moved” money without physically “moving” it through electronic book entries and the daily netting of transactions between businesses and financial intermediaries communicating largely through proprietary networks. No significant effort to create digital money for consumers occurred until companies introduced smartcards and digital wallets to transmit electronic money in the late 1990s.

I participated in the Mondex electronic money and smartcard beta test in Swindon, England, in the mid-1990s and worked with an alphabet soup of regulatory agencies on the issues that these products created. Unfortunately, consumers were not prepared to swap cash and credit cards for smartcards, regulators were skeptical and merchants saw no reason to spend millions to retool point-of-sale terminals and upgrade software programs.

When whoever Satoshi Nakamoto is introduced bitcoin in 2009, it ignited a second round of digital money euphoria. A new generation of digital pioneers were eager to once again experiment with new, real-time methods of creating and moving retail money that could be more efficient and cost-effective. But money and payments systems are as much a product of trust and confidence as they are convenience and effectiveness. Crypto seems to have transcended these values by creating a new category of “aspirational money” that lies somewhere between money and a security.

Crypto products are innovative and will ultimately transform the next generation of financial services products and delivery systems. There is no stopping that progress. Blockchain and technologies like it boast of relying on a new “peer-to-peer” system of transaction validation instead of traditional trusted intermediaries such as banks. It may be more accurate to say that blockchain substitutes traditional intermediaries with new ones. In any case, these new platforms offer a glimpse of a future that purports to “cooperatize” financial networks by allowing crypto miners and investors to “own” a portion of the ones they create.

Proponents argue that such an end-run around banks and Big Tech companies create systems that “should” be safer because of the way that blockchains eliminate the centralization of data and require every user’s approval to generate or change it.

Similarly, they point out that inconsistent regulation across borders will inevitably shove the developments of new technologies into geographic sanctuaries that are willing to accommodate them.

There is both truth and salesmanship to these arguments. We need progress to grow, and the drive of pioneers helps to realize that progress. But as even the crypto executives volunteered before Congress, we also need a balancing of interests.

I evaluate progress through the eyes of a financial services pragmatist, understanding that since 1980 more than 3,500 financial companies have failed in the United States. Not everything goes the way it is planned. The benefits, efficiencies, inclusiveness and cost-savings that blockchains and crypto assets can produce must be vigorously pursued. But as we tap the benefits of groundbreaking new financial products, everyone – entrepreneurs, users, legislators, regulators and system providers – should understand the new risks and how they must be managed.

Global financial services markets come under strain when there is a rapid migration of money and capital from traditional sources to alternative systems. The events leading up to the financial panics of the 1980s and 2008 are evidence of that. Simply replace money market funds and subprime mortgages with crypto assets, and the picture gets a little clearer.

But even more concerning is the obvious insecurity of the internet. Can crypto banks and exchanges guarantee that the coins they store will always be there in the morning, or that the data they control is protected?

Similarly, should central banks be introducing digital currencies because they can, or only when they know that they will withstand the unrelenting cyberattacks that will inevitably come? In such an increasingly insecure ecosystem, it is hard to imagine crypto assets not aggravating financial stability risks, even before the impact of quantum computing is felt and every form of online security today must be revamped.

The potential threats created by cryptocurrencies would be easier to deal with if we had a safer and more secure internet, greater online transparency, smarter regulation, global online security protocols, absolute authentication and standardized rules of conduct in the virtual world backed up by enforcement capabilities. Unfortunately, we don’t have any of those things.

We must do a better job of balancing the innovation, speed, efficiency and attractiveness of new crypto products with their potential impact on the security and stability of financial systems. If we do, we will avoid a larger economic price tag down the road. The choice is ours to make.

Thomas P. Vartanian is executive director of the Financial Technology & Cybersecurity Center and the author of “200 Years of American Financial Panics: Crashes, Recessions, Depressions And The Technology That Will Change It All.”

Since 2008, Monetary Policy Has Cost American Savers about $4 Trillion by Alex J. Pollock

Since 2008, Monetary Policy Has Cost American Savers about $4 Trillion by Alex J. Pollock

November 16, 2021

My long-time friend, Alex Pollock, Senior Fellow at the Mises Institute, has just published a significant article on the very substantial, hidden costs to society of the Federal Reserve’s monetary policies over the past decade or so. I encourage you to read the article. Alex’s bio follows.

Alex J. Pollock is a Senior Fellow at the Mises Institute. Previously he served as the Principal Deputy Director of the Office of Financial Research in the U.S. Treasury Department (2019-2021), Distinguished Senior Fellow at the R Street Institute (2015-2019 and 2021), Resident Fellow at the American Enterprise Institute (2004-2015), and President and CEO, Federal Home Loan Bank of Chicago (1991-2004). He is the author of Finance and Philosophy—Why We’re Always Surprised (2018) and Boom and Bust: Financial Cycles and Human Prosperity (2011), as well as numerous articles and Congressional testimony. Pollock is a graduate of Williams College, the University of Chicago, and Princeton University.

With inflation running at over 6 percent and interest rates on savings near zero, the Federal Reserve is delivering a negative 6 percent real (inflation-adjusted) return on trillions of dollars in savings. This is effectively expropriating American savers’ nest eggs at the rate of 6 percent a year. It is not only a problem in 2021, however, but an ongoing monetary policy problem of long standing. The Fed has been delivering negative real returns on savings for more than a decade. It should be discussing with the legislature what it thinks about this outcome and its impacts on savers.

The effects of central bank monetary actions pervade society and transfer wealth among various groups of people—a political action. Monetary policies can cause consumer price inflations, like we now have, and asset price inflations, like those we have in equities, bonds, houses, and cryptocurrencies. They can feed bubbles, which turn into busts. They can by negative real yields push savers into equities, junk bonds, houses, and cryptocurrencies, temporarily inflating prices further while substantially increasing risk. They can take money away from conservative savers to subsidize leveraged speculators, thus encouraging speculation. They can transfer wealth from the people to the government by the inflation tax. They can punish thrift, prudence, and self-reliance.

Savings are essential to long-term economic progress and to personal and family financial well-being and responsibility. However, the Federal Reserve’s policies, and those of the government in general, have subsidized and emphasized the expansion of debt, and unfortunately appear to have forgotten savings. The original theorists of the savings and loan movement, to their credit, were clear that first you had “savings,” to make possible the “loans.” Our current unbalanced policy could be described, instead of “savings and loans,” as “loans and loans.”

As one immediate step, Congress should require the Federal Reserve to provide a formal savers impact analysis as a regular part of its Humphrey-Hawkins reports on monetary policy and targets. This savers impact analysis should quantify, discuss, and project for the future the effects of the Fed’s policies on savings and savers, so that these effects can be explicitly and fairly considered along with the other relevant factors. The critical questions include: What impact is Fed monetary policy having on savers? Who is affected? How will the Fed’s plans for monetary policy affect savings and savers going forward?

Consumer price inflation year over year as of October 2021 is running, as we are painfully aware, at 6.2 percent. For the ten months of 2021 year-to-date, the pace is even worse than that—an annualized inflation rate of 7.5 percent.

Facing that inflation, what yields are savers of all kinds, but notably including retired people and savers of modest means, getting on their savings? Basically nothing. According to the Federal Deposit Insurance Corporation’s October 18, 2021, national interest rate report, the national average interest rate on savings account was a trivial 0.06 percent. On money market deposit accounts, it was 0.08 percent; on three-month certificates of deposit, 0.06 percent; on six-month CDs, 0.09 percent; on six-month Treasury bills, 0.05 percent; and if you committed your money out to five years, a majestic CD rate of 0.27 percent.

I estimate, as shown in the table below, that monetary policy since 2008 has cost American savers about $4 trillion. The table assumes savers can invest in six-month Treasury bills, then subtracts from their average interest rate the matching inflation rate, giving the real interest rate to the savers. This is on average quite negative for these years. I calculate the amount of savings effectively expropriated by negative real rates. Then I compare the actual real interest rates to an estimate of the normal real interest rate for each year, based on the fifty-year average of real rates from 1958 to 2007. This gives us the gap the Federal Reserve has created between the actual real rates over the years since 2008 and what would have been historically normal rates. This gap is multiplied by household savings, which shows us by arithmetic the total gap in dollars.

To repeat the answer: a $4 trillion hit to savers.

The Federal Reserve through a regular savers impact analysis should be having substantive discussions with Congress about how its monetary policy is affecting savings, what the resulting real returns to savers are, who the resulting winners and losers are, what the alternatives are, and how its plans will impact savers going forward.

After thirteen years with on average negative real returns to conservative savings, it is time to require the Federal Reserve to address its impact on savers.

Remarks by FDIC Chairman Jelena McWilliams at Money 20/20

Remarks by FDIC Chairman Jelena McWilliams at Money 20/20

October 27, 2021

FDIC Chairman Jelena McWilliams has a fascinating life story and has certainly lived the American Dream. She has given a good deal of thought to governance issues facing bank regulators generally and the FDIC specifically. If you are wondering about the future of crypto currencies in the US and global economies, please read the latest thoughts on the subject from Chairman McWilliams.

Today, I will discuss my regulatory approach, and why it is critical for regulators to be open to innovation.

Before I do so, I will share a personal story that has shaped my world view, including my regulatory approach. Thirty years ago, I immigrated to the United States by myself with $500 in my pocket, a small sum that my parents had borrowed. Within six months of my arrival in the United States, the country I was born in – Yugoslavia – and the airline that brought me here – PanAm – ceased to exist.

Now, if you come to the United States as an 18-year old with $500, it is hard to survive. I sold cars and Cutco knives, I cleaned houses, and I worked the closing shift at Blockbuster.

Along the way, I tried desperately to help my family in Yugoslavia as the country grappled with a civil war, international sanctions and the second-longest period of hyperinflation in world history. Hyperinflation in the former Yugoslavia peaked in January of 1994 at a monthly rate of 313 million percent, or more than 2 percent per hour. I took on extra cleaning jobs in order to send $20 to my parents in Yugoslavia from time to time.

Now, sending money 30 years ago was complicated. I would take one of my photographs (and for those of you too young to remember – photographs used to be printed), tape $20 to the back of it, tape the photo inside a birthday card, put that card in an envelope and mail it. One in four mailings would reach my parents; the other three times, the postal workers would take it. Sometimes, my parents received the card and the picture – with tape removed and $20 missing.

I would like to think that my story is unique, but it is shared by millions of immigrants who send money home on a daily basis.

The power of innovation

Today, moving money is a few clicks away on a smart phone. And remittances are not the only place where innovation has transformed people’s lives and expanded access to credit. Not too long ago, you had to dress up and take stacks of paper to the bank to apply for a mortgage. Today, you can get quotes from multiple lenders while wearing pajamas in the comfort of your own home.

Innovation has not only made financial markets more efficient, it has democratized finance. Financial innovation has increased access to products and services, lowered their cost, and expanded the pool of creditworthy consumers.

Regulating Innovation

If you were a kid growing up on the wrong side of the Iron Curtain in the 1970s, you quickly realized that “Bazooka” was a superior chewing gum, Levis 501’s were the best jeans ever, and that anyone who could afford Converse Chuck Taylor’s was wearing a pair. American inventions transformed the world with the first mass-produced automobile, the first commercial flight, the first personal computer, the first cellphone, and many more.

Now that I have had the privilege of being in the United States for 30 years and am in charge of a venerable federal regulatory agency, I ask myself daily: what is the proper role of government in enabling innovation? What are the consequences of getting it wrong? How do we ensure that the United States remains the place where ideas become concepts and those concepts become the products and services that improve people’s lives?

The 20th Century was America’s century. Whether the 21st Century is America’s century depends on many factors, including whether our regulatory framework promotes or inhibits innovation.

This is especially important as regulators grapple with how to approach blockchain technology and digital assets. “Two [regulatory] roads [seem] to diverge in a yellow wood:”

1. Prohibit banks from engaging in this activity, which means it will inevitably develop in non-banks; or

2. Regulate it appropriately and set forth clear regulatory expectations for banks.

This is not the first time that regulators are trying to fit new technologies into the existing legal framework. I was in law school in the late 1990s, taking classes on how the existing intellectual property legal regime would address the internet. It was not easy then, as it is not easy now, to figure out how to create a regulatory framework for something that is out of the ordinary. Slowly but surely, U.S. policymakers developed a series of laws, regulations, and legal principles that allowed the internet to survive, grow, and change everything. They did not cut the Gordian Knot, but slowly unraveled it. Had they not done so, your cell phones would still be just phones and your document exchange would involve a fax machine.

More recently, the United States has been a leader in the development of machine learning, artificial intelligence, and other cutting edge technologies. But other countries, often not saddled with legacy systems such as ours, are moving forward at a breathtaking pace. In China, for example, the value of mobile payment transactions is greater than the worldwide value of Visa and Mastercard transactions combined.7 In Kenya, 70 percent of adults have used mobile money, even if only 55 percent have a traditional bank account.8 The United States can simply no longer take for granted that we will be at the forefront of technological advancement. We should not take for granted American exceptionalism, it has to be earned.

Crypto Assets

Which brings me to crypto assets. As a regulator, my job is not to make predictions about the future of crypto assets. My job is to provide clear rules of the road – to allow innovation to flourish, while mitigating risks. If we fail to do this, we risk stifling innovation and forfeiting America’s leadership in developing world-changing technologies.

Over the past several months, the FDIC has been engaged with the Federal Reserve and the Office of the Comptroller of the Currency in what some have called a “crypto sprint.” Through this process, the agencies are coordinating policies for how and under what circumstances banks can engage in activities involving crypto assets.

My objective is to provide clear guidance to the public on how our existing rules and policies apply to crypto assets, what types of activities are permissible for banks to engage in, and what supervisory expectations we have for banks that do engage in such activities. We plan to issue a series of policy statements in the coming months.

Over the past couple of years, we have seen a dramatic increase in the use of stablecoins, primarily to facilitate converting crypto-assets into fiat currency. But stablecoins have several other potential uses. Several firms, including existing stablecoin issuers, are actively exploring the potential for stablecoins to serve as a mechanism for retail payments. We have also seen banks establish limited payment networks for commercial customers to transfer funds using tokens in near-real time.

Stablecoins can offer many potential benefits . . . a faster, cheaper, more efficient mechanism for making payments than legacy systems . . . “programmable” payments that happens automatically based on the occurrence of a specified event, which could lead to better management of debt repayment.

Alongside these benefits, stablecoins also present certain risks, specifically if one or more were to become a dominant form of payment in the United States or globally. This could lead to substantial sums of money migrating out of insured banks with significant ramifications for credit creation, financial stability, and bank funding.

In order to realize the potential benefits stablecoins have to offer, while accounting for potential risks, stablecoins should be subject to well-tailored government oversight. That oversight should rest on the foundation that stablecoins issued from outside the banking sector are truly backed 1:1 by safe, highly liquid assets.

If issuers purport to have reserves available on demand to satisfy withdrawal requests, regulators should have authority to ensure the funds are there, specifically if such issuers are large enough that a stablecoin “run” could result in financial instability. There are other potential risks we must be cognizant of, such as ensuring operational resilience and preventing money laundering. Establishing clear regulatory expectations will be paramount to give this market an opportunity to grow and mature in a responsible manner.

Conclusion

I assumed the chairmanship of the FDIC with a firm belief that the role of government in our society is to promote, not inhibit, growth and innovation. Every day I try to exercise humility by telling myself that regulators should not assume we know where the market is going, or that we can fully appreciate the potential that lies beneath.

We must be cognizant that our American values, culture, and influence face increasing competition from abroad, including from regulatory systems that focus intently on promoting technological innovation and taking the mantle from the United States.

Regulators should be agile and open to risk mitigation for new technologies . . . and not throw out the baby with the bathwater. That proverbial baby, with proper care, may just grow up to be a responsible, productive, and, perhaps, brilliant adult.

BankThink Modernize regulation or risk an ’80s-style economic crisis by Thomas P. Vartanian published by American Banker

BankThink Modernize regulation or risk an ’80s-style economic crisis by Thomas P. Vartanian published by American Banker

October 22, 2021

[Tom Vartanian, a long time friend who has incredible experience in the financial services world, wrote the article below on the urgent need for the US to reorganize and refocus financial regulation in the US. This subject has been talked about for over 50 years but nothing of consequence has been done about it. I urge you to read Tom’s latest article and urge members of Congress and the Administration to pay attention to these issues before we fall into another major and avoidable financial calamity, resulting in Congress enacting even more costly and mostly ineffective regulations. Bill Isaac, Former Chairman, FDIC]

The post office’s recent announcement that it was entering the banking business is a stark reminder of how we seem to have forgotten the causes of the second worst economic decade in the country’s history — the 1980s. Forty years later, we are about to recreate the events that caused it.

In the 1980s and early 1990s, about 3,000 federally insured financial institutions failed; 1,600 of them were banks. The Dow Jones Industrial Average had nearly tripled, short-term interest rates topped 12%, inflation hit double digits, and the price of oil collapsed from a high of $111 to $26 a barrel. But perhaps most disruptive was the shifting ground under bankers’ feet created by competition from the increasing popularity of mutual and money market funds.

Those funds attracted huge amounts of what otherwise would have been insured bank deposits. That was because money market funds were not banks and were not subject to Regulation Q, which limited banks and savings institutions to paying 5.5% on deposits. Consumers naturally flocked to an instrument that was able to pay 12% or more. As a result, the money market fund industry doubled in size in those years, growing from $66 billion to $122 billion, causing massive disintermediation and liquidity crises at banks at a time when the economy was already quite challenging.

At the same time, the Federal Deposit Insurance Corp., the Federal Reserve, the Securities and Exchange Commission, the Federal Home Loan Bank Board, the Office of the Comptroller of the Currency, the Treasury Department and state regulators bickered over brokered deposits, the regulation of funds, bank capital, the chartering of new banks and when and how to close failing institutions. Some of those intramural disputes actually ended up in court, causing further uncertainty in financial markets.

It feels like we are approaching a similar inflection point of competitive chaos. As William M. Isaac, former chairman of the FDIC, and I explained in our American Banker article on July 14, 2021, there is already a substantial economic bubble being driven by government largesse, low interest rates, a ballooning Fed balance sheet, excess liquidity and increasing leverage. And the competitive landscape is also shifting again, threatening to pop that bubble.

The role of money market funds today is being played by technology companies. Armed with great new financial ideas, products and delivery channels, fintechs are rapidly realigning the competitive dynamics in financial markets. Most of these new players are not prudentially regulated and naturally want to avoid such oversight while enjoying the benefits of operating in the financial services market. Banks are beginning to remember what it was like to be disintermediated from their customers in the 1980s.

A new breed of competitor is emerging at every edge of the banking business. Cryptocurrencies and stablecoins of all sizes and shapes have gained a remarkable level of acceptability, reaching $2 trillion in value notwithstanding that they aren’t generally used as money, and many have no intrinsic value or government safety nets to fall back on when the inevitable cracks appear.

But crypto companies are now testing their ability to function as payment mechanisms, accept what banks would call deposits and make loans. Crypto exchanges are acquiring trust charters and a range of fintech companies are seeking to acquire bank charters. If that is to the benefit of consumers, that process is a good one. Yet, more than a decade into this experiment, neither Congress nor the regulators have come to a consensus about whether or how they should be regulated.

And then there is the government itself trying to compete with banks. The Federal Reserve is evaluating the benefits of issuing a central bank digital currency, a product that by the Fed’s own admission is fraught with security challenges and could significantly dislodge banks from their roles as financial intermediaries.

Finally, the post office has just begun to offer paycheck-cashing services at several East Coast locations. In short, the government, or in this case, an entity underwritten by the government, wants to be a low-cost payday lender. This is ironic on many levels, but particularly given the post office’s financial history and recent performance relative to the need in the banking business for stability and durability.

It is not the role of the government to prevent or redirect progress, and it should not be competing with the market if the market can fill the financial needs of the public. And it is not in the public interest for federal and state regulators to once again be squabbling over jurisdiction and facing each other in courts duking it out over the right to regulate and collect assessments from new tech players.

Government’s job is to ensure a safe environment for the private sector to experiment with financial evolution, and then adapt the regulation needed to maintain a safe and sound financial system. That did not happen in the 1980s, and we paid the price then and again in 2008. We will pay the price yet again if the obsolete regulatory structure in place today is not modernized to match the changes in the market being forged by new technologies.

As to the obsolescence of the current regulatory structure, remember that when it was created between 1932 and 1940, banks controlled 95% of the financial services market. There was every reason for prudential regulation to be bank-centric. Today, banks control less than 40% of total deposits and assets under management, suggesting that in rough terms, the government now devotes 100% of its prudential regulatory resources to oversee less than 40% of the financial services market. As we saw in 2008, such a lopsided regulatory approach encourages high levels of financial risk to gravitate toward the unregulated parts of the market, building the potential for systemic risk to hide in plain sight.

Technology is today’s squealing siren warning us that it is time to modernize the financial regulatory structure. Effective financial regulation should be applied functionally based on the financial activities a company engages in rather than whether it is a bank. There must be a level regulatory playing field between banks and every other company that wants a piece of their action. Similarly, financial regulation must incorporate Big Data techniques, artificial intelligence and sophisticated algorithms to function on a real-time basis. Regulation must be more predictive and less reactive. Finally, the regulatory system must be streamlined, consolidating agencies to achieve greater efficiency and effectiveness.

The goal of regulation is not to limit progress. It should be neutral toward technology except to the extent that it needs to adapt as markets change to ensure equal advantages for and obligations on those that impact the security and stability of the economy. Keeping the regulatory apparatus up to date is one of the best ways of avoiding financial crises, something that the U.S. has not been very good at doing in the last 200 years.

Political Disasters in U.S. Housing — The Lessons of History by Alex Pollock & Ed Pinto

Political Disasters in U.S. Housing — The Lessons of History by Alex Pollock & Ed Pinto

October 2, 2021

My long-time friends, Alex Pollock and Ed Pinto, have devoted their careers to promoting and supporting sound and affordable housing for our nation. Unfortunately, their wisdom and advice have too often fallen on the deaf ears of politicians seeking expedient ways to lure campaign contributions, power and votes. I urge you to take some time to read their latest article below. These issues are enormously important to our nation. By Bill Isaac

As the philosopher George Santayana said, those who cannot remember the past are condemned to repeat it. The U.S. has a history of catastrophic housing finance blunders to remember, but will we? There have been three dramatic failures of government policy in four decades – hardly an enviable track record! The issue is now whether we wish to risk another one by again reducing credit quality through Fannie Mae and Freddie Mac. Unfortunately, it looks like this will probably happen.

Fannie and Freddie remain the dominant companies in American housing finance, in spite of having little capital and being hyper-leveraged. Their assets to equity ratio is 116:1. They are regulated by the U.S. Federal Housing Finance Agency (FHFA), which is also their Conservator and has great power over them.

In June 2021, the U.S. Supreme Court ruled that the FHFA was unconstitutionally structured because its director could only be removed from office for cause. The Court held that the director must be able to be removed from office at any time by the President.

Upon the Court’s decision, President Biden immediately fired the FHFA director, Mark Calabria. This was a pretty clear example of how political U.S. housing finance is.

Calabria had been following a policy of increasing the capital of the GSEs in preparation for privatizing them, and of reducing their risk to the taxpayers; his acting replacement forthwith reversed this course. We are already seeing a sharp change in the regulatory marching orders for Fannie and Freddie – from a future as privatized companies to a future of being used to accumulate the risk of the government’s housing policies, from reducing to increasing the risk to the taxpayers who are on the hook for Fannie and Freddie’s losses.

Following the Supreme Court decision, any U.S. President now has direct political control over most of the mortgage finance system, including the nearly $7 trillion in mortgage risk held in the Fannie and Freddie balance sheets.

Although we agree that the Supreme Court’s decision about the FHFA is correct on its constitutional merits, it does aggravate the fundamental problem: that the U.S. has a heavily nationalized and socialized housing finance system.

We turn to the history of the travails and enormously costly mistakes this system has made.

The first time began in 1968. The Department of Housing and Urban Development (HUD) presented a “10-year housing program to eliminate all substandard housing,” but since there were then, like now, very large budget deficits, this program was implemented off-budget.

This was done through the 1968 Housing and Urban Development Act, which had the government insuring subsidized single- and multifamily loans through the Federal Housing Administration and then Fannie Mae funding them. Fannie had been up to then a government agency with its debt on-budget, but to hide it, the 1968 Act converted it to an off-budget entity.

The off-budget Fannie funded the largest expansion of subsidized housing in the nation’s history with up to 40-year fixed rate loans. Just like the savings and loans of the time, it lent very long and borrowed short on a leveraged balance sheet, but its lending at fixed rates for 40 years as it headed into years of sharply rising funding costs eclipsed even the savings and loans’ 30-year fixed rate loans.

By the 1970s, HUD’s program turned into a disaster for cities and their residents, as described in the book Cities Destroyed for Cash: The FHA Scandal at HUD (1973). Detroit, Chicago, Cleveland and many other cities long suffered from the effects of HUD’s scheme. And by the early 1980s Fannie’s loans had accumulated such huge interest rate risk losses that it was effectively insolvent. It was only able to continue in business given its backing by the Treasury.

The second time is the spectacular failure of the savings and loan industry, with a $150 billion taxpayer bailout in 1989. This collapse reflected massive losses from both interest rate risk and credit risk, but the savings and loan industry was in its heyday a darling of American politicians. Its trade association, the U.S. League for Savings, now long gone, was a power in Washington DC. The savings and loans benefitted from many special advantages and from a political regulator, the Federal Home Loan Bank Board (FHLBB), which acted as a cheerleader for the industry and maintained close ties to the housing industry. The FHLBB was abolished in 1989, but the current FHFA is its third-generation successor.

The third time began in 1992. Over the following years, the government forced Fannie and Freddie to reduce their credit standards so as to acquire hundreds of billions of dollars in risky loans under the rubric of affordable housing. The first of many “trillion-dollar commitments” was announced by James Johnson, Fannie’s very politically connected CEO, in March 1994. He vowed to “transform the housing finance system.” He did, but not in the way he intended.

In 1994, HUD trumpeted its National Homeownership Strategy,’ about which President Clinton claimed: “Our home ownership strategy will not cost the taxpayers one extra cent.” A poor prediction indeed! The bailout of Fannie and Freddie alone took $190 billion.

This government policy was pursued until 2008 through HUD’s authority to impose what were called “Affordable Housing Goals” on the GSEs. To meet ever more aggressive HUD goals, Fannie and Freddie had to continually reduce their mortgage credit standards, especially with respect to loan-to value and debt-to-income ratios. Instead of HUD’s strategy advancing homeownership,
The full extent of the catastrophic credit risk expansion that took place has now been documented in a detailed analysis researchers at FHFA and AEI released in May 2021. This is the first “comprehensive account of the changes in mortgage risk that produced the worst foreclosure wave since the Great Depression.” By analyzing over 200 million mortgage originations from 1990 onward, they showed “that mortgage risk had already risen in the 1990s, planting seeds of the financial crisis.” In 2008 Fannie and Freddie were bailed out by the taxpayers and put into conservatorship.

The Congress elected in the wake of the crisis adopted the Dodd-Frank Act of 2010, which reflected the view that insufficient regulation caused the crisis. But the key culprits, Fannie and Freddie, were untouched by the legislation, left with no capital, but still functioning. It had become entirely clear that the US government is effectively the 100 percent guarantor of Fannie and Freddie, with the taxpayers fully on the hook, so the financial markets provide unlimited funds for their operations. Fannie and Freddie continue to operate profitably in their government conservatorship by using the U.S. Treasury’s global credit card. In addition, the Federal Reserve owns more than $2 trillion of their mortgage-backed securities and is still buying them for the central bank balance sheet.

Now the “American Jobs Plan” proposes spending $318 billion to construct and modernize more than two million houses. It is almost certain that the government will use its heightened control over Fannie and Freddie to once again make them the central elements of its housing plans by another weakening of credit standards. Thus, we face the prospect of combining some of the features of HUD’s 1968 subsidized housing debacle, with the housing subsidies of the savings and loan system, with Fannie and Freddie’s disastrous foray into high credit risk lending. It looks like we are once again heading for trouble.

However, the government does not have to follow the flawed policies of previous administrations. If instead, the following four principles were followed, the United States would have robust, successful housing finance system it needs without nationalized mortgage risk:

1. The housing finance market can and should function principally as a private market, not a government-dominated one.

2. We can create a robust housing finance market without depending on a government guarantee by ensuring mortgage credit quality and fostering the accumulation of adequate capital behind housing risk.

3. The federal government should use on-budget, transparent and sustainable programs if it wants to subsidize low-and moderate-income home buyers effectively. Fannie and Freddie have no role here, as the only way they can participate is through reducing their credit standards with the real cost hidden in the form of expanding risk.

4. Fannie and Freddie should be truly privatized, with their hidden subsidies and government-sponsored privileges eliminated over time.

It is certain that none of this will happen in the near term, and indeed the opposite of these principles will probably be followed by the current administration. Nonetheless, the principles define the housing finance strategy that a future, market-oriented Congress and administration should take. In the meantime, all mortgage actors will need to protect themselves against the increased credit risk that Fannie and Freddie, under orders from the FHFA, will be generating.

Fannie Mae and Freddie Mac – What Happened, Why it Happened, and How to Fix It. A simple solution: the Truth. Declare Victory, by Gary E. Hindes. Published by the Delaware Bay Company

Fannie Mae and Freddie Mac – What Happened, Why it Happened, and How to Fix It. A simple solution: the Truth. Declare Victory, by Gary E. Hindes. Published by the Delaware Bay Company

September 1, 2021

Gary Hindes, Chairman & Managing Member of the Delaware Company, LLC and a significant investor in Fannie Mae and Freddie Mac, wrote a deep and important piece on the conservatorships forced on the housing mortgage giants by the Bush Administration in 2008, and they remain in conservatorship all these years later. Once Britney Spears is released, as expected, from her court-imposed conservatorship, Fannie Mae and Freddie Mac will hold the new record for the longest conservatorships ever. Whether or not there was merit to the Fannie & Freddie conservatorships in the beginning (Hindes believes there was none), it is impossible to argue with a straight face that the government, including the courts, should not have restored them to the marketplace long ago. Please take the time to read Hindes’ paper, as it is a must read.

Bush’s final words were “we have to make clear that (conservatorship) is transitory, because otherwise it looks like nationalization.”
— President Bush to Treasury Secretary Paulson, Thursday, September 4, 2008, in the Oval Office.

In just a week, the conservatorships of Fannie Mae and Freddie Mac will enter their 14th year. The two government-sponsored entities (“GSEs”) are currently tied with Britney Spears for the title of being among the longest known conservatorships in history. But even though they have been, for the past decade, two of the most profitable companies in the world – and even though the government has been repaid over $100 billion more than it advanced during the 2008 financial crisis – it appears Ms. Spears might soon be released from her conservatorship, ceding the dubious title to the GSEs. At this point, her plaintive query to the judge overseeing her case is especially relevant: “I mean, Your Honor, how much longer is this supposed to go on?

The Trump Administration having dropped the ball on the one-yard line, the Biden Administration now must decide what to do about Fannie and Freddie. Should it continue down the recap-and-release path promoted by former FHFA director Mark Calabria? Can it/should it use the two companies to promote its affordable housing goals? Should it do nothing and leave the never-ending conservatorships for a fifth Administration to deal with?

Tim Howard, Fannie Mae’s former vice-chairman and chief financial officer, has a rather bold yet simple solution: “Admit that the de-facto nationalization of Fannie and Freddie in 2008 was unjustified and a mistake, then undo it”.

A bit of history.

During the final months of the Bush Administration, Treasury Secretary Henry Paulson forced Fannie and Freddie into conservatorship. With the private-label mortgage securities market having collapsed, and banks cutting back drastically on lending because of soaring mortgage delinquency rates, the housing market froze up and then saw the worst decline in home values since the Great Depression. The Too-Big-To-Fail banks having basically gone AWOL from the home mortgage market, Paulson was unwilling to leave Fannie and Freddie as “the only game in town” as the financial crisis was unfolding. He also saw in the crisis an opportunity to get control of two companies Treasury had historically opposed and replace them with a “free market” alternative. Perhaps most important, if the government could obtain control, it could use Fannie and Freddie to douse the conflagration then raging in the mortgage markets.1 So after seizing the companies and firing their directors and management, FHFA ordered them to book over $320 billion in temporary or estimated non-cash expenses. These dubious accounting entries were intended to make the companies appear to be insolvent and forced them to draw $187 billion in non-repayable senior preferred stock from Treasury (which carried a 10 percent after-tax annual dividend, thus creating a crushing payment burden of $18.7 billion per year – more than the companies’ combined profits in any year in their histories). It was, indeed, the classic “concrete life preserver”, intended to keep them in conservatorship until Congress could pass legislation replacing them. (Only that never happened.)

After convincing a judge to put 11,000 documents connected with the takeovers under seal (allowing anyone to read them, it argues to this day, would threaten ‘national security’), Treasury and its allies rewrote history to falsely blame Fannie and Freddie for the financial crisis, labeling the $187 billion ($151 billion in book losses plus $36 billion in accumulated dividends paid on the draws from those losses) as a real cost of their “rescue”. In fact, the ‘book’ losses that Paulson imposed upon the companies fully reversed themselves in just 18 months.3 Yet just after they returned to profitability, Treasury and FHFA changed the dividend on Treasury’s senior preferred stock from 10 percent per year to a “net worth sweep” of 100 percent of the companies’ net income in perpetuity. There was never a housing-related business reason for this action. To the contrary, the new-and-improved concrete life preserver prevented Fannie and Freddie from recapitalizing and allowed Treasury to collect $124 billion more than it would have been owed under the original 10 percent dividend obligation. A top White House official admitted contemporaneously that the real purpose of the net worth sweep was to keep the companies from “escaping” conservatorship and to ensure that shareholders would never see a dime of their companies’ profits.

The Howard solution: the truth.

As Mr. Howard puts it, “the Biden administration can fix the widespread misconception that Fannie and Freddie caused the financial crisis and are terribly risky . . . by publicly reversing the misguided and ideologically motivated takeovers of Fannie and Freddie by the Bush administration. It has the facts to back this up. Fannie and Freddie were not the worst sources of mortgage finance going into the crisis; they were by far the best. Readily available data show that going into, during and after the crisis their delinquency and default rates were one-third those of banks, and one-tenth those of subprime lenders and the loans in private-label securities. Nor do the companies need reform; they have been reformed. Compared with before the crisis, they no longer are in the portfolio investment business, and no longer give price discounts to larger lenders (both long-time complaints of their critics). Moreover, because of Dodd-Frank and other reforms, Fannie and Freddie no longer finance the “toxic” products and risk combinations that resulted in half their credit losses during and after the crisis, and today their average charged guaranty fee is more than double what it was in 2007. With half the riskiness and double the guaranty fees, Fannie and Freddie are far more resistant to a stress environment than they were pre-crisis.

Another falsehood put out by the anti-Fannie-and-Freddie crowd (and which the government’s attorneys continue to repeat in court) is that the companies were frozen out of the capital markets and on the verge of collapse during the financial crisis; hence, there was no choice but to step in and save them. Really? How to explain that just three days prior to their seizure, they had managed to sell $5 billion of unsecured debt (rated AA+/AAA-) through an underwriting group led by Wall Street’s top investment banks.7 (Actually, the deal was oversubscribed so it was upped at the last minute to $6 billion.) Were the underwriters, rating services, and buyers all fools? Did none of these people get the memo?8 And what about the fact that just two weeks earlier, FHFA issued a letter confirming that both companies were in full compliance with their capital requirements? How did that happen? (Actually, there’s a story behind it – which I will leave for another day.)

TINA

There is a reason Congress has not been able to replace Fannie and Freddie for going on 14 years: There Is No Alternative. The Biden administration needs to embrace this reality. It would start by admitting what everyone else knows: Fannie and Freddie have paid back the $187 billion they were forced to draw during the crisis, with 10 percent interest (double what the banks which accepted TARP money were charged).10 The administration should deem Treasury’s senior preferred stock to have been repaid in full and should cancel Treasury’s liquidation preference. That the government continues to argue that not only has it not been repaid, but that the GSEs still owe $187 billion is utterly immoral.

Quoting Mr. Howard: “Once Treasury’s senior preferred has been deemed repaid and its liquidation preference cancelled, settling the remaining lawsuits should not be difficult. Then, a true risk-based capital standard should enable Fannie and Freddie to raise the capital necessary for their release from conservatorship fairly quickly, since the amount of new equity issued under this standard will be more reasonable, and investors will be more eager to buy it if they believe that as a matter of public policy the Biden administration (actually) wants the companies to succeed.

Déjà vu.

During the savings-and-loan crisis of the 1990s, the government faced dozens of lawsuits for illegally seizing various banks and S&Ls. Known as the Winstar cases, they were presided over by Loren Smith, chief judge of the U. S. Court of Federal Claims. At one point, Judge Smith called all the parties into his courtroom and told them: “It is the obligation of the United States to do right. Every free government can be judged by the degree to which it respects the life, liberty, and property of its citizens. The United States stands tall among the nations because it is a just nation. In the instant cases (however), the United States has not acted in a manner worthy of the great (and) just nation (that) it is. Because the dollars at stake appear to be so large, the government has raised legal and factual arguments that have little or no basis in law, fact or logic.

“While the court can appreciate the concerns of the government’s attorneys to protect the public treasury, and they are honorable people, it must severely criticize the tactics and approach of the government . . . if the arguments put forth here are the strongest the United States can muster against liability, then the government has a moral obligation to seek a fair and equitable settlement from the parties whose contracts were breached. If this cannot be achieved, then the court is here to resolve these cases. However, the court is a tool of last resort. Where the government has violated rights, it should first attempt to do justice without judicial prompting.

The rating services.

In the meantime, where are Fitch, Moody’s and Standard and Poor’s? For going on 14 years, they have gone along with the charade that the GSEs haven’t been nationalized, thus allowing Uncle Sam to keep their $6-trillion-plus of debt off the government’s books. But at some point, they will have to face the reality that we are in what appears to be a never-ending conservatorship. In addition to risking a credit downgrade, adding $6-plus trillion to our national debt will, at the very least, make Congressional negotiations over extending the debt ceiling limit quite interesting.

An appeal to reason.

Our government was never intended to own private, profit-making, companies, nor should it be allowed to do so under the guise of a never-ending conservatorship. If it can step in and take all the equity and profits of a company without any compensation to its shareholders – here, essentially, the two largest expropriations of private property in history – then, as one observer put it a few years ago, we are living “in a Stalinist state”. I do not believe that it can – nor that we are.

The total amount of publicly owned preferred stock in Fannie and Freddie is $33 billion. The combined companies earn that much in a little over a year. The companies have been highly profitable for the past decade and the future looks quite favorable. Yet for the past 13 years, shareholders haven’t seen a penny in dividends, while the value of their shares has been decimated. Meanwhile, having already booked over $115 billion in profit (with another $100+ billion possible from monetizing the government’s warrants to buy 79.9 percent of their common equity for just under $73,000, Fannie and Freddie have turned out to be the best deal for the taxpayer since the Louisiana Purchase.12 Admitting the government has been fully repaid would immediately open the door for capital infusions from the private sector which would allow Fannie and Freddie to operate at little, if any, risk to the taxpayer.

President Biden has pledged to get us out of what he (and many others) call America’s “never-ending wars”. What about “never-ending conservatorships”? Isn’t over $100 billion of profit, 14 years, and three administrations enough?

It’s time for the President to declare victory and finally put an end to this last bit of unfinished business from the 2008 financial crisis.

Gary E. Hindes
September 1, 2021
646-467-5242
gary.hindes@delawarebayllc.com