{"id":663,"date":"2014-05-21T13:21:58","date_gmt":"2014-05-21T13:21:58","guid":{"rendered":"http:\/\/www.wallstreetandkstreet.com\/?p=663"},"modified":"2014-05-22T17:05:35","modified_gmt":"2014-05-22T17:05:35","slug":"wsj-may-24-2006-fed-freakout-a-bernankey-geithner-recession","status":"publish","type":"post","link":"https:\/\/www.wallstreetandkstreet.com\/?p=663","title":{"rendered":"WSJ May 24 2006 Fed Freakout: a Bernanke Geithner Recession?"},"content":{"rendered":"

Fed Freak-out<\/strong><\/p>\n

A Bernanke Geithner Recession?<\/strong><\/p>\n

Real Estate Reels from Coast to Coast<\/strong><\/p>\n

By Randall Cunningham And Martha Ridzoli<\/p>\n

WASHINGTON\u00a0 May 23\u00a0\u00a0 The Federal Reserve\u2019s surprise decision a week ago to prohibit sub-prime lending continued to roil financial markets and politics. Some analysts speculate it could cause a recession and cost Republicans control of Congress. Since the announcement stocks have dropped 8%, with the heaviest losses in financial firms exposed to housing such as Fannie Mae, Freddie Mac, Countrywide, and Washington Mutual, which have all dropped 16% or more. Shares of investment banks heavily exposed to sub-prime also declined sharply. In the bond market yields on lower-rated real estate related issues soared 150-200 basis points even as rates on 10-year Treasuries fell 35 basis points to 4.64%. Countrywide suspended a planned $350 million bond offering; its share price plunged 26% in two days. As part of its controversial decision the Fed pledged to provide liquidity to adversely affected firms; one fund manager likened that to the gun slinger who offers to pay his victim\u2019s funeral expenses.<\/p>\n

Economists disagree as to whether the Fed move will cause a full-fledged recession. Pessimists note that, after a prolonged spell of anemic job growth, hiring had finally accelerated, led by construction jobs and housing-related service jobs such as mortgage bankers, appraisers, lawyers, and realtors. The Fed decision is already having an impact. Wells Fargo announced 5,000 temporary mortgage servicing layoffs; Wachovia, Washington Mutual, and Countrywide made similar announcements. The housing market is starting to slow. Paul Johansen, manager of KB Homes\u2019 new Alta Vista development near Sacramento, said traffic slowed sharply last weekend, with interest declining not only for entry-level homes but also more expensive models. \u201cMove-up customers know the Fed decision makes it tougher to sell their homes to first-time buyers. We\u2019ll finish the houses we\u2019ve started but won\u2019t be laying any new foundations for a while.\u201d<\/p>\n

Wall Street\u2019s enormous mortgage banking machine is grinding to a halt, costing jobs and shrinking anticipated year-end bonuses. Last week trading desks took heavy losses on sub-prime paper, which may push some banks\u2019 second quarter income statements into the red. Madelyn Wentworth, realtor with Douglas Elliman, expects sales of Manhattan co-ops and East Hampton vacation homes to decline sharply. \u201cBuyers will pull back and wait for bargains to appear,\u201d she said.<\/p>\n

The Fed move met with harsh bi-partisan criticism on Capitol Hill, which has been bombarded with complaints from groups ranging from the National Association of Home Builders to the NAACP. \u201cThe Federal Reserve\u2019s arbitrary decision will shut tens of thousands of hard-working middle class Americans out of the housing market. For them, the American dream will remain just a dream\u201d said Martha Rodriguez, spokesperson for the NAHB. Barney Frank (D: Massachusetts), ranking Democrat on the House Financial Services Committee, said yesterday on Meet the Press, \u201cSomeone needs to remind Mr. Bernanke and Mr. Geithner that the mission of the Fed is to prevent recessions, not cause them.\u201d Congressman Ron Paul (R: Texas) said, \u201cThe Federal Reserve\u2019s reckless decision is a direct result of its promiscuous and unrestrained money printing which created a runaway bubble in the housing market. If anyone needed more evidence that the Fed is out of control and requires major reform, this is it.\u201d Republican politicians attempted to distance themselves from the Fed decision but Nathan Gottesman, an independent political consultant, said \u201cThe probability the GOP can maintain control of Congress just got a lot smaller. Even if the economy merely slows sharply over the next six months and then recovers, in early November voters will be seeing economic reports from September, which won\u2019t be pretty.\u201d<\/p>\n

Critics charged the Fed\u2019s sub-prime crackdown was unnecessary, because it represents a small part of the mortgage market and an even smaller share of overall lending. They cite a 2005 study by Federal Reserve economists who \u201cprojected that even if there were a 20 percent nationwide decline in housing prices, it would cause only about half the economic damage of the bursting of the dot-com bubble.\u201d One government economist stated, \u201cSubprime is only about one-seventh of the mortgage market, barely $1 trillion out of the nation\u2019s $55 trillion in financial assets, and it does not appear to be infecting the rest of the credit boom. Delinquencies on and loan losses on consumer lending continue to run at quite low rates.\u201d But pessimists counter that the U.S. is in an unprecedented credit expansion fueled by rising home prices. They argue many low-income consumers are taking out risky, complex mortgages with low down payments that they will be unable to service unless home prices continue to increase. Even a modest decline in home . . . . .<\/p>\n

\u00a0<\/strong><\/p>\n

TMD Note:<\/strong> The two quotations in the last paragraph describe actual Fed studies mentioned in Timothy Geithner\u2019s book, Stress Test<\/strong>. Biased critics blame the financial crisis on bankers\u2019 greed and deregulation, but that is only partly correct. Geithner does cite Alan Greenspan\u2019s na\u00efve faith in the rationality of markets; someone should have reminded Alan about the panics of 1819, 1837, 1857, 1873, 1893, 1907, 1929 and 1987. Both Greenspan and Larry Summers were far too confident in the ability of derivatives to limit risk; often they amplified it.\u00a0 They should have known that financial innovations, not yet tested in a downturn, usually produce nasty surprises. (Think commercial banks in the 1790s, leveraged investment trusts in the 1920s, portfolio insurance in 1987.) Geithner takes pride in his cautionary speeches about financial risk delivered between 2003 and 2007, but no one on Wall Street was paying attention.<\/p>\n

But regulatory failure was the product not only of free-market ideology but also malfunctioning government institutions. Deregulation? Many thousands of bureaucrats were showing up for work every day at the Federal Reserve, the Treasury, the Office of Thrift Supervision, the Office of the Comptroller of the Currency, the Securities and Exchange Commission, the Federal Deposit Insurance Corporation, the Commodity Futures Trading Commission, the Office of Federal Housing Enterprise Oversight, and the New York State Insurance Commission, not to mention many other state agencies and various committees of Congress. Why was this cast of thousands so spectacularly ineffectual? As Geithner admits, \u201cregulatory capture\u201d (particularly at the Office of Thrift Supervision, Wamu\u2019s regulator), fragmented responsibility (e.g., the Fed regulated Bank Holding Companies such as JPM and Citi but not their banking subsidiaries), and clueless incompetence (particularly at Chris Cox\u2019s SEC, regulator of the investment banks) all played a role. No one had overall responsibility for survival of the system; everyone was handling just one part of the elephant. Senior folks at the Fed were insufficiently aware of crazy mortgage lending (which was being widely discussed on Wall Street), and they were too confident in their economists\u2019 analyses. \u201cEveryone knew\u201d that some borrowers were taking out ridiculously risky mortgages, such as undocumented \u201cliar loans,\u201d\u201cPick a Payment\u201d loans and low teaser rate mortgages, but no serious effort was made to prohibit them.<\/p>\n

One key factor which Geithner ignores: Democrats\u2019 relentless pressure on banks and Fannie\/Freddie to expand lending to low-income borrowers. It started with the Community Reinvestment Act of 1977 and accelerated in the later years of the Clinton Administration, led by HUD Secretary Andrew Cuomo. Banks were under the gun to make what were later reclassified as \u201cpredatory loans.\u201d Democrats, and some Republicans, opposed the Bush Administration\u2019s efforts to pass legislation designed to reduce risk at Fannie and Freddie. So it is clear that a massive and multifaceted governmental failure was a prime cause of the financial crisis, which by 2005 or 2006 could not have been averted without a costly economic downturn.<\/p>\n

Copyright Thomas Doerflinger 2014.\u00a0 All Rights Reserved.<\/p>\n

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