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Saturday, March 22, 2008 6:49 PM

Quiet Coup Towards Nationalization

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The Financial Times is reporting Central banks float rescue ideas.

Central banks on both sides of the Atlantic are actively engaged in discussions about the feasibility of mass purchases of mortgage-backed securities as a possible solution to the credit crisis.

Such a move would involve the use of public funds to shore up the market in a key financial instrument and restore confidence by ending the current vicious circle of forced sales, falling prices and weakening balance sheets.

The Bank of England appears most enthusiastic to explore the idea. The Federal Reserve is open in principle to the possibility that intervention in the MBS market might be justified in certain scenarios, but only as a last resort. The European Central Bank appears least enthusiastic.

Any move to buy mortgage-backed securities would require government involvement because taxpayers would be assuming credit risk. There is no indication as yet that the US administration would favour such moves. In the eurozone it would require agreement from 15 separate governments.

One argument among policymakers and bankers has been that new international rules have exacerbated the credit squeeze by requiring assets to be valued at their current record lows rather than at face value.

Fed officials are monitoring the impact of the latest barrage of Fed liquidity moves and interest rate cuts. They also believe the US has not exhausted all the options short of wholesale public intervention and further intermediate steps are available to them.

These could include still more aggressive use of the Fed’s own balance sheet to boost liquidity in the markets.

Analysts say the US government also has plenty of scope to boost support for the markets indirectly through the Federal Housing Administration or Fannie Mae and Freddie Mac.

The UK lacks these institutions, which could be one reason why the Bank of England is keenest to explore outright intervention. The UK government has already become heavily involved in buying mortgages since September with the recent nationalisation of Northern Rock, the mortgage lender.
Fed and BOE Deny Rumors

Reuters is reporting Fed deny mortgage security buyout plan.
The Federal Reserve and Bank of England denied a report on Saturday that they were in talks over possibly using public funds to make mass purchases of mortgage-backed securities to ease the global credit crisis.

However, the Bank of England said it was considering a number of other, unspecified options to address the turmoil in financial markets, which has continued despite the injection by central banks of billions of dollars of liquidity and cuts in interest rates.

The European Central Bank had no comment.

"Central banks, including the Bank of England, have been looking at ways to ease the strain," a BoE spokesman said. "The BoE is not, however, among those reported today to be proposing schemes that would require the taxpayer, rather than the banks, to assume the credit risk."

"We can, however, confirm that we have been examining a number of other options. But it is too early to go into any detail," the spokesman said.

A senior Fed official said: "The Federal Reserve is not involved in discussions with foreign central banks for coordinated buying of MBS (mortgage-backed securities)."
Is the BOE Doing Enough?

Sir Peter Burt, former deputy chairman of Bank of Scotland says Bank of England must do more to help banks according to the TimesOnline.
Sir Peter Burt, who was chief executive of Bank of Scotland before its merger with Halifax to create HBOS, told the BBC’s Today programme that the Bank risked sending Britain into a “depression” because of its worries over moral hazard.

Speaking two days after the Bank was forced to make an unprecedented statement denying that any bank had sought emergency state funding, Sir Peter said that Mervyn King, its Governor, should “go the extra mile” by offering more cash and accepting a wider range of collateral, as had the US Federal Reserve.

Institutions have complained that its auctions of extra liquidity were sporadic and that it accepted only asset-backed securities based on AAA-rated credit card and mortgage debt. The Bank said on Thursday it would auction an additional £5 billion a week until April 9 and Mr King is thought to be sympathetic to the pleas for a more relaxed attitude to collateral.

Thursday’s auction was three times oversubscribed, while the auction of an extra £5 billion on Monday was almost five times oversubscribed, indicating the desperate need among Britain’s banks for additional liquidity.
Rubin Pleads For Government Intervention

Bloomberg is reporting Rubin Calls for Urgent Government Action to Stem Foreclosures.
Former Treasury Secretary Robert Rubin called for quick government action to tackle the rising level of home foreclosures and he indicated taxpayer money will have to be used.

"There is a strong need for urgent action," Rubin, who is chairman of Citigroup Inc.'s executive committee, said. "I would be very, very seriously considering the possibility of using public funds in one form or another."

The Federal Housing Administration should be involved in any stepped-up government effort to help homeowners facing the loss of their houses, Rubin said an interview on Bloomberg Television's "Political Capital with Al Hunt," to be aired today. "The piece that's missing now, at least in my judgment, is addressing all of these mortgages that face foreclosure."

Democratic lawmakers, including House Financial Services Committee Chairman Barney Frank of Massachusetts and Senate Banking Committee Chairman Chris Dodd of Connecticut, have put forward a plan to have the FHA insure refinanced mortgages after lenders reduce principal to help struggling borrowers. The Bush administration is resisting the proposal.

"The credit markets themselves are really in uncharted waters," Rubin said. "A lot of trouble could lie ahead."
Pawning The Family Silver

A Washington Post editorial is talking about More Cash for Mortgages.
TO UNDERSTAND Wednesday's decision by federal regulators to let Fannie Mae and Freddie Mac set aside less cash to protect against losses, imagine a family that keeps its precious antique silver in a strongbox on a high shelf, beyond easy reach. The regulators have essentially authorized Fannie and Freddie to pawn some of their family silver.

Scouring the federal government's sphere of influence for every drop of cash that could improve liquidity for securities markets, the Federal Reserve Board and the Treasury Department have prevailed upon OFHEO to release some of Fannie and Freddie's pent-up capacity.

The GSEs enjoy an implicit federal guarantee, but reducing their capital for a purpose such as this, at a time such as this, goes a fair way toward making that bailout promise an explicit one.
Thoughts from Noland At Prudent Bear

Here are some interesting thoughts in this week's Credit Bubble Bulletin by Doug Noland on Nationionalization
It would be an outright crime if thinly-capitalized Fannie and Freddie were allowed to increase their Books of Business (mortgages retained on their balance sheets and MBS guaranteed in the marketplace) by $2 Trillion this year – “if the market needs that money.” I was shocked when Mr. Lockhart imparted that they were now in a position to accomplish such a feat. It is certainly a terrible idea to put Fannie and Freddie guarantees on millions of new mortgages created from restructuring loans of troubled borrowers. This would amount to nothing less than a despicable transfer of massive prospective Credit losses directly to the American taxpayer (current owners of this paper should not be bailed out).

I have fully expected the GSEs, at some point, to be taken over by the federal government. It may have been orchestrated subtly, but I can only presume that such a historic endeavor was accepted this week as the only means of averting financial dislocation. And for their regulator to suggest that the GSEs today have any handle whatsoever over their unfolding “risk management” challenge is wishful thinking - at best.

As far as I’m concerned, much of the U.S. mortgage market was this week essentially Nationalized. I’ll take the dramatic narrowing in agency debt and MBS spreads as support for this view. Additional support arrived from comments from Mr. Lockhart, Mr. Paulson, and actions by the Federal Reserve. Having lived contently for years with the markets’ interpretation of the (grey-area) “implied” government backing of the GSEs, our policymakers are surely today satisfied with the inferred market acceptance of mortgage industry Nationalization. To be sure, the Fed’s Splashy “Sunday Night Special” bailout of Bear Stearns is rather trivial in both its implications and consequences when compared to Thursday’s Quiet Coup.
Let's look at the Fed's denial one more time: "The Federal Reserve is not involved in discussions with foreign central banks for coordinated buying of MBS (mortgage-backed securities)."

Reading carefully, that statement is not a denial of having discussions (I presume they are). It is only a denial of "coordinated buying of MBS". What about uncoordinated buying? Still, such action would have to come from Congress, not the Fed.

And (for now anyway), I doubt that Fannie and Freddie are going to go on a garbage mortgage gobbling spree. Just because there are new higher limits at Fannie and Freddie, that does not mean that Fannie and Freddie will be taking every loan in sight.

Both are requiring large down payments and/or much higher rates on new loans, especially in distressed areas. They also have debt to income limits and require full doc.

Fannie and Freddie are likely to get into further trouble but it will likely take some time as the housing market continues to deteriorate. Indeed, the actions by the Office of Federal Housing Enterprise Oversight (OFHEO) to give Fannie and Freddie more rope in which to hang themselves are "quiet" step that will play out over time. It's not a waterfall event. Down the road, should Fannie and Freddie blow up, expect to see shareholders brutally punished, just as happened with Bear Stearns.

Mike "Mish" Shedlock
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