Wednesday, January 11, 2012

"Loss allocation" as government policy

This is usually the sort of thing that I just post on my Twitter feed and let pass, but given my past rants against the Fed, I can't let their most recent acts of political activism go unmentioned. Rather than do my own ranting, though, I'll let the king of blog ranting (Karl Denninger) take over. He absolutely goes after the Fed here (mimicking the Wall Street Journal), and deservedly so.
There's a point at which The Fed's actions reach into the realm of rank politicking and attempts to protect their "chosen many" from their own foibles; we've certainly seen plenty of games played in the last three years.
But this paper, sent to Congress unsolicited, apparently went too far for even the Journal's bankster-crank-stroking reflexes.  Among other things it said:
In this report, we provide a framework for thinking about directions policymakers might take to help the housing market. Our goal is not to provide a detailed blueprint, but rather to outline issues and tradeoffs that policymakers might consider. We caution, however, that although policy action in these areas could facilitate the recovery of the housing market, economic losses will remain, and these losses must ultimately be allocated among homeowners, lenders, guarantors, investors, and taxpayers.
This is where the problem is, of course.  Where does the government get the right to "allocate losses" through interventions?  The dirty little secret about the housing mess is that:
  • The Fed was largely complicit in causing the housing bubble.  In fact, Greenspan intentionally stoked this speculative orgy and further, both he and Bernanke intentionally averted their eyes from the monstrous credit expansion that "maintained" economic output and which was utterly unsustainable -- a mathematical fact that was obvious to anyone who bothered to look at the very data The Fed maintains!  In other words The Fed is now trying to find ways to evade responsibility for what it did
  • The losses are real but being hidden by further Fed actions!  Just one example is the hundreds of billions of dollars of second lines (Home Equity and "Silent Second" mortgages) that are behind underwater, non-performing first line mortgages.  These have an actual net present value in a foreclosure of zero, as they're not entitled to one penny of recovery until every dollar of the first is satisfied, and the first is underwater and thus will not be fully recovered.  All of our large banks have monstrous exposures in this regard -- almost none of these loans were securitized and thus they are all sitting on bank balance sheets, most at nearly 100 cents on the dollar.  These accounting values are fictions.
The reason that The Fed and our Government are desperate to hide these losses, praying for a miracle to somehow keep them from being recognized, is quite simple -- these long-duration investments are typically held by insurance companies and pension funds.  Recognition of these losses will cause the allegedly "healthy" firms and funds that hold this paper to be shown to be severely impaired or worse.
Denninger is absolutely dead on here, and I really have little to add. Our federal government (along with the Fed) has increasingly decided that it is their job to determine winners and losers in the economy. "Loss allocation" is not a central government function, nor should it be. The potential for unintended consequences and conflicts of interest is simply too high, a fact that some people in government still recognize and appreciate.

We can hide these losses as long as we want, but sooner or later it's clear where they will end up--on the backs of taxpayers, those who are paying the least attention. If you don't explicitly refuse to take these losses, you're going to end up with them by default. Therefore, ignore these games that the Fed is playing at your own peril--it's your money that's at stake.

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