Working Papers

Greenspan was Right

Alan Greenspan tries to educate a deaf and dumb US Congress, 6 April 2005:

We at the Federal Reserve remain concerned about the growth and magnitude of the mortgage portfolios of the GSEs, which concentrate interest rate risk and prepayment risk at these two institutions and makes our financial system dependent on their ability to manage these risks. Although Fannie and Freddie have chosen not to expand their portfolios significantly this past year (presumably at least partly in light of their recent difficulties), the potential for rapid growth in the future is not constrained by the existing legislative and regulatory regime. It is a reasonable presumption that rapid growth is likely to resume once Fannie and Freddie believe they have resolved their current difficulties. Without changes in legislation, Fannie and Freddie will, at some point, again feel free to multiply profitability through the issuance of subsidized debt. To fend off possible future systemic difficulties, which we assess as likely if GSE expansion continues unabated, preventive actions are required sooner rather than later.


posted on 28 October 2008 by skirchner in Economics, Financial Markets

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Great article, if only more of pieces like this were available in the popular media.

I have one concern.

“If there is a role for government, it is in facilitating the re-emergence of these private markets, without crowding them out or standing in the way of the market adjustment process.”

I think this is very dangerous ground.  Which is no doubt getting trampled over.

For us to facilitate the re-emergence of these private markets, we first must understand why they’ve stopped trading.

One reason is asymmetrical information.  The erosion of trust between counterparties (not to mention unknown counterparties of counterparties counterparties).

This seems to be what regulators are focussed on.  Rebuilding that trust.  At all costs mind you.

What if there was a stronger reason that these markets have stopped trading?  That reason being, parties no longer have the funds to lend, due to great deleveraging of the financial markets.  Where all parties are deleveraging at the same time.

If regulators come up with ways to restore trust and the real problem is a lack of funds what are the consequences?

-Attempts to restore trust would be impotent in solving the problem.
-Negative aspects of these attempts would still remain.

Now perhaps regulators actually focussed on the problem of the massive deleveraging taking place.  What could they possibly do?
I cant think of anything?  Anything helpful anyway.  The market is demanding less appetite for risk.  Imagine the consequences of ignoring this… again.

Its time to pay the piper.  The pyramid scheme of over leverage and silly risk was sitting on too fragile a base.  Propping it up only increases the chances of making things worse.

Posted by .(JavaScript must be enabled to view this email address)  on  10/29  at  03:44 PM

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