PrefBlog

James Hamilton of Econbrowser passes on a debunking of Shadowstats … I confess, I have not examined the issues raised very closely, but this is the sort of thing I like to see. The internet has offered looney-tunes a pulpit, which is generally a bad thing; on the other hand, it makes this kind of thinking more visible and susceptible to criticism.

You can tell where my sympathies lie, despite my professed ignorance regarding this particular issue! Assiduous Readers will remember the forecast of the end of the world last February, narrowly averted when it was shown that Armageddonists can’t read balance sheets or do arithmetic.

Accrued Interest reviews the GSE situation and sets up a straw-man proposal:

What if the Treasury agreed to guaranty the principal (not the interest) on a preferred stock offering.
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The preferreds would be callable after 5 years, with the call becoming automatic if the GSEs share price reaches some milestone. The idea would be that if the GSEs are able to issue common equity, then they would be forced to call the tax-payer backed preferred and issue their own securities of some variety.

The Treasury could charge some fee in exchange for the guaranty.
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Here are the advantages of such a plan. First, it could be implemented right away, allowing for stability in the mortgage market and likely a decline in mortgage lending rates. Second, its probably a cheaper plan for tax payers when compared with other options.
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Unfortunately, this kind of solution has a number of problems. First, it creates all kinds of moral hazard, as common equity holders wind up benefiting from the tax payers risk.
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Second, this plan doesn’t move us any closer to a more permanent solution to the problem of macro risk and the GSEs.

Well, I don’t like the plan either! I continue to feel that nothing should happen until the GSEs either fall below their regulatory minimum capital (a la IndyMac), or become unable to finance themselves in a normal commercial manner (a la Bear Stearns). Then Treasury steps in and backstops a rights issue of senior preferred shares convertible into common at a dollar, possibly with a provision that no dividend be paid on the existing and suddenly junior preferreds until some specified capital ratios are met.

Any GSE bail-out will be politically divisive enough; to take action before the last minute will simply exacerbate the attention paid to side issues while increasing the potential for future moral hazard without providing a solution that is necessarily any more effective.

And what to do now? Start drafting legislation that turns the GSEs into regular banks. And start weaning the American mortgage market off fully open mortgages with a 30-year term. That’s the root of the problem.

But stay tuned! After the markets closed, the WSJ said Treasury is Close to Finalizing Plan to Backstop Fannie, Freddie. There are no details, but speculation is rampant on, for instance, Accrued Interest, Bloomberg and Dealbreaker.

Jian Wang of the Dallas Fed writes an interesting review on VoxEU: Understanding exchange rates as asset prices and comes to a conclusion that is consistent with my understanding of the FX markets and markets in general:

In a seminal paper, Richard Meese and Kenneth Rogoff (1983) found that economic fundamentals – such as the money supply, trade balance and national income – were of little use in forecasting exchange rates, at least over short to medium time horizons. They compared existing models to an alternative in which fundamentals are excluded and any exchange rate changes are purely random. They found the “random walk” model to be just as good.
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We argue that exchange rate movements may be driven by both a permanent long-term trend and some transitory noise. These noisy terms can drive exchange rates away from their long-run levels in the short run. As time passes, exchange rates gradually move back to their long-run levels, exhibiting long-horizon predictability. In several models, such as the monetary model and the Taylor rule model in Engel and West (2005), the short-term noise is related to a fundamental that isn’t observable – the risk premium for holding a currency, for example.

Not much price action today, on reasonable volume. All eyes were on the stock market!

There were seventeen other index-included $25-pv-equivalent issues trading over 10,000 shares today.

This entry was posted on Friday, September 5th, 2008 at 8:30 pm and is filed under Market Action. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.