[Reuters Reports] Federal Discount Window Open to Fannie and Freddie [and then backs off the story].

[According to a Reuters story, reported on CNBC about 2:45pm ET:]The Federal Reserve discount window is now open to Fannie Mae and Freddie Mac. Both stocks, which were down by huge percentages, began climbing. And the Dow has moved from down 250 points earlier today to down 100 points at 2:50ET.

UPDATE: Now Reuters is backing off the story and the DOW, which went positive at about 3:05pm ET, is off 140 points at 3:40pm ET. This week, rumors are flying on Wall Street (there was a phony one about Lehman earlier this week).

Rather than tell us were Fannie, Freddie and the Dow have been, how about telling us where they are going, so we can get our bets down?

And for those who might not care to place a c-a-s-i-n-o bet on markets, please say how we should apprehended what is going on with our economy now, using a scale of 1 to 10 to say how good/bad things really are, 1 being absolutely sanguine and 10 being reading for the next Great Depression. A 6.5?
7.11.2008 3:13pm
Just learned that the VC's spam filter block posts that may be touting gambling opportunities. The word for a "public room or building for gambling and other entertainment" appears to be impermissible for that reason, hence I had to go with "c-a-s-i-n-o."
7.11.2008 3:18pm
Benjamin Davis (mail):
Oh that good old affirmative action for the rich and powerful whose greed put them in a financial bind - how about opening the window to poor folks who are struggling too?

I know that can only be seen as a joke in these times but figure I would put it here for all the folks who piously talk against intervention by the feds as they take their student loans (a comment I once heard by a beneficiary of a bailout to a group of Harvard law students).

There is the old adage that if you owe the bank 100 dollars you do not sleep at night, but if you owe the bank 100 million dollars, they don't sleep at night.
7.11.2008 3:22pm
Jim at FSU (mail):
I do not know much about securities law. What is this federal window that people speak of?
7.11.2008 3:36pm

Oh that good old affirmative action for the rich and powerful whose greed put them in a financial bind - how about opening the window to poor folks who are struggling too?

How about Fannie Mae is that window for "poor folks who are struggling" to buy a home in the first place. See, e.g., this 2003 speech by William Poole, then-President, FRB St. Louis. Or the consideration that the federal government bears some responsibility for maintaining systematic stability - the "unit of commerce is the nation" idea taught in 1L ConLaw - but does not bear responsibility for individual economic issues. Your comment is particularly ironic given that much of the current systematic instability is attributable to loans benefitting those same "poor folks."

If you detect tone, it's because the economically ignorant poverty-pimp/class warfare/blame-it-on-the-rich routine quickly grows old.
7.11.2008 3:46pm

A financial institution can suffer what is known as liquidity insolvency, in which it has insufficient liquid resources to pay debts as they come due, i.e., it may be balance sheet solvent, but unable to efficiently liquify those assets quickly enough to make payments to creditors. When a major financial player loses liquidity, it can spread rapidly to other major financial players who were depending on payments from the first financial institution or depending on obtaining credit that is now unavailable on the market. This is known as a "contagion." The solution is that the Fed acts as a lender of last resort, such that an institution suffering liquidity problems can obtain loans through the Fed; this is the "discount window."
7.11.2008 3:52pm
Cactus Jack:

The Discount Window? It's bar off of 20th street in foggy bottom. It's legendary for its half-smokes, homebrew and free money giveaways. They have a ben bernanke look alike contest during happy hour on Fridays. Rumor has it that bernanke himself often enters, but to date has not won.
7.11.2008 3:53pm
I don't really see how opening the discount window solves the problem.

FNM and FRE have not had a problem raising cash in the short-term (like Bear Stearns did). The GSEs are highly concentrated in increasingly worthless mortgages that they have to write-down, which requires them to raise additional capital. Accessing the discount window won't solve that problem.
7.11.2008 4:26pm
Benjamin Davis (mail):
I guess they retracted it but to keep at it.

So mortgages get made, get bundled and get sold to investors (not poor people) in the financial markets. Everything takes a dive as the poor people can not pay so who gets the bailout? The poor people who lost their house?

Poor folks got the loans - the banker who sold the loans and got the fees that made all the money should be protected when the banker was indifferent to credit risks or did not lay them off in a reasonable manner? Isn't that rewarding incompetence?

Yeah - I know Fannie Mae bailouts are all about helping out all the poor folks on their mortgages. Right.

And of course stability in the financial sector is SO important but instability for the folks losing their houses is - well, their own fault.

How about this? Fannie Mae does not get the government handout, declares bankruptcy, goes into receivership, and gets its house in order or liquidates. Other companies can buy back Fannie Mae assets at a prayer. Creative destruction in capitalism. The market dives and people lose jobs on Wall Street because of their taking far too many risks in search for returns. People stop being bankers and go off to do something else. Wall Street bankers learn as each household has to learn that - there is a downside.

I know that kind of market discipline is too hard for folks who preach toughness and self-reliance for the poor.

But what's good for the goose is good for the gander goes up and down the income levels.

Or, here is another thing. How about the government just taking the billions and paying off the mortgages of as many of those poor people as they can and keeping them in their homes because it is better for neighborhoods (social cost benefit type analysis) to have families in there houses rather than be boarded up (did you hear that in some neighborhoods in Detroit bears have started to come back because they have become such ghosttowns?).

I know what I speak is heresy to most of you and no doubt there will be wonderful arguments on efficiency raised against it.

But, the point I am trying to make is that just because rich people have the power to get special treatment does not mean that that special treatment is not something that can be imagined or given for the disadvantaged.

7.11.2008 4:35pm
Ben, don't you read the financial pages? Huge numbers of mortgage bankers, originators, underwriters, investment bankers, real estate lawyers and financial services executives have lost their jobs. Do you feel better?
7.11.2008 4:57pm
Benjamin Davis (mail):
I just hope the ones being fired are the ones who made the dumb decisions (and without their golden parachutes). Having listened to the tapes of the old Enron guys and there absolute disdain for the pain caused ordinary people, I do not lose sleep at night for sharks who got burned (floundered? mixing metaphors) in a bear market. Sharks, burned and bears oh my!
7.11.2008 5:37pm

Fannie Mae does not get the government handout, declares bankruptcy, goes into receivership, and gets its house in order or liquidates.

There is a reason why certain major financial players, i.e., insured banks, are not allowed to declare bankruptcy. See 11 U.S.C. Sec. 109. That major financial companies and GSEs are permitted to do so is a serious defect in the bankruptcy code. If you want to make sure that no one - rich or poor - has a job, and that no one - rich or poor - can get a mortgage, invoke an automatic stay for an organization like Bear Stearns or Fannie Mae. Or have you not thought about the consequences of doing so? If you do have a serious answer to this problem, I would certainly like to read it.
7.11.2008 5:39pm

Ben, don't you read the financial pages?

For some reason, I doubt it.
7.11.2008 5:40pm
byomtov (mail):
This week, rumors are flying on Wall Street

Rumors??? On Wall Street??? No!!!
7.11.2008 6:03pm
My God, Ben! Have you no respect for the sanctity of a business contract?
7.11.2008 6:27pm
"I just hope the [financial services workers] being fired are the ones who made the dumb decisions"

Alas, that isn't the way "creative destruction" works--it doesn't go by individual merit. If you are in an enterprise or an industry that is being "creatively destroyed," you just lose. That is one reason why many people find the free market so distasteful.
7.11.2008 6:38pm
Or have you not thought about the consequences of doing so?

The free market has a chance to work?
7.11.2008 7:07pm

For someone who bemoans "economically ignorant" arguments, you display a surprising lack of economic literacy yourself. First of all, "liquidity insolvency" is a term that exists solely in banking law, and is economically meaningless (and widely mocked). Second of all, you can't "liquify" assets; you liquidate assets. I'm surprised you haven't picked that up from all your reading of the financial pages. Finally, Fannie isn't even remotely like a discount window for "poor folks who are struggling." Fannie and Freddie don't even make home loans; they operate exclusively in the secondary mortgage market. Moreover, they only buy conforming loans.

And if you detect tone, it's because the whole "I've taken a few classes on banking and securities law and therefore I'm an expert on financial markets" routine also quickly grows old.
7.11.2008 8:38pm
Perseus (mail):
How about the government just taking the billions and paying off the mortgages of as many of those poor people as they can and keeping them in their homes because it is better for neighborhoods (social cost benefit type analysis)

If you want the government to dole out subsidies to all of the financially imprudent people who took out mortgages they really could not afford, why not have the government dole out subsidies to all of the more financially prudent people who have been renting and saving while waiting for housing prices to decline to less bubblicious levels?
7.11.2008 10:01pm
Benjamin Davis (mail):
Assuming Anon Law Student has the law right, does anyone find it so convenient for banks not to be allowed to go into bankruptcy? Bankers sure are able to wield that power to make sure the way out is they get bought out as opposed to going belly up. Provided they are big enough!

After all the efforts by the banks to dismantle the protections between commercial and investment banking (Glass-Steagal Act and all that) so they can get into more profitable (read risky) business, it seems to me that the downside risk for the bank leaders should be commensurate. When they get bought out and merged like this in the name of stability, I am just not convinced that is the best discipline. Or, maybe, if that special treatment is ok for them, then let us think more broadly about special treatment to other persons in difficult straights.

All the people who are paying off their loans in these hard times and were prudent probably have a decent credit rating too and the market is barking at their doors to keep them. The one's who lost everything will have the bailout information on their credit rating making it very hard for them to get new credit - but stabilizing their neighborhoods. I think the credit report incentive is strong enough for the reasonable people to see an incentive to be where they are.

As to the people who got in trouble, maybe what we need to do in the mortgage arena is move to a method of interpretation of these contracts that follows the reasonable expectations doctrine - a provision will be interpreted with the reasonable expectations of a borrower. This is a doctrine from insurance contracts that maybe should be expanded in these boilerplate type contracts to help avoid persons facing these kind of form contracts (like insurance) from being taken by terms that are against what a reasonable person would expect.

I know there are people out there who read every word of these documents. However, I sometimes feel these contracts are like reading Stephen Hawkings (sp?), A Brief History of Time where I understood every word I read and then completely missed what was going on in some of the sections (26 dimensional universe - still trying to get my head around that).

The interaction of different parts of the contract are not really intelligible to the average person. And I suspect the banker eager to make the loan is not giving the kind of clear advice that people want.

I will give you an example from myself from a car loan. When I bought a car three years ago, I purchased it with no money down. I also bought gap insurance in case the car was totalled to cover any unpaid balance after insurance would have paid for the totaled car. The original credit was through the dealer credit company. Later I went to my credit union and found I could refinance the loan and get a smaller payment at a lower rate for the car loan. My son totaled the car two weeks ago (fortunately everyone is OK). I called about the gap financing and found out (yes, I know all you smart people out there who know this are gloating) that the original gap financing from the dealer would not apply to the credit union gap because of the refinancing. So then I asked the credit union whether I could have bought the gap financing from them when I got the refinanced loan. I found out (two or three years late granted) that I could have gotten that too. So what a dummy I am - this is the second time buying car and first time totaled. The point being here that the uninitiated keep learning the hard way. So let bankers learn the hard way too.

Another example that my landlord told me. There was a real estate dealer who sold houses as land contracts. Under the land contracts a person put down a big non-refundable deposit (say $5000) to get in the house and had a period of say three months in which to get the financing to purchase the house (roughly this is the deal). So the person selling the land contracts would focus on people with weak credit to do this with. So what happens, the person who moves in keeps the place nice because it is their home. They go around seeking the loan to pay for the house and no bank will lend them the money. So they end up having to leave after three months and the guy who sold them the place on land contract pockets the $5000. A house can be flipped like this four or five times a year - an easy $20 000-25 000. Preying on people's hopes and dreams.

Yep all these dumb people who are trying a way to have their American dream and being preyed on for fees and everything. Hey, my empathy is for them getting bailed out and not the "clever by half" types who really think we are a bunch of hicks here to be fleeced. My empathy is with the hicks just trying to live a decent life.

The point I am making is that what is normally done and what is the current normal is not necessarily the best normal - it's just one way of doing it and I doubt it is a way that takes care of the broader interests of the average American.

7.11.2008 10:52pm
Benjamin Davis (mail):
On reading the financial pages, yeah I read them but every time I read the nonsense on the WSJ editorial page, it just turns me off. Went to Harvard Business School 25 odd years ago and I know the folks I am talking about. Gordon Gecko was a sweetheart compared to many of these guys and gals. Let me tell you something - at the top of international capital there are only two things that are of interest 1) what increases sales 2) what decreases costs. There is nothing else - no value, no social norm, no philosophical point of view, no religious thing - NOTHING. Trust me I have been there and seen those folks and I will guarantee you that if you think there is anything meaningful there you are mistaken. It was a good lesson for me when I worked at the World Business Organization or the International Chamber of Commerce.
7.11.2008 10:57pm
Grover Gardner (mail):
Are you going to leave these comments open for more than a few hours, Jim, or should we rush to get our sound bites in?
7.12.2008 12:36am

(1) Fannie Mae - through its purchase, guarantee, and repackaging of loans - is what allows those "poor folks" to obtain loans that no bank could justify keeping on its own books quality-wise, and in quantities not available through a traditional depository lender system. Hence the reason Mr. Poole notes the existence of a mortgage market as a causal factor for the increase in stock and quality of housing, while attributing a significant role in the creation of that market to the GSEs.
(2) The concept of liquidity insolvency applies to any institution that has long-term assets that are difficult to liquidate in the short term. In recent months, this has taken the form of subprime mortgages that are difficult if not impossible to value. They have some value, but no one knows exactly what that value is for lack of a model, hence no one will buy them.
(3) Fannie Mae also has another issue with liquidity: it finances long-term assets with short term debt obligations. According to the NYT, Fannie Mae has "$769 billion in obligations on its balance sheet, and $896 billion in off-balance-sheet guarantees." As of 2003 (I'm too lazy to find more recent data), 45% of these debt obligations are due within one year. One should note that the financing long-term assets with short-term debt has caused significant problems in the past.

On a personal note, I never took "a few classes on banking and securities law" while I was in law school. I am, however, well enough read to see populist economic prattle for what it is. When a man who purports to be a law school professor prattles on about how an institution should be required to file for bankruptcy, but has to "assume" that someone else correctly interpreted the relevant portion of the bankruptcy code, I categorize that as prattle to be called out. My appologies for the incorrect use of "liquify."
7.12.2008 1:04am

Fannie and Freddie only securitize conforming loans; they don't securitize "loans that no bank could justify keeping on its own books quality-wise." Conforming loans have to meet Fannie and Freddie's underwriting guidelines, which set a maximum LTV, a total debt-to-income ratio, documentation requirements, etc. The "poor folks who are struggling" aren't the ones getting conforming loans, so it's hard to argue that Fannie and Freddie are like a discount window for poor people. The GSEs only very recently started to buy certain subprime mortgages, and that was only to help the financial markets unload subprime-backed securities, not to expand poor people's access to credit -- if anything, poor people's access to credit has deteriorated since the GSEs started buying subprime mortgages.

Of course the GSEs played a big role in expanding the stock of housing -- that's what secondary market-makers do. But that has nothing to do with your argument, which was that the GSEs are like a discount window for poor people. They're nothing of the sort.

I know what "liquidity insolvency" is supposed to mean. In economics (and every other field except banking law) we call it a "liquidity crisis." Also, all banks, by definition, finance long-term assets with short-term debt -- that's the whole reason banks exist. It's not unique to the GSEs.
7.12.2008 2:53am
Mr. Davis seems to think it some sort of benefit to banks to be prohibited from filing for bankruptcy. It isn't. Failing banks are taken over by the appropriate regulator, the equity holders are wiped out, and the depositors with over $100,000 on deposit may also lose. (I hope Mr. Davis is careful where he puts his money, if he has more than $100,000.) It's a benefit to a company to be able to file for bankruptcy, where the company can propose a plan of reorganization under Chapter 11 or at least liquidate under Chapter 7.
7.12.2008 8:35am