Month in review: May, 2006
[Previous months in review: Apr, Mar, Feb, Jan, Dec-05.]
May’s big news was the ever-unfolding Fannie Mae scandals, which compelled me to devote three posts to the basis of government-sponsored enterprise (GSE) economics.
The things we can make with money …
Because the GSE have an implicit Federal guarantee of their securities, they can always achieve a lower Weighted Average Cost of Capital, so that within the Primary and secondary loan markets, the GSEs have a proprietary earnings engine, whose profits they can further boost by balance-sheet turbocharging.
As a thought experiment, let’s presume for the moment that evil Lex Luthor become the next Fannie Mae CEO.
Luthor would extract maximum value for minimal cost by turning each knob to its maximum setting. Luthor would set his lending interest rates with the tiniest advantage possible relative to the competition; five or ten basis points maximum. Our economically insatiable Lex Luthor would want all the volume he could secure, by means fair, foul, or scurrilous.
“We should be freely able to compete in every market.”
“What’s good for Lex Luthor is good for the country,” he and his followers would repeat at every possible moment and in every possible context. If, as Verbal Kint suggested, “The greatest trick the Devil ever pulled ever pulled was convincing the world he didn’t exist,” then Luthor’s greatest political triumph would be to make himself (and Mr. Mxyzptlk) invisible, so beloved and apolitically altruistic that his continued existence would be taken for granted — and then he would return to running the earning engine as fast and as hard as ever he could.
“And like that” — poof! — “he’s gone.”
All of this is a prelude to the extraordinary lashing Fannie Mae received from OFHEO: Blasting Fannie Mae:
When the scandal’s full history is written, OFHEO’s report may well prove the turning point, for its language is uncompromising and unrelenting:
“The image of Fannie Mae as one of the lowest-risk and ‘best in class’ institutions was a facade,” said [OFHEO Acting Director James B.] Lockhart. “Our examination found an environment where the ends justified the means. Senior management manipulated accounting; reaped maximum, undeserved bonuses; and prevented the rest of the world from knowing. They co-opted their internal auditors. They stonewalled OFHEO.”
Can’t you see we’re disclosing everything we can?
Over and over, the language is extraordinary — unprecedented in my thirty-year career. I predict there will now be calls to ‘privatize’ Fannie Mae and Freddie Mac by canceling their Federal charters and severing all their Federal benefits, which cost taxpayers $6-10 billion a year.
If not, there should be.
If you think that’s harsh, review Fannie Mae: the story so far.
I’ll have much more to say about this when I’ve properly reorganized the OFHEO report so it demonstrations not just the actions but the means, motive, and opportunity.
On the purely local level, we examined the tensions around assessment in Who pays property taxes?, the question of abutters’ rights (if any?) to contest zoning changes in Do the neighborly thing: Part 1 and Part 2, and the consequences of inflexibility in Housing demography: what, you’re leaving?, confirmatory evidence that
Does the micro implies the macro? Starting very small, in a four-part series from the birthplace of American apartments,
DeSoto’s dryer, Part 1 and Part 2 on smuggled appliances in Big Apple co-ops, Part 3 on the gradual eighteenth and nineteenth-century formalization of American informal settlements, and concluding in Part 4 with some principles that might usefully apply to our current immigration debate.
All of these secondary effects are harmful. They all make the ecosystem worse. Cheating, subornation, connivance and evasion, avoidance enabling, tacit accomplices, and emigration — they’re all bad for cities and civitas.
The harm extends beyond our little building. Since the installers and installee both wish to conceal the washer-dryer’s installation, they collaborate to short-circuit normal consumer protections (building permits) and the installee forfeits the normal warranty protection because the vendor can always blow the whistle. An overly restrictive rule leads to violation that forfeits legal and regulatory protection. The rule of law and administration is thus eroded.
In May I applauded the great work of Kurt van Kuller, the housing analyst I read, Part 1 and Part 2, while his great predecessor Sherlock Holmes laid out investment banking principles of The financing quilt: the Musgrave Ritual, Part 1 and Part 2.
Key principles of financial structuring
“Assembling the financing quilt”
1. Start with the safest capital, move gradually to the riskiest.
2. Typically, each piece of capital takes one and only one major risk. Each source has a different mixture of collateral and guarantee requirements.
3. Debt commitments are normally secured before equity commitments.
4. Any earlier (non-amortizing) commitment is predicated on a takeout forward commitment.
5. Each earlier loan is lower leverage than its successors.
6. Each earlier loan is higher cost (spread over the safe rate) to reflect the risk premium.
7. Each boundary between capital sources involves negotiating changes in guarantees, commitments, and equity obligations.
8. The price of control is risk acceptance.
9. Maximum leverage equals lowest average cost but highest risk volatility.
With politicians fiddling, the shape of New New Orleans becomes ever clearer, NNO: what rough beast slouches toward birth, while for some who left the
Saint Expedite, patron saint of New Orleans?
I opened the month with a curious tale of residents worried about being displaced from their Mobile home sweet what? Part 1, and Part 2, and continued the story in June: Mobile loopholes? Part 1 and Part 2.
