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谢国忠

谢国忠博客:只说出心中真相

 
 
 

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麻省理工学院经济学博士

个性介绍: 1960年出生于上海,1983年毕业于上海同济大学路桥系,1987年获麻省理工学院土木工程学硕士,1990年获麻省理工学院经济学博士。同年加入世界银行,担任经济分析员。在世行的五年时间,谢国忠所参与的项目涉及拉美、南亚及东亚地区,并负责处理该银行于印尼的工商业发展项目,以及其他亚太地区国家的电讯及电力发展项目。1995年,加入新加坡的Macquarie Bank,担任企业财务部的联席董事。1997年加入摩根士丹利,任亚太区经济学家,2006年9月辞去该职务。

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the crisis returns  

2008-08-18 14:40:45|  分类: 言论 |  标签: |举报 |字号 订阅

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The credit crisis may soon crunch harder than ever as the U.S. mortgage industry collapses.

By Andy Xie, guest economist to Caijing and a board member of Rosetta Stone Advisors Limited


The worst stage of the creditcrisis may have arrived.  The pillars of the U.S. mortgage industry,the Federal National Mortgage Association, nicknamed Fannie Mae, andthe Federal Home Mortgage Corporation, nicknamed Freddie Mac, arecollapsing.  They are government sponsored enterprises (GSEs) and areperceived as too big to fail, as their failures would cut off fundingfor the US housing market.  They own $1.5 trillion of mortgage assetsand guarantee another $3.9 trillion, covering half of the mortgages inthe U.S.  The government has to bail them out.

The current crisis is due toexcessive borrowing for property purchases.  'Financial innovations' inrecent years purported to decrease risks to credit investors, whichallowed less capital and more debt for property purchases.  In additionto their traditional business of buying mortgages from banks forsecuritization, Fannie Mae and Freddie Mac bought new financialproducts that supported the credit derivative market.  Their supportfor the new financial products was the key to their viability, both dueto their size and their high credit rating as GSEs.  As it turns out,the risk reduction from financial innovations was an illusion.  Theperceived reduction in risk was due to the bubble that the belief inrisk reduction caused.  As these two institutions collapse, the heartof the credit bubble is exposed.  This may be the worst moment in theongoing crisis.

The crisis won't end with thecollapse and bailout of these two institutions.  More financialinstitutions like regional banks may fail. For example, IndyMac Bank, aprolific mortgage specialist that helped fuel the housing boom, wasseized July 11 by federal regulators, in the third-largest bank failurein U.S. history.  The failure may cost the Federal Deposit InsuranceCorp. between US$ 4 billion and US$ 8 billion, potentially wiping outmore than 10 percent of the FDIC's US$ 53 billion deposit-insurancefund.  Indeed, the Federal government may have to recapitalize the FDICsoon.  Some estimates put the total loss from the current credit crisisat US$ 1 trillion.  The recognized losses so far, including the lossestimates for Fannie Mae and Freddie Mac, are half that.

Even the trouble on WallStreet is far from over.  The death of the Bear Stearns doesn't giveeveryone else the license to live.  They are temporarily being keptalive by the Fed's liquidity support.  Several Wall Street institutionsmay be comatose already.  Like patients in a vegetative state, theirdeaths are all but recognized.  In one year's time, Wall Street willhave fewer players left standing.

The U.S. Treasury Secretary,Hank Paulson, announced interim stabilization measures and theintention to secure congressional authorization to bail out the twoinstitutions.  The interim measures are to sustain their operations bymaking the implicit government guarantees on their debts explicit. Investors can continue to purchase their bonds to sustain theiroperations-buying mortgages for securitization.  Otherwise, there wouldbe no financing for the U.S. housing market.  One of the interimmeasures is for the Fed to make its short-term lending facilityavailable to them.  The Fed is already lending directly to investmentbanks.  By lending directly to these two mortgage behemoths, it showsthat the U.S. is printing money to bail out its financial system and,ultimately, monetize the losses from the property price decline.

The bailouts of Fannie Mae andFreddie Mac will weaken the dollar, increase inflation, and boost bondyield.  I believe that the bailout money will ultimately come from theFed printing money or partly from the Treasury issuing bonds.  As Iargued last August, a Fed bailout would boost money supply andinflation via commodity speculation.  The U.S. can monetize the lossesfrom its financial crisis because the dollar is a global currency andmonetization causes the dollar to depreciate but not collapse.  Asinternational investors hold $16 trillion of U.S. dollar financialassets, monetization is a preferred strategy for the U.S.; foreignersmay share one third of the cost through inflation and dollardepreciation.  To stop it, foreign investors should sell U.S.treasuries now to drive up the bond interest rate sky high, which woulddeter the Fed from printing money.  So far, international investors,mainly central banks, are scared stiff and don't know what to do.  TheU.S. is taking advantage of the opportunity to stuff the world with itslosses.

As argued above, the financialcrisis is causing global stagflation.  The credit crisis bursts theproperty bubble, which depresses demand globally.  At the same time,the Fed prints money to bail out the financial system.  When the moneyflows into the financial system, speculators use it to buy commoditieslike oil.  Hence, the growth of money supply immediately turns intoinflation for the whole world.  The resulting negative interest ratesdon't help the economic growth, as it redistributes income to oilexporting economies that are already spending as much as they can. Their trade surpluses are recycled into the global financial system tocause more inflation.  This vicious cycle will end when the Fed raisesinterest rate to 6 percent and keep it there.

I do expect the Fed to startraising interest rate after the November presidential election. Fearing the economic impact, it will do so slowly first, hoping thatsmall rate hikes could scare away oil speculators.  By the second halfof 2009, it will realize that the scare tactic doesn't work and beginraising interest rate quickly.  By the end of 2009, the Fed funds ratecould be close to 5 percent.  That will cool oil price.  However, asthe economy tankers, the Fed would cut interest rate again in 2010,which would bring back the speculators.  This game of chicken betweenthe Fed and speculators will continue for many years, causing waves ofinflation like in the 1970s.  Eventually, the U.S. government wouldappoint a new Paul Volker-like Fed Chairman.  The new chairman willraise interest rate to 10 percent, crushing inflation and speculatorsfor good.  History repeats itself!

Back to the current crisis,Fannie Mae and Freddie Mac are like state-owned banks in China.  Theydepend on the perceived government backing to function.  Fannie Mae wascreated as a state-owned and operated enterprise in 1938 to combat theGreat Depression.  It basically supported numerous local Savings andLoans (S&L) that lent to small town residents for propertypurchases.  If you have watched the Christmas Movie 'It's a WonderfulLife' starring Jimmy Stewart, you would know what a local S&L wasand how vulnerable it was to an economic downturn.  Fannie Mae boughtmortgages from them to provide them with liquidity, providing funds fortheir expansion and keeping them afloat during bank runs.  In 1968, itwas corporatized with shares listed in the stock exchange, similar towhat Chinese state banks have done recently.  With the development ofmortgage securitization, its role expanded and became morecomplicated.  It bought mortgages from variety of intermediaries likebanks, finance companies, or investment banks and securitized them inthe capital market.  By leveraging the capital market, it becamedominant in the mortgage market.  To limit its monopoly power, the U.S.government chartered Freddie Mac in 1970 to compete against it.

These two institutions haveplayed an enormous and positive role in spreading homeownership -- thequintessential American Dream -- since their establishment. Homeownership is the foundation of a stable market economy.  A homeprovides the most important consumption and doubles as the mostimportant asset.  Spreading homeownership improves social stability. Hence, it makes sense for government to lend its credit to makemortgage cost as low as possible.  To control risk, Fannie Mae andFreddie Mac require the mortgages that they purchase to meet strictstandards in down payment as a share of purchase cost and householdincome to debt service ratio.  Until the current crisis, they werealways profitable.

There are three reasons thatthey have failed.  First, the risk control measures that they have arenot sufficient if property price is excessively inflated during abubble.  The U.S. home value peaked in this cycle at 170 percent of GDPin value.  Compared to the historical average of about 100 percent, thedownside was much greater than the cushion of 20-30 percent of downpayment.  As a mortgage contract is a limited liability contract underthe U.S. law, the mean reversion that is occurring now will lead todefaults by those who experience negative equity.  The Case-Schillerhome-price index dropped 15.3 percent in April from one year ago.  Thechances are that it could drop by as much in future for the meanreversion to complete.  At the end of March, the two claimed to haveUS$ 81 billion of capital or 1.5 percent of their assets.  Obviously,when property price may decline 30 percent on average, it is easy tosee that they will lose more money than their capital.

Second, as GSE's, they arecalled upon to do public services.  After the subprime crisis began inAugust 2007, politicians called them to stabilize the market.  Withoutother buyers, they became buyers of the last resort in the mortgagemarket.  In the first quarter, they bought or guaranteed 81 percent ofall mortgage securities in the first quarter.  At a time like this, themortgage securities on offer are probably dubious in value, asfinancial institutions try to unload the worst assets in theirinventories.  While it is too early to assess how much their financiallosses stem from their public service, it is a significant factor inpushing them under.

Third, as GSEs, they cannotoperate effectively in a complex financial world.  Like China'sstate-owned enterprises, their employees are similar to civilservants.  The employees on Wall Street who manufacture and sellcomplex financial products are highly paid.  Their employees areprobably not well equipped to understand the products that Wall Streetoffers to them.  Hence, Wall Street is probably incentivized to takeadvantage of their ignorance.  Some of the short sellers of theirstocks told me that they didn’t know what they bought.  I am not in aposition to assess this view.  But, considering how Wall Street takesadvantage of anyone it can, Fannie Mae and Freddie Mac were probablythe biggest suckers in the credit bubble that Wall Streetmanufactured.  Of course, as government enterprises, the government ison the hook for their losses.  As the Fed monetizes its losses, all thedollar holders in the world become suckers.

Many pundits attack Fannie Maeand Freddie Mac on ideological grounds, calling them socialistcreatures.  I don't think that these two institutions are fundamentallyflawed and should exist.  Spreading homeownership is the best supportfor a stable market economy.  A home is both the most important thingto consume and the most important asset.  Making financing availableand at lowest possible cost generates significant externalities thatjustify government intervention.  When most households own their homes,a neighborhood functions better as everyone is mindful of their homevalue.  The synergy effect makes homeownership justifiable forgovernment intervention.

The U.S. system for supportingthe housing market worked reasonably until the current cycle.  The riskcontrol measures worked well during the previous cycles.  The twoinstitutions have benefited mortgage borrowers by lowering theirinterest rate.  They basically grant the government credit ratings tomortgage borrowers.  As long as the risk control measures work, it's avirtuous cycle for both mortgage borrowers and the government.  Amongthe three reasons that I cited above for their failures, the last oneis key.  By buying complex financial products from Wall Street, theyprovided the ammunition for the bubble.  Government enterprises simplydon’t have the capability to understand complex financial products. I'm worried that China's state owned financial institutions are tooeager to mix with Wall Street and may be making the same mistake.

This financial crisis ischaracterized by rolling explosions in the financial system.  There areno nuclear explosions that expose the problems and mark the bottom.  IfFannie Mae and Freddie Mac were allowed to go bankrupt, it would be thenuclear explosion to bring the market to the bottom.  Of course, theU.S. government is bailing them out.  The crisis will drag on.  Incontrast, during the Asian Financial Crisis in 1998, Asian countriesdevalued their currencies by half and their stock markets dropped byover half.  Their asset markets shrank quickly by three quarters inU.S. dollar terms.  Their banks went bankrupt quickly.  Over arelatively short period of time, markets were confident that the crisisbottomed.

The difference is that theU.S. borrows money in its own currency.  When foreigners want theirmoney back, the Fed can print more money to pay them.  For a normalcountry, in anticipation of currency oversupply, the exchange ratewould collapse, triggering hyper inflation.  Russia experienced thiswhen it tried to print money to pay off debts ten years ago.  But, thedollar is a global currency.  The world economy has fundamental demandfor dollars.  Hence, we cannot run out of dollars completely.  Printingmoney can be an effective strategy for the U.S. to pay for the lossesfrom the crisis.

The sluggish pace of thecrisis development is due to the complex credit products that bury theleverage built up during the bubble throughout the financial systemaround the world.  One explosion leads to another.  But, as manyfinancial institutions don't mark to market their assets and those thatdo can fudge accounting, the truth takes time to come out.  This is whythe rolling explosions are prolonged.  Also, it creates difficultiesfor us to judge when the crisis is over.  It may take an extra sixmonths before people realize that the crisis is over.  It takes thatlong without a major explosion for people to believe.  Hence, forbottom fishers, there is no urgency for timing the market.

The dragging of the feet bythe U.S. government and financial institutions is possible because ofthe dollar's special status.  The leverage in the U.S. has been builtup with foreigners' money but in U.S. dollars.  The Fed can print asmuch as it wants to plug losses from each explosion.  Foreigners whosemoney is on the line have no say in this matter.  For the U.S., thetradeoff comes from the income loss from rising oil price and the freemoney for covering the financial losses.  The U.S. imports over 10million barrels per day.  If the oil price rises by ten dollars, theU.S. loses $36 billion in a year.  As long as this loss is smaller thanthe benefit for covering the financial loss, the Fed will keep printingmoney.

As long as the Fed keepsprinting money to deal with the U.S. financial crisis, oil, gold andcommodities will do well, bonds will do poorly.

 


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