HUD Provides $54 Million to Help Missouri Recover from Last Year’s Severe Storms

WASHINGTON – U.S. Housing and Urban Development (HUD) Secretary Shaun Donovan today allocated $400 million in emergency aid to help communities in eight states to recover from presidentially declared natural disasters in 2011.

‘Too Big To Fail’ Delaying Recovery, Undermining Public Trust

The
Federal Reserve Bank of Dallas recently published an essay titled Choosing the Road to Prosperity: 
Why We Must End Too Big to Fail – Now”
written by its Executive
Vice President and Director of Research Harvey Rosenblum.  This is part two of a summary of that essay.  Part one can be found here: Is Fed Endorsing Ending to Too Big to Fail?

When
financial institutions started to fail and credit froze in 2008 the Federal
Reserve used the customary tools to get the economy moving again, first cutting
and keeping the federal funds rate – what banks charge one another for
overnight loans – close to zero.  This
usually makes short-term credit available at lower rates, driving borrowing by
consumers and businesses while pushing up the value of assets thus bolstering
business balance sheets and consumer wealth. 
Declining rates drive down the dollar making U.S. exports cheaper and
more attractive overseas as long as other countries don’t also drive down
rates.  Second, the Fed has injected
billions of dollars into the economy by purchasing long-maturity assets on a
massive scale, pushing long term rates down as well.  While this reduces the burden on borrowers it
punishes savers, especially those who depend on interest payments.

While
growth restarted in mid-2009 it has been tenuous and fragile and stock market gains
while large have been volatile.  Job
growth has been disappointing with only a third of the jobs lost to the
recession regained.

“The
sluggish recovery has confounded monetary policy.  Much more modest Fed actions have produced
much stronger results in the past.  So
what’s different now?”  Part of the
answer is excesses that have not been wrung out of the system including falling
house prices that continue to drag down the housing market.  “The Too Big to Fail (TBTF) banks remain at
the epicenter of the foreclosure mess and the backlog of toxic assets standing
in the way of a housing revival.”

Another
part of the answer is the monetary policy engine is not hitting on all
cylinders.  Low federal funds rates haven’t
delivered a large expansion of credit because if one part of the economy isn’t
functioning properly it degrades the performance of the rest.  Some contributions to recovery such as asset
value and wealth have been weaker than expected partly because burned investors
are demanding higher-than-ever compensation for risk.

Recovery
also requires well capitalized financial institutions and the machinery of
monetary policy haven’t worked well because of TBTF.  Many of the biggest banks still have balance
sheets clogged with toxic assets while smaller banks are in much better shape
either because they didn’t make big bets on mortgage-backed securities, derivatives
and other risky investments or if they did they have already failed. 

Injecting
capital into the system as the Fed did in 2008 was necessary but one downside
was a residue of distrust in the government and the banking system and an
erosion of faith in American capitalism
It showed ordinary workers and consumers a “perverse side of the system”
where they see that normal rules of markets don’t apply to the rich, powerful,
and well connected.  TBTF violated basic
tenants of a capitalistic system. 
Capitalism requires:

  • The freedom to
    succeed and the freedom to fail. Hard
    work and good decisions should be rewarded; more importantly, bad decisions
    should lead to failure.
  • Government to
    enforce the rule of law. This requires
    maintaining a level playing field. TBTF undermines equal treatment, reinforcing
    the perception of a system tilted in favor of the rich and powerful.
  • Accountability. The perception and reality is that virtually
    nobody has been punished for their roles in the financial crisis.

The
economy faces two challenges.  The short
term must focus on repairing the mechanisms so the impacts of monetary policy
will travel through the economy faster and with greater force.  In the long term the country must ensure that
taxpayers won’t be on the hook for another massive bailout.  Both challenges require dealing with the threat
posed by TBTF institutions.

The
government’s main response to the crisis was the Dodd-Frank Wall Street Reform
and Consumer Protection Act and its effectiveness will depend on its final rules.  The lack of regulatory certainty has already
undermined growth and is delaying repair of the lending and financial markets
parts of the monetary policy engine. 

Policymakers
can have the most impact with Dodd-Frank by requiring banks to hold more
capital, “tacking on additional requirements for the big banks that pose
systemic risk, hold the riskiest assets and venture into the more exotic realms
of the financial landscape.”  Capital
cushions should be tied to size, complexity, and business lines and give TBIF
institutions more skin the game and restore market discipline.  Small banks didn’t ignite the regulatory
crisis and shouldn’t face the same burdens as big banks that follow risky
business models.  TBTF banks’ sheer size
and their presumed guarantee of government help provided a significant edge –
perhaps at least a percentage point – in the cost of raising funds.  Making them hold more capital will level the
playing field among banks.

Higher
capital requirements will require the biggest banks to raise equity through
stock offerings or by retaining earnings through reduced dividends.  “Banks that clean up their balance sheets
will have a better chance at raising new funds while laggards will find it more
difficult and may further weaken and need to be broken up, their viable parts
sold off to competitors.  It is important
to redistribute these assets so as to enhance overall competition.”

While
the near-zero federal funds rate helped many banks’ capital rebuilding process
it could be argued that the zero interest rates are taxing savers to pay for
recapitalizing those who caused the problem in the first place.

Unfortunately
the sluggish recovery is a cost of the long delay in setting new standards for
capital
.  Given the urgent need to
restore growth and a healthy job market “the guiding principles for bank capital
regulation should be:  codify and
clarify, quickly.  There is no statutory mandate
to write hundreds of pages of regulations and hundreds more pages of commentary
and interpretation.  Millions of jobs
hang in the balance.”

As
part of its strategy to end TBTF, Dodd-Frank expanded the role of regulators
and added new ones, in effect shifting responsibility from the Fed to Treasury
and injecting politics into the mix.  The
current remedy for insolvent institutions, i.e. FDIC resolution, works well for
smaller banks but TBTF rescues over the last three decades have penalized
equity holders while protecting bond holders and bank managers.  Disciplining the management of big banks,
just as happens at smaller bank, would reassure a public angry with reckless
behavior necessitating government assistance.

The
question remains whether the new resolution procedures will work in the next
crisis.  Because big banks often follow
parallel practices, odds are that several will get into trouble at the same
time and this might overwhelm even the most far-reaching regulator scheme.  TBTF might become TMTF – too many to fail –
as happened in 2008.

A
second issue is credibility.  The
Implicit guarantee imputed to Fannie Mae and Freddie Mac became explicit for
them and for big banks when the federal government did indeed come to their
rescue.  Words on paper only matter when bankers
and their creditors actually believe that Dodd-Frank puts government out of the
bailout business although the new law has begun enforcing some market
discipline.   “The credibility of Dodd
Frank’s disavowal of TBTF will remain in question until a big financial
institution actually fails and the wreckage is quickly removed so the economy
doesn’t slow to a halt.  Nothing would do
more to change the risky behavior of the industry and its creditors.”

The
survivors of 2008 have not changed; their corporate cultures remain based on
short -term incentives of fees and bonuses, they have the lawyers and money to resist
federal regulation and, their significant presence in dozens of states confers
enormous political clout.

The
Dallas Fed has advocated breaking up the nation’s largest banks into smaller
units but it won’t be easy.  There are
thorny issues about how to reduce the size of banks; the level of concentration
deemed save will be difficult to determine, and the big financial institutions
will dig in to challenge any breakups. 
But a financial system composed of enough banks to ensure competition in
funding businesses and households with none big enough to put the overall
economy in jeopardy will give the country a better chance of navigating through
future financial difficulties and this level playing field will restore faith in
market capitalism.

As
stated at the beginning, the problems that periodically roil the financial
system are the result of complacency arising from sustained good times, greed
and irresponsibility that run riot without market discipline, the exuberance
that overrules common sense, and the complicity of going along with the
crowd.  These are natural to humans and
we cannot eliminate them, merely be alert to them.  But concentration in the financial sector is
not natural but rather the result of artificial advantages including that some
banks are TBTF.  Human weakness will
cause market disruptions; big banks backed by government turn them into
disasters.

Dodd
Frank hopes to eliminate TBTF but the new law leaves the banks largely intact
and they remain a danger to the financial system.  “The road to prosperity requires
recapitalizing the financial system as quickly as possible.  The safer the individual banks, the safer the
financial system.  The ultimate
destination-an economy relatively free from financial crises-won’t be reached
until we have the fortitude to break up the giant banks.”

…(read more)

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Is Fed Endorsing Ending to Too Big to Fail?

Annual reports from financial
institutions rarely make the best seller list, but the one published by the
Federal Reserve Bank of Dallas is beginning to rocket around the Internet
because of an essay it contains.  The
essay, written by Harvey Rosenblum, Executive Vice President and Director of
Research at the Bank is titled “Choosing the Road to Prosperity:  Why We Must End Too Big to Fail – Now.

The essay is stunning enough in and by
itself, but in an accompanying cover letter the Dallas Fed’s President Richard
Fisher expressly endorses it, in effect putting at least a part of the Federal
Reserve System on record as advocating an end to Too Big to Fail (TBTF) institutions. 

“In addition to remaining a lingering threat to
financial stability,” Fisher says, “these mega banks significantly hamper the
Federal Reserve’s ability to properly conduct monetary policy.”  Likening the economy to a car he said that
the Fed had filed the tank with plenty of cheap, high-octane gasoline, but it
takes more than gas to propel a car.  “If
there is sludge on the crankshaft – in the form of losses and bad loans on the
balance sheets of the TBTF banks – then the bank-capital linkage that greases the
engine of monetary policy does not function properly to drive the real
economy.  No amount of liquidity provided
by the Federal Reserve can change this.”

Propagating
TBTF has also resulted in an erosion of faith in American capitalism, he said,
and diverse groups “argue that government-assisted bailouts of reckless
financial institutions are sociologically and politically offensive.  From an economic perspective, these bailouts
are certainly harmful to efficient workings of the market.”

Rosenblum’s
essay
tracks the downfall of the economy but less as a tick-tock than as a
sociological study.  It is long and
difficult to summarize so we will do so in two parts.

 * 
*  *

Good times
breed complacency, not right away but over time, as memories of past setbacks
fade.  In 1983 the U.S. entered a 25 year
span interrupted by only two brief shallow downturns accounting for just 5
percent of that period.  There was strong
growth, low unemployment and stable prices.

Before the
Federal Reserve was founded in 1913 the economy spent 48 percent of the time in
recession, in the 99 years since recessions have affected the economy only 21
percent of the time.  “When calamities
don’t occur, it’s human nature to stop worrying.  The world seems less risky.”

In the
run-up to 2008 the public sector grew complacent and relaxed the
financial systems constraints, explicitly in law and implicitly in enforcement,
and felt secure enough to pursue social engineering goals such as expanding
home ownership.  The private sector also
became complacent, downplaying the risks of borrowing and lending.

There was greed;
capitalism cannot operate without self-interest and most of the time competition
and laws keep it in check.  But when
competition declines incentives often turn perverse and self-interest can
become malevolent.  That’s what happened
in the years before the financial crisis. 
New technologies and business practices reduced “skin in the game,” and
greed led “innovative legal minds” to push boundaries of integrity.

Success
led to complicity.  The banks were
making money, investors wanted part of it, and credit rating agencies got
involved.  The Fed kept interests rates
too low too long, contributing to the speculative binge in housing and pushing
investors to seek higher rewards in riskier markets.  “Hindsight leaves us wondering what financial
gurus and policymakers could have been thinking.  But complicity presupposes a willful blindness.  Why spoil the party when the economy is
growing and more people are employed? 
Imagine the political storms and public ridicule that would sweep over
anyone who tried.”

“Easy
money leads to a giddy self-delusion.” 
The certainty of rising housing prices convinced some homebuyers that
high-risk mortgages weren’t that risky; that draining equity to pay for new
cars or a vacation was prudent.  Buying
into the exuberance gave people what they wanted, at least for a while.

These
traits, complacency, greed, complicity, and exuberance were intertwined with
concentration, the result of a natural desire to grow bigger, more important,
and a dominant force in one’s industry. 
Concentration amplified the speed and breadth of the subsequent damage
to the banking sector and the economy as a whole.

Since the
early 1970s the share of the banking industry assets controlled by the five
largest institutions
has more than tripled from 17 percent to 52 percent.  These mammoth institutions were built on
leverage which was often hidden by off-balance sheet financing.  The equity share of assets dwindled as banks
borrowed to the hilt to chase easy profits in new, complex and risky
instruments and balance sheets deteriorated. 
Accounting expedients allowed banks to claim they were healthy until
they weren’t.  Write-downs were later
revised by several orders of magnitude to acknowledge mounting problems.

With size
came complexity as banks stretched their operations to include proprietary
trading and hedge fund investments and spread their reach into dozens of
countries.  “Complexity magnifies the
opportunities for obfuscation and top management may not have known everything
that was going on, especially in regards to risk and regulators didn’t have the
resources to oversee the banks’ vast operations.

These
large, complex institutions aggressively pursued profits in overheated markets,
pushed the limits of regulatory ambiguity and lax enforcement.  They carried greater risk and overestimated
their ability to manage it and in some cases top management groped around in
the dark because their monitoring systems didn’t keep pace with their expanding
enterprises.

A healthy
financial system keeps the economy humming and we take its routine workings for
granted – until the machinery blows a gasket. 
It was the biggest investment and commercial banks that took the first
write-offs on their mortgage backed securities in 2007 and as the housing
market continued to deteriorate policy-makers became alarmed, seeing the number
of big globally interconnected banks involved 
and fearing the loss of even one would bring the whole system down.

This fear
was justified as Lehman Brothers collapsed and credit markets froze forcing the
government to inject billions to keep other institutions afloat.   “The situation in 2008 removed any doubt that
several of the largest U.S. banks were too big to fail.” 

With the
financial system disabled, the entire system spun downward into the longest
recession in the post-World War II era.

In the second part of the essay
Rosenblum looks at the Fed’s reaction to the recession, why TBTF has stymied
recovery, and what might be done about it.

…(read more)

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Federal Registers

FR-5480-N-119 Notice
of Submission of Proposed Information Collection to OMB; Impact of Housing
and Services Interventions for Homeless Families
FR-5480-N-118 Notice
of Submission of Proposed Information Collection to OMB; Transformation
Initiative: Natural Experiment Grant Program

Mortgage Delinquency Spikes in TransUnion Q4 Report

TransUnion is reporting that serious
mortgage delinquencies rose
during the fourth quarter of 2011 for only the
second time since the end of 2009.  The
rate increased 13 basis points from 5.88 percent in the third quarter to 6.01
percent. 

The increase was widespread; 37
percent of the states reported increases as did 64 percent of metropolitan
areas.  The latter figure is unchanged
from Quarter 3 but up substantially from the 21 MSAs that experienced an
increase in Quarter 2.  New Jersey and
Vermont had the largest annual increases. 
Their delinquency rates rose between Quarter 4, 2010 and Quarter 4, 2011
by 11.98 percent and 11.11 percent respectively.  South Dakota had an increase of 10.36
percent.  Arizona, California, and
Wyoming had the greatest decreases in their rates, all three in the range of 20
percent.

The highest serious delinquency
rates, defined as over 60 days, were reported in Florida (14.27 percent),
Nevada (12.08 percent) New Jersey (8.32 percent) and Arizona (7.50 percent) and
the lowest rates in North Dakota (1.50 percent), South Dakota (2.45 percent),
Nebraska (2.57 percent) and Alaska (2.77 percent).

“To see that, quarter over
quarter, fewer homeowners were able to make their mortgage payments is not
welcome news,” said Tim Martin, group vice president of U.S. Housing in
TransUnion’s financial services business unit. “However, it was not
unexpected. First, there tends to be a natural seasonality, evident well before
the recession, of higher delinquencies in the fourth quarter; perhaps explained
by borrowers balancing holiday spending vs. debt payments. Secondly, on the
economic front, house prices continued to deteriorate in the fourth quarter and
unemployment remained stubbornly high. This combination leads to more negative
equity in homes and reduced real personal income that can affect borrowers’
ability and willingness to pay their mortgages.

…(read more)

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