Comments on: Fannie, Freddie and Northern Rock – who was right? http://www.johnredwoodsdiary.com/2008/07/14/fanny-freddie-and-northern-rock-who-was-right/ Conservative Party Candidate for Wokingham Sat, 20 Mar 2010 16:56:39 +0000 http://wordpress.org/?v=2.9.2 hourly 1 By: APL http://www.johnredwoodsdiary.com/2008/07/14/fanny-freddie-and-northern-rock-who-was-right/#comment-24256 APL Mon, 08 Sep 2008 07:15:52 +0000 http://www.johnredwoodsdiary.com/?p=1182#comment-24256 Monday 8 August. Fannie & Freddie to be nationalised. Costing the US tax payer $500b now and heading for 1T in due course. lets see how the dollar reacts on the news. Monday 8 August.

Fannie & Freddie to be nationalised. Costing the US tax payer $500b now and heading for 1T in due course.

lets see how the dollar reacts on the news.

]]> By: Matthew http://www.johnredwoodsdiary.com/2008/07/14/fanny-freddie-and-northern-rock-who-was-right/#comment-22390 Matthew Wed, 16 Jul 2008 07:14:13 +0000 http://www.johnredwoodsdiary.com/?p=1182#comment-22390 Willem Buiter also thinks the Fed and Treasury have made a mistake http://blogs.ft.com/maverecon/2008/07/the-rescue-of-fannie-and-freddie-by-hankie-and-feddie/#more-280 Willem Buiter also thinks the Fed and Treasury have made a mistake

http://blogs.ft.com/maverecon/2008/07/the-rescue-of-fannie-and-freddie-by-hankie-and-feddie/#more-280

]]> By: Robert http://www.johnredwoodsdiary.com/2008/07/14/fanny-freddie-and-northern-rock-who-was-right/#comment-22362 Robert Tue, 15 Jul 2008 10:14:53 +0000 http://www.johnredwoodsdiary.com/?p=1182#comment-22362 John, With reference to your reply to the last posting , I fear you have underestimated the liquidity/capital that would have been required. Though I understand early invention can sometimes have more impact. John,
With reference to your reply to the last posting , I fear you have underestimated the liquidity/capital that would have been required. Though I understand early invention can sometimes have more impact.

]]> By: anon http://www.johnredwoodsdiary.com/2008/07/14/fanny-freddie-and-northern-rock-who-was-right/#comment-22354 anon Tue, 15 Jul 2008 06:56:24 +0000 http://www.johnredwoodsdiary.com/?p=1182#comment-22354 So, how long have you been a socialist John? So, how long have you been a socialist John?

]]> By: William B. http://www.johnredwoodsdiary.com/2008/07/14/fanny-freddie-and-northern-rock-who-was-right/#comment-22349 William B. Mon, 14 Jul 2008 23:00:42 +0000 http://www.johnredwoodsdiary.com/?p=1182#comment-22349 I have tried gamely to understand what the government did wrong in its handling of Northern Rock, but am not sure I really understand the criticisms all these months later. On the face of it there were three options open once NR ran out of money: (i) let it fold, (ii) lend it the money it was unable to raise on the markets in the hope it could trade its way out of trouble or (iii) buy the business (i.e. nationalise it). The first option was decried as dangerous and impractical because it would cause a loss of confidence in British banking as an institution. But since a major mortgage lender was bust it is hard to see that confidence was anything other than overstated. On a political level the more important issue was not confidence in British banking but confidence in the British government. Savers with Northern Rock had placed their liquid assets with a company which was thriving on a bubble of the government's making. Had it folded they would not just have lost their attractive returns but their capital itself might have been in danger. There were votes to be lost by the bubble bursting all over sensible people with savings. The second option was tried but by then the bubble had been exposed, at least to the satisfaction of the savers, hence the "run" on the bank. Other banks also took emergency loans from the Bank of England but Northern Rock was different from the other major mortgage lenders because its business was a bubble on a bubble. There was the national bubble of feel-good synthetic wealth ... "look darling, we have made an extra £20,000 on the value of the house this month let's have dinner at Granita". That bubble existed no matter who lent the money to buy the property. Northern Rock's supplementary bubble was caused by its appallingly risky business model. It engaged in far too much equity lending, giving little heed to the value of the borrower's personal covenant to repay. And it did so because the taps were open; money could be borrowed in seemingly endless amounts on the money markets, then lent at a narrow margin and presented as secure (on paper) because the equity in the property was rising and rising. There was risk at both ends - the raising of the money and the lending. Other banks could have followed this model but the others had learned from the 1989-92 crash and were much stricter about proof of income and loan-to-value ratios (still too lax on both counts, however) and their businesses were not so highly concentrated on domestic mortgage lending. In the end the third option was inevitable. The government can be criticised for taking a little longer than necessary to get there, but that seems rather unfair to me because the run on the bank was halted by emergency lending - the very same system of emergency lending which was used by other banks with less risky business models - and government guarantees. The panic was over. Had the government given those interested in taking over Northern Rock 6 weeks rather than 3 or 4 months to formulate their bids it is a matter of conjecture whether the result would have been any different. I see no difference in substance between the guarantees the government gave Northern Rock in October last year and the guarantees the US government has given the troublesome siblings, Fannie and Freddie. Both expose the taxpayer to huge risks and do little if anything to improve the business model of the equity lender. By all means criticise the government for creating the initial bubble, a bubble which has been exposed more and more as the months have passed. By all means also criticise the government for not acting as fast as it could have done, but in making this latter criticism one must ask whether faster action would have improved the situation. If we are in exactly the same situation as if the government had been Linford Christie rather than Fatty Arbuckle, the criticism is empty. To criticise the government for taking over Northern Rock and then restricting its ability to lend is, in my view, equally unfair. Quite apart from the need not to use the might of the public purse to gain unfair advantage (a need which is both political and legal), it was essential to cut back on much of the core business because they were lending too much to people who could not afford to repay them. That part of the market simply had to be reduced. If I might say so Mr Redwood, I feel your article today exceeded legitimate criticism of the government. But don't worry, I'll agree with you, as usual, tomorrow and we can surely both enjoy a steady run of arrant knee-jerk nonsense from Mr Brown and his merry incompetents in the months ahead. In other guise I have predicted what is to come under this government: Reply: If you want to see my contemporary criticisms before the run on the Rock then look under the Rock tab on this site. I recommended a fourth way - keeping the markets more liquid in August/september 2007 so the Rock could borrow the money it needed. http://thefatbigot.blogspot.com/2008/07/government-by-sit-com.html I have tried gamely to understand what the government did wrong in its handling of Northern Rock, but am not sure I really understand the criticisms all these months later.

On the face of it there were three options open once NR ran out of money: (i) let it fold, (ii) lend it the money it was unable to raise on the markets in the hope it could trade its way out of trouble or (iii) buy the business (i.e. nationalise it).

The first option was decried as dangerous and impractical because it would cause a loss of confidence in British banking as an institution. But since a major mortgage lender was bust it is hard to see that confidence was anything other than overstated. On a political level the more important issue was not confidence in British banking but confidence in the British government. Savers with Northern Rock had placed their liquid assets with a company which was thriving on a bubble of the government’s making. Had it folded they would not just have lost their attractive returns but their capital itself might have been in danger. There were votes to be lost by the bubble bursting all over sensible people with savings.

The second option was tried but by then the bubble had been exposed, at least to the satisfaction of the savers, hence the “run” on the bank. Other banks also took emergency loans from the Bank of England but Northern Rock was different from the other major mortgage lenders because its business was a bubble on a bubble.

There was the national bubble of feel-good synthetic wealth … “look darling, we have made an extra £20,000 on the value of the house this month let’s have dinner at Granita”. That bubble existed no matter who lent the money to buy the property. Northern Rock’s supplementary bubble was caused by its appallingly risky business model. It engaged in far too much equity lending, giving little heed to the value of the borrower’s personal covenant to repay. And it did so because the taps were open; money could be borrowed in seemingly endless amounts on the money markets, then lent at a narrow margin and presented as secure (on paper) because the equity in the property was rising and rising. There was risk at both ends – the raising of the money and the lending. Other banks could have followed this model but the others had learned from the 1989-92 crash and were much stricter about proof of income and loan-to-value ratios (still too lax on both counts, however) and their businesses were not so highly concentrated on domestic mortgage lending.

In the end the third option was inevitable. The government can be criticised for taking a little longer than necessary to get there, but that seems rather unfair to me because the run on the bank was halted by emergency lending – the very same system of emergency lending which was used by other banks with less risky business models – and government guarantees. The panic was over. Had the government given those interested in taking over Northern Rock 6 weeks rather than 3 or 4 months to formulate their bids it is a matter of conjecture whether the result would have been any different.

I see no difference in substance between the guarantees the government gave Northern Rock in October last year and the guarantees the US government has given the troublesome siblings, Fannie and Freddie. Both expose the taxpayer to huge risks and do little if anything to improve the business model of the equity lender.

By all means criticise the government for creating the initial bubble, a bubble which has been exposed more and more as the months have passed. By all means also criticise the government for not acting as fast as it could have done, but in making this latter criticism one must ask whether faster action would have improved the situation. If we are in exactly the same situation as if the government had been Linford Christie rather than Fatty Arbuckle, the criticism is empty.

To criticise the government for taking over Northern Rock and then restricting its ability to lend is, in my view, equally unfair. Quite apart from the need not to use the might of the public purse to gain unfair advantage (a need which is both political and legal), it was essential to cut back on much of the core business because they were lending too much to people who could not afford to repay them. That part of the market simply had to be reduced.

If I might say so Mr Redwood, I feel your article today exceeded legitimate criticism of the government. But don’t worry, I’ll agree with you, as usual, tomorrow and we can surely both enjoy a steady run of arrant knee-jerk nonsense from Mr Brown and his merry incompetents in the months ahead.

In other guise I have predicted what is to come under this government:

Reply: If you want to see my contemporary criticisms before the run on the Rock then look under the Rock tab on this site. I recommended a fourth way – keeping the markets more liquid in August/september 2007 so the Rock could borrow the money it needed.

http://thefatbigot.blogspot.com/2008/07/government-by-sit-com.html

]]> By: Derek http://www.johnredwoodsdiary.com/2008/07/14/fanny-freddie-and-northern-rock-who-was-right/#comment-22348 Derek Mon, 14 Jul 2008 20:25:04 +0000 http://www.johnredwoodsdiary.com/?p=1182#comment-22348 "I want to start looking forward to recovery". I hope you've got a powerful telescope. “I want to start looking forward to recovery”.

I hope you’ve got a powerful telescope.

]]> By: Matthew Reynolds http://www.johnredwoodsdiary.com/2008/07/14/fanny-freddie-and-northern-rock-who-was-right/#comment-22346 Matthew Reynolds Mon, 14 Jul 2008 18:15:27 +0000 http://www.johnredwoodsdiary.com/?p=1182#comment-22346 What is happening in the US & UK is a rebalacning of the economy away from debt fuelled consumption towards exports and industry . The US is making a better fist of it as their budget deficit is lower as a share of GDP thus making sure that some stimulus in the form of tax cuts can be provided to ease this transition . Relying on imports , a rising PSBR & rampant levels of personal debt is unsustainable - in the context of a flawed & complex system of financial regulation & monetary policy it is just folly . The chickens have come home to roost - I do not gloat as I fear the results . What is happening in the US & UK is a rebalacning of the economy away from debt fuelled consumption towards exports and industry . The US is making a better fist of it as their budget deficit is lower as a share of GDP thus making sure that some stimulus in the form of tax cuts can be provided to ease this transition . Relying on imports , a rising PSBR & rampant levels of personal debt is unsustainable – in the context of a flawed & complex system of financial regulation & monetary policy it is just folly . The chickens have come home to roost – I do not gloat as I fear the results .

]]> By: Matthew Turner http://www.johnredwoodsdiary.com/2008/07/14/fanny-freddie-and-northern-rock-who-was-right/#comment-22342 Matthew Turner Mon, 14 Jul 2008 15:58:49 +0000 http://www.johnredwoodsdiary.com/?p=1182#comment-22342 Clive Crook has a slightly different take on Fannie and Freddie which is worth reading. http://www.ft.com/cms/s/0/7572a444-513b-11dd-b751-000077b07658.html Clive Crook has a slightly different take on Fannie and Freddie which is worth reading.

http://www.ft.com/cms/s/0/7572a444-513b-11dd-b751-000077b07658.html

]]> By: cityunslicker http://www.johnredwoodsdiary.com/2008/07/14/fanny-freddie-and-northern-rock-who-was-right/#comment-22332 cityunslicker Mon, 14 Jul 2008 12:39:34 +0000 http://www.johnredwoodsdiary.com/?p=1182#comment-22332 A great post this - a near perfect summation of all the wrongs committed over Northern Rock. A great post this – a near perfect summation of all the wrongs committed over Northern Rock.

]]> By: Robert http://www.johnredwoodsdiary.com/2008/07/14/fanny-freddie-and-northern-rock-who-was-right/#comment-22327 Robert Mon, 14 Jul 2008 09:55:53 +0000 http://www.johnredwoodsdiary.com/?p=1182#comment-22327 John, No one I hope, thinks that either lending or borrowing is an original sin! An appropiate understanding of risk/reward and the concept of not over-stretching oneself to have it 'now' would have meant a large number of people being in a much better position to withstand this downturn. The masochists probably feel that the economy/consumer (I am grossly generalising here) gorged themselves at the table of unsustainable borrowing and that buy to let and 'investing' in the housing market etc, were a one way bet. Anyone with a modicum of good sense should realise that borrowing against inflated prices (the housing market bottomed in '92-93 in London) on grossly inflated multiples could leave you open to a major problem in a downturn. No one I am sure wants people to suffer, but individuals have to be reponsible for their actions. The last 7-8 years of the UK's growth has primarily been driven by consumption, financed by increasing indebtiness based on rising asset prices and a massive increase in spending by government based on taxation and government debt (don't even get me onto the issue of the huge expansion of government employees). This is why we are the most vulnerable economy in G8 and why our currency will continue to be weak and will have further to fall, potentially importing further inflationary pressures. I would also point out it takes two to tango' - for every greedy financier there is a 'greedy' borrower. The one inescapable truth is that this crisis will, and is altering the Bank's business models for the future, though the cynics amongst us will say only until the collective memory fades, and 'greed' gets the upper hand again! The necessary rebuilding of both the banks, government, and personal sector balance sheets is going to take a number of years (2-3 years at least?) and this will result in lower economic growth for sometime to come. With regard to loosening monetary policy, I would agree that it may be appropiate to do this in the Autumn if we see no evidence of wage inflation, particularly in the public sector, that is not covered by 'productivity' growth. Even the monetarists who were so wildly condemned and ignored ahead of the debt bubble are now advocating a reduction in base rates, whether much of this is passed on in the short term would remain to be seen due to the shrinkage in capital. This bubble was not based on a 1 to 10 traditional leverage model but in some cases a 1 to 70 or even a 1 to 90 leverage basis, this will take time to fill! Obviously, for those with capital/cash there are going to be great opportunities over the next few years particularly if we hopefully manage to avoid deflation, so I am optimistic that there will be a recovery but it will be long and hard and sometime away, though as ever the markets will rise in anticipation, usually providing a 18-24 month lead to the change in direction of unemployment. John,
No one I hope, thinks that either lending or borrowing is an original sin! An appropiate understanding of risk/reward and the concept of not over-stretching oneself to have it ‘now’ would have meant a large number of people being in a much better position to withstand this downturn. The masochists probably feel that the economy/consumer (I am grossly generalising here) gorged themselves at the table of unsustainable borrowing and that buy to let and ‘investing’ in the housing market etc, were a one way bet. Anyone with a modicum of good sense should realise that borrowing against inflated prices (the housing market bottomed in ‘92-93 in London) on grossly inflated multiples could leave you open to a major problem in a downturn. No one I am sure wants people to suffer, but individuals have to be reponsible for their actions. The last 7-8 years of the UK’s growth has primarily been driven by consumption, financed by increasing indebtiness based on rising asset prices and a massive increase in spending by government based on taxation and government debt (don’t even get me onto the issue of the huge expansion of government employees). This is why we are the most vulnerable economy in G8 and why our currency will continue to be weak and will have further to fall, potentially importing further inflationary pressures. I would also point out it takes two to tango’ – for every greedy financier there is a ‘greedy’ borrower. The one inescapable truth is that this crisis will, and is altering the Bank’s business models for the future, though the cynics amongst us will say only until the collective memory fades, and ‘greed’ gets the upper hand again! The necessary rebuilding of both the banks, government, and personal sector balance sheets is going to take a number of years (2-3 years at least?) and this will result in lower economic growth for sometime to come. With regard to loosening monetary policy, I would agree that it may be appropiate to do this in the Autumn if we see no evidence of wage inflation, particularly in the public sector, that is not covered by ‘productivity’ growth. Even the monetarists who were so wildly condemned and ignored ahead of the debt bubble are now advocating a reduction in base rates, whether much of this is passed on in the short term would remain to be seen due to the shrinkage in capital. This bubble was not based on a 1 to 10 traditional leverage model but in some cases a 1 to 70 or even a 1 to 90 leverage basis, this will take time to fill! Obviously, for those with capital/cash there are going to be great opportunities over the next few years particularly if we hopefully manage to avoid deflation, so I am optimistic that there will be a recovery but it will be long and hard and sometime away, though as ever the markets will rise in anticipation, usually providing a 18-24 month lead to the change in direction of unemployment.

]]> By: a-tracy http://www.johnredwoodsdiary.com/2008/07/14/fanny-freddie-and-northern-rock-who-was-right/#comment-22324 a-tracy Mon, 14 Jul 2008 09:01:31 +0000 http://www.johnredwoodsdiary.com/?p=1182#comment-22324 "there will be several builders out of work". Wouldn't this be a good time for the Olympic organisers to get moving on the building of the Olympic village and stadium to redeploy many of these workers. If they built an accommodation block first, the builders from out of area could live there Mon to Thur. It would be quite unique to get something built on time and in budget for a change. “there will be several builders out of work”. Wouldn’t this be a good time for the Olympic organisers to get moving on the building of the Olympic village and stadium to redeploy many of these workers. If they built an accommodation block first, the builders from out of area could live there Mon to Thur. It would be quite unique to get something built on time and in budget for a change.

]]> By: APL http://www.johnredwoodsdiary.com/2008/07/14/fanny-freddie-and-northern-rock-who-was-right/#comment-22321 APL Mon, 14 Jul 2008 07:38:41 +0000 http://www.johnredwoodsdiary.com/?p=1182#comment-22321 JR: "My answer is simple – you are getting that anyway. The authorities have done quite enough on both sides of the Atlantic to so tighten credit that property prices are falling and will fall further. Mortgages are much scarcer than before, builders are losing their jobs.. " Ah! the variation of "we must not talk ourselves into a recession". Really, Mr Redwood. We are all here commenting on current affairs, very very few of us are in a position to influence events, no amount of platituedes and reassurance, even if that is what people want to hear, will change the course of events now. Fanny Mae and Freddy Mac are GOVERNMENT SPONSORED organisations, they are rotten to the core and those two things are not a coincidence. A Tory ought to be pointing that out. JR: " for the masochists among you who want more pain you will see plenty of it." Not masochists, realists. JR: “My answer is simple – you are getting that anyway. The authorities have done quite enough on both sides of the Atlantic to so tighten credit that property prices are falling and will fall further. Mortgages are much scarcer than before, builders are losing their jobs.. ”

Ah! the variation of “we must not talk ourselves into a recession”. Really, Mr Redwood. We are all here commenting on current affairs, very very few of us are in a position to influence events, no amount of platituedes and reassurance, even if that is what people want to hear, will change the course of events now.

Fanny Mae and Freddy Mac are GOVERNMENT SPONSORED organisations, they are rotten to the core and those two things are not a coincidence. A Tory ought to be pointing that out.

JR: ” for the masochists among you who want more pain you will see plenty of it.”

Not masochists, realists.

]]> By: Matthew http://www.johnredwoodsdiary.com/2008/07/14/fanny-freddie-and-northern-rock-who-was-right/#comment-22320 Matthew Mon, 14 Jul 2008 07:36:16 +0000 http://www.johnredwoodsdiary.com/?p=1182#comment-22320 A bit of research has found that John Redwood made restoration of MIRAS (ie at the time restoring it to its full rate) one of the main themes of the mid-1990s, including his leadership bid. So the issue might have traction. A bit of research has found that John Redwood made restoration of MIRAS (ie at the time restoring it to its full rate) one of the main themes of the mid-1990s, including his leadership bid. So the issue might have traction.

]]> By: crown http://www.johnredwoodsdiary.com/2008/07/14/fanny-freddie-and-northern-rock-who-was-right/#comment-22319 crown Mon, 14 Jul 2008 07:35:54 +0000 http://www.johnredwoodsdiary.com/?p=1182#comment-22319 Once people realise that mortgage lending has returned to normal after years of abnormal lending, we will be able to put this whole sorry affair behind us. Let it never be forgotten the Gordon Brown ruled the treasury at the time when lenders were allowed to lend like crazy fools under a regulator that is totally useless and a totally inept government. Remember how much grief Gordon gave the Tories for pension misselling? See here http://thecrownblogspot.blogspot.com/2008/04/historic-northen-rock-e-mail.html http://thecrownblogspot.blogspot.com/2008/06/brief-history-of-irresponsible-mortgage.html Once people realise that mortgage lending has returned to normal after years of abnormal lending, we will be able to put this whole sorry affair behind us.

Let it never be forgotten the Gordon Brown ruled the treasury at the time when lenders were allowed to lend like crazy fools under a regulator that is totally useless and a totally inept government.

Remember how much grief Gordon gave the Tories for pension misselling?

See here
http://thecrownblogspot.blogspot.com/2008/04/historic-northen-rock-e-mail.html

http://thecrownblogspot.blogspot.com/2008/06/brief-history-of-irresponsible-mortgage.html

]]> By: Matthew http://www.johnredwoodsdiary.com/2008/07/14/fanny-freddie-and-northern-rock-who-was-right/#comment-22318 Matthew Mon, 14 Jul 2008 07:28:35 +0000 http://www.johnredwoodsdiary.com/?p=1182#comment-22318 Well, if the UK authorities decided to deal with Northern Rock a la Fannie and Freddie they would simply give the company an implicit government guarantee not available to other mortgage providers and tell it to go and get new business. That might just work. I wonder what other commenters here think about whether it is time for the Conservatives to consider the reintroduction of mortgage interest tax relief? I think this would cost about £5bn - £10bn a year and would provide tax relief to 15-20m families. Well, if the UK authorities decided to deal with Northern Rock a la Fannie and Freddie they would simply give the company an implicit government guarantee not available to other mortgage providers and tell it to go and get new business. That might just work.

I wonder what other commenters here think about whether it is time for the Conservatives to consider the reintroduction of mortgage interest tax relief? I think this would cost about £5bn – £10bn a year and would provide tax relief to 15-20m families.

]]> By: Kit http://www.johnredwoodsdiary.com/2008/07/14/fanny-freddie-and-northern-rock-who-was-right/#comment-22316 Kit Mon, 14 Jul 2008 07:08:36 +0000 http://www.johnredwoodsdiary.com/?p=1182#comment-22316 Why do politicians always chose recovery now and inflation later? Don't answer that the answer obvious. Why do politicians always chose recovery now and inflation later? Don’t answer that the answer obvious.

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