Dear Mr. Buffett_ What an Investor Learns 1,269 Miles From Wall Street - Janet M. Tavakoli [108]
In September 2008, the Fed let Lehman Brothers (a larger investment bank than Bear Stearns) fail, and helped AIG with a credit line of $85 billion. Were there alternatives? In my view, there were. AIG could have contacted its credit default swap counterparties and asked them for better collateral terms while it was still rated double-A.There is a precedent for this. When ACA, the failed monoline bond insurer (unlike AIG it did not have a diversified business with valuable assets) needed time, its counterparties gave it a six month reprieve. But that was before the Fed bailed out Bear Stearns’s creditors. AIG knew it could run to the Fed, and it initially did, even before it approached JPMorgan Chase and Goldman Sachs for a loan. AIG remained in denial for many months. It worked on a strategic plan instead of acting on its problems, Moral hazard creates opportunity costs, because people with a sense of entitlement tend to get complacent about managing complex risk. Taxpayers can only hope that AIG’s valuable assets are ultimately enough to cover its liabilities, but it never should have become the problem of U.S. taxpayers.We may have to come up with a new slogan—no taxation without regulation.
The Federal Reserve should have saved its fire power, because we have even more serious problems. Warren’s Berkshire Hathaway backs Clayton Homes’ business. In contrast, Fannie Mae and Freddie Mac are highly (and dangerously) leveraged. They had only a 2 percent core capital requirement; banks hold a minimum of 6 percent in “tier one” capital. The burden of both mortgage giants increased in the past two years. In 2006, they accounted for 33 percent of total mortgage backed securities issuance, and as of the summer of 2008 they accounted for 84 percent. Fannie Mae and Freddie Mac have been pressured to help other lenders out of the mortgage mess. Fannie Mae and Freddie Mac guarantee approximately 40-45 percent of the $11.5 trillion U.S. residential mortgage market. As of March 31, 2008, Fannie Mae and Freddie Mac had combined debt of $1.6 trillion and credit obligations of $3.7 trillion.This is a total of $5.3 trillion, roughly the same as U.S. government bonds.18 The U.S. government took over Fannie Mae and Freddie Mac on September 7, 2007, and this is the problem that will probably cost taxpayers the most.The government is in charge of financing most of the U.S. mortgage market, and the mortgage market is still under-regulated. U.S. taxpayers have too many sticky bombs.
The new regulators and the new CEOs do not inspire me with confidence. James Lockhart is the head of the Federal Housing Finance Agency (which will now also oversee the 12 Federal Home Loan Banks) and he was head of the Office of Federal Housing Enterprise Oversight (starting June 15, 2006, just when effective action seemed most needed), the former regulator for Fannie Mae and Freddie Mac. It had over 200 employees and wrote long after-the-fact reports. As Warren put it to CNBC: “You had two of the greatest accounting misstatements in history.You had all kinds of management malfeasance . . . the classic thing was . . . OFHEO wrote a 350-400 page report . . . they blamed [everyone else].”19 This predated Lockhart, but under Lockhart’s watch, things went from bad to conservatorship.
Initially, the mortgage giants charged fees to guarantee prime mortgages (up to a specific size) and borrowers made 20 percent down payments. It was a license to print money, which motivated Warren Buffett to make a large investment in their shares in the first place. It is amazing to me that Fannie, Freddie and OFHEO could screw this up, but