Auto Safety

Personal responsibility, a traditional value in America.

In his weekly WSJ column on 3/17/09, Joe White looked at the global car market. An example is the Ford Focus, a compact popular in Europe and also sold in the U.S.. “Next year, Ford will launch a new Focus in the U.S. that will have 80% of its parts in common with the European version.” Why not 100%, I thought. Oh yeh, I reminded myself, they have to put the steering wheel on a different side of the car over in Europe.

Silly me. Here’s the most expensive item on the list. “U.S. government crash standards … require car makers to take into consideration the potential harm to passengers who aren’t wearing seat belts.” Europeans, on the other hand, expects a driver to act responsibly. This and other minor differences like bumpers and mirror size add up to “hundreds of dollars a car”.

All 49 states except New Hampshire have seat belt laws. Jennifer Levitz, in a 3/18/09 WSJ article, tells us that protesters gathered last week in Concord, N.H. to voice their opposition to a proposed seat belt law in that state. One protestor said that “the state is moving toward, basically, communism.”

New Hampshire passes up $3.7 million in federal money if they don’t institute a law by July of this year. In 2007, “70% of those who died in traffic accidents in the state weren’t wearing seat belts.”

One protestor wears a seat belt now, but swears to stop wearing it if the law is passed. Representative Jordan Ulery, an opponent of the bill, said “New Hampshire is a sovereign state; we can do as we damn well please.”

Mortgage Refinance

It was a little after High Noon today in Colorado when CNBC interrupted their broadcast of House hearings on the $165 million AIG had paid out in bonuses. The voice sounded similar in quality to the one we hear when programs are interrupted for severe weather warnings. It was not a weather warning but an announcement from the monthly Federal Reserve meeting.

The Fed was keeping interest rates at 0%, as expected, but they announced that they intended to keep them there for the coming months. They announced a plan to increase their purchases of long term Treasury notes by $300B and extend another $750B to buy mortgages. That puts the total Fed commitment to mortgages at $1.25T.

Within 5 – 10 minutes after the announcement, both the stock market and Treasury notes shot up about 2%.

So what! It’s not as exciting as the video of Brittany Spears practicing her dance routine for her upcoming tour. It’s not as fantabulous as a preview of the upcoming Jonas Brothers concert movie. It’s well, adult exciting. No, not that kind of adult excitement, you perv. The other kind of exciting, the green kind.

Now is the time for mortgage holders to start talking to a mortgage lender near you about refinancing. Average 30 year fixed mortgage rates were just a scosh below 5%. The Fed’s announcement will probably cause the mortgage rate to drop to 4.5% or so.

A fairly close approximation of the monthly principal and interest payment (PI) on a 30 year fixed mortgage at 4.5% is to chop off the last two zeroes on the amount of the loan, then divide by 2. For example, take a $200,000 amount, chop off the last two zeroes, which results in $2000. Divide by 2 and the PI comes to $1000. The actual amount, using a mortgage calculator , is $1013.37. Close enough for government work.

For anyone who might have an existing 6.5% mortgage rate, which was approximately the norm a year ago, the monthly payment reduction on a $165,000 balance is over $200 a month.

B.J. made a comment a few weeks ago that the government should just reset all mortgages, by fiat, to 4%. That is a sweeping government intrusion into the private marketplace, more extensive than the government has already done.

B.J. must have spoken to Ben Bernanke, the Fed chief, who agreed with her target interest rate. He just went about it without issuing an emperor’s decree. Instead of picking the cats up and taking them where he wanted them to go, Bernanke simply put the food down where he wants the cats to be.

Mexico Truckin’

Besides the AIG retention bonus fiasco in the news this week is the start of a trade war between Mexico and the U.S. In the $410B omnibus spending bill that President Obama signed recently was a provision to halt an 18-month pilot program that allowed a few Mexican trucks beyond a border buffer zone.

We will hear a lot of accusations from those on the free trade side against the narrow self-interest of the Teamsters, the Owner-Operator Independent Drivers Association’s (OOIDA) , labor unions in general, and claims that “Congress and President Barack Obama are catering to the Teamsters union.”

From those on the labor, jobs and safety side we will hear this: “the true purpose of the program was to allow American trucking companies access to the Mexican drivers, who often are paid less than half of prevailing U.S. wages, and allow them access to trucks maintained to much more lax safety standards than those in the U.S., further reducing costs for American trucking companies hiring Mexican trucks and their drivers.”

What is this accusation and concern based on? “From 1992-2002 some 1,300 Mexican-domiciled companies — all of which were majority U.S.-owned — received ‘certificates of registration’ to deliver ‘exempt commodities’ from Mexico to the U.S.” Source . In short, U.S. truck companies set up shop in Mexico. Did they use cheaper labor? Probably.

From a Feb. 23, 2007 press release from the U.S. Dept of Transportation (USDOT): “U.S. trucks will get to make deliveries into Mexico while a select group of Mexican trucking companies will be allowed to make deliveries beyond the 20-25 mile commercial zones currently in place along the Southwest border.”

“[U.S. Transportation] Secretary Peters said the new demonstration program was designed to simplify a process that currently requires Mexican truckers to stop and wait for U.S. trucks to arrive and transfer cargo. She said this process wastes money, drives up the cost of goods, and leaves trucks loaded with cargo idling inside U.S. borders. The Secretary added that under current rules, U.S. trucks are not allowed into Mexico because the United States refused to implement provisions of the North American Free Trade Agreement that would have permitted safe cross-border trucking.”

How slow do the wheels of our government move? After 9/11, glacially slow. “In 2001, Congress authorized the cross border inspection program and listed 22 safety requirements that had to be in place before other steps were implemented.” These included improvements in U.S. border stations, inspection and documentation procedures.

So what conditions did Mexican truck drivers have to meet? “The regulations require all Mexican truck drivers to hold a valid commercial drivers license, carry proof they are medically fit, comply with all U.S. hours-of-service rules and be able to understand questions and directions in English.”

How do shipments not under the program cross the border from Mexico to the U.S.? The W.P. Carey School of Business at Arizona State U. reports “First, a Mexican vehicle drops off its shipment near the U.S. border. The goods are then picked up by drayage companies that specialize in the time-consuming hop across the border and through U.S. Customs. Once in the United States, the shipment is loaded onto an American truck en route to the final destination, or held in a warehouse until it can be picked up.”

The unpredictability of the delay in shipment makes it difficult for those U.S. companies in the supply chain, waiting for the goods. “The inspections can delay shipments for hours or even days. As it stands, the process generates pollution, raises costs for shipping companies and exasperates producers and retailers. For produce, delays mean lost freshness and quality.”

Here’s a Feb. 9th, 2009 report from USDOT:

“This final report presents the status of our review of the Department’s ongoing North American Free Trade Agreement (NAFTA) cross-border trucking demonstration project, at the conclusion of the first year of the project. The Department initiated the demonstration project on September 6, 2007, for 1 year, and extended the project for 2 additional years on August 6, 2008.” The project was due to end on August 6, 2010 but the omnibus bill effectively ended the project early by stopping any spending for the project.

A summary of the report’s finding:
“Demonstration Project Lacks An Adequate Number of Carriers and Participants Are Not Representative In Some Respects of Mexican Carriers Likely to Conduct Long-Haul Operations in the United States. Based on our analysis, at the end of the first year of the demonstration project, participants had lower out-of-service rates than all U.S. carriers, but FMCSA [Federal Motor Carrier Safety Administration] had not defined or enrolled an adequate number of Mexico-domiciled carriers to provide statistically reliable results, as required by Congress.”

“Only 29 of 100 projected Mexican carriers were admitted to the project and 2 of those carriers have since withdrawn. This level of participation is not adequate to yield statistically valid findings. Only 118 of a projected 540 trucks have participated.”

The findings were by an independent panel in August 2008. The FMCSA decided to continue the project for another 2 years. For those on the free trade side, we have heard the better safety record portion of this report. We have not heard about the inadequate participation rate.

Sounds simple. Inadequate participation. Project cancelled. But there’s more:

“Trinity [a Mexican trucking company with a better safety record than many U.S. trucking companies] officials informed FMCSA that requirements to check every truck during every border crossing were proving costly to its operations. Our analysis showed that when Trinity was participating in the demonstration project, it received an average of 16 inspections each day. When not participating, the inspection rate dropped to less than one inspection per day.”

Trinity dropped out of the program. Trucks fully participating in the study carried GPS trackers. No doubt, they received extra attention from the “approximately 1,700 law enforcement personnel from 16 states … and the International Association of Chiefs of Police (IACP).” The line between diligence and harrassment is a matter of viewpoint.

“The Owner-Operator Independent Drivers Association’s (OOIDA) claim that Trinity had received over 112 violations per truck during the year prior to the demonstration project was substantiated”. Violations! Poor safety by Mexican truckers!

But OOIDA was trying to pull a fast one. The report continues “but OOIDA’s claim did not indicate that Trinity’s out-of-service violations numbered only 74, or an average of 7.4 out-of-service violations per motorized vehicle over the 1-year period. Trinity’s out-of-service rates were lower than similar rates for United States carriers during this same period.”

Competition. Protect jobs. Free market. Safety. Tough economy so buy local. More competition means better prices. The rhetoric on both sides of the debate will contain many half-facts because half-facts are simpler than full-facts. There is a witticism “If you think you know [blank], then you haven’t studied [blank] enough.”

Employee Costs

The top editorial in the WSJ on 3/16/09 was a review of OECD (Organisation for Economic Co-operation and Development) data on the “tax wedge” as a percentage of labor costs. In an accompanying chart graphic Germany is shown at 52.2%. The U.S. is shown at 30.0%. The countries in the European Union have an average tax wedge cost of 42.5%. The editorial uses this data to argue against the Employee Free Choice Act, unionization, universal health care and the “Obama revolution” and warns of the impending transition of the U.S. into a “European Model” economy.

What is the “tax wedge”? According to the OECD it is the personal income tax, employer and employee Social Security contributions for a single worker without children making the average wage in a particular country.

The OECD warns that they are simply reporting the data that was reported to the organization by the various countries.

As a small employer, the 30.0% tax wedge figure for the U.S. struck me as incorrect.
In May 2007, the Bureau of Labor Statistics (BLS) reported that the average annual income was $40,690, or about $3391 a month. The IRS withholding tables for 2007 show $431 withholding for a single person with one exemption, or 12.7%. The OECD Table 0.2 shows 15.7% income tax, a 3% discrepancy.

In the U.S., the employer and employee each pay 7.65% in Social Security (SS) and Medicare (MC) tax for a combined 15.3%. 15.3% + 15.7% (as reported to OECD) should equal 31.0%. OECD shows it as 30.0%.

I then checked on Germany’s data as reported to the OECD. Table O.2 shows an 18.4% income tax, and a 33.8% combined social security contribution by the employee and employer for a total of 52.2%.

I found some easier to read (I don’t read German) data on employer, employee costs at Sonnenberg Law Firm. In Germany, pension insurance (SS insurance in the U.S.) is 19.5% of gross and is split between the employer and employee. Nursing care insurance is mandatory (I am cautiously presuming this is similar to Medicare in the U.S. but it may be a long term care insurance?) is 1.7, split between employer and employee. This gives a total of 21.2% plus 18.4% income tax for a total of 39.6% cost compared to the 30.0% in the U.S. But what did Germany report to the OECD? 52.2% – almost 13% higher. Sonnenberg reports that basic mandatory health care insurance in Germany is 12-15% so I can only guess that Germany reported 13% in health care costs as a “Social Security” benefit.

Different countries have different definitions of what “Social Security” means. In the U.S., it does not include health care insurance. In Germany, it does. The OECD data is flawed because it is comparing apples to oranges to pears. I have not taken the time to check the other countries in the OECD data set.

Let’s consider adding in U.S. health care costs. The Kaiser Family Foundation’s 2008 survey of health care costs found that an employer paid $9325 and an employee paid $3354 annually for their health insurance. That is a total of $12679, or 31.2% of average income.

How To Germany reports that “benefits include in-patient (hospital) care as a ward patient with doctor on duty at your nearest hospital, out-patient care with registered doctors (Kassenärzte) and basic dental care. Your non-working dependents resident at your address in Germany are included in your insurance at no additional cost.” In 2008, a Kaiser family plan HMO in Colorado with a $30 copay for a 45 year old employee was just under $12,000, including basic dental with a $1000 benefit cap.

Add that 31.2% health care cost to the reported 30.0% for the U.S. and the comparable tax wedge percentage is about 61.2%. But the tax wedge concept is based on a single person with no children. The same Kaiser HMO plan was $3600 annually for a single 40 year old employee. That is only 8.8%, far less than the 13% health care costs reported by Germany to the OECD.

In Germany, you pay for coverage for non-working dependents, whether you have them or not. In the U.S., you pay for the dependents you have and that you can afford. If you have a family and a non-working spouse, your health care costs are lower in Germany. If you are single, your health care costs are lower in the U.S. However, because of the way health care costs are structured differently in the U.S. and other countries, it is difficult to make a good comparison of averages.

What we do know is that Social Security and Medicare contributions are about 4% of income less in the U.S. than they are in Germany and that the Social Security benefit is better in the U.S. than it is in Germany. In the U.S. “Social Security replaces 43 percent, slightly more than two-fifths, of the amount that someone retiring at normal retirement age in 2006 (age 65 and 8 months) was earning before retirement.” Source here. Germany pays about 33% on average.

Data sets taken at face value can be deceiving. When data seems to confirm our beliefs, our ideologies, we are less likely to question that data.


Harold L. Cole and Lee E. Ohanian, two economics professors, relate some employment numbers during the 1930s depression in a Feb. 2nd, 2009 op-ed in the WSJ “How Gov’t Prolonged the Depression.”

“Total hours worked per adult, including government employees, were 18% below their 1929 level between 1930-32, but were 23% lower on average during the New Deal (1933-39). Private hours worked were even lower after FDR took office, averaging 27% below their 1929 level, compared to 18% lower between 1930-32.” They ask why there wasn’t a vigorous recovery, noting that “Productivity grew very rapidly after 1933, the price level was stable, real interest rates were low, and liquidity was plentiful.”

They acknowledge the benefits of a “basic social safety net through Social Security and unemployment benefits, and by stabilizing the financial system through deposit insurance and Securities Exchange Commission.” But those benefits were offset by “suppressing competition, and setting prices and wages in many sectors well above their normal levels.” These latter policies “choked off powerful recovery forces that would have plausibly returned the economy back to trend by the mid-1930s”.

These recovery forces included expansionary [see my note at the end of this blog entry] Federal Reserve policy and productivity growth. They note that the National Industrial Recovery Act (NIRA) voided existing antitrust laws and “permitted industries to collusively raise prices” as long as they paid their workers above average wages, in effect, gaming the system. The NIRA codes detailed conduct for 500 industries that were designed to eliminate “excessive competition”, which Roosevelt believed to be the cause of the depression. “These codes distorted the economy by artificially raising wages and prices, restricting output, and reducing productive capacity by placing quotas on industry investment in new plants and equipment.” NIRA was declared unconstitutional in 1935 but the practices continued.

At the end of 1938, with the reversal of some of these New Deal policies, the economy began to recover. The main lesson to be learned, the writers contend, from the policies of the 1930s and price controls introduced in the 1970s, is that government intervention on a large scale can have unintended consequences. The professors call for reforms including updated bank regulations, tax changes that “broaden rather than narrow the tax base”, as well as savings and investment incentives.

A person reading Milton Friedman’s analysis of Federal Reserve policy during the depression years would hardly call that policy “expansionary”, as these two authors do. Here is a more detailed telling of the Federal Reserve’s role in the depression. There is also a book of essays by the current Fed chairman, Ben Bernanke.

Nationalize Banks?

In Turku Varadarajan’s Weekend Interview in WSJ 2/21/09 with the economist nicknamed “Dr. Doom”, Nouriel Roubini: Roubini makes a case for temporary and quick nationalization of some of the largest U.S. banks in order to “clean them up, and you sell them in rapid order to the private sector”.

Roubini is a believer in market economies as being the best of a lot of bad alternatives. He notes that “paradoxically, the proposal [of nationalization] is more market-friendly than the alternative of zombie banks.” Lindsey Graham, the conversative Republican senator, said he wouldn’t take the idea off the table. Alan Greenspan concurred that it might be necessary to “facilitate a swift and orderly restructuring.”

Banks that were too big to fail have become “even-bigger-to-fail” as one bank giant swallows up another bank on the verge of collapse. Roubini proposes a hypothetical takeover of one of the giant banks, splitting it into 3 or 4 pieces, making each piece a regional or national bank and selling them.

The more troubling question to Roubini is that we repeatedly get into periods of asset and credit bubbles, bubbles that a lot of people believe are sustainable until they implode. He criticizes Greenspan for losing sight of his central mission: as head of the central bank in the U.S., his job was to provide financial stability. Roubini believes that Greenspan kept a rigid ideological adherence to Ayn Rand’s philosophy, a belief that “there are no market failures, and no issues of distortions on incentives.”

Roubini characterizes the last decade as one of self-regulation which created a “law of the jungle”, where greed is untempered by either supervision or fear of loss. Lastly, he criticizes the media: “in the bubble years, everyone becomes a cheerleader, including the media.”

Get It Right

As the economy worsens, the number of people in need is increasing. They turn to their local government agencies and find that these large agencies have the same problems as the cable company and the telephone company, as Citigroup and large private companies. They become so large that they become difficult to manage, stressing their systems infrastructure, their database managment, their customer service. In short, they fail to execute.

In Colorado, the Denver Post reported increasing delays in administering their food stamp program, a program that has had problems since 2004 because of a faulty software program, the Colorado Benefits Management System. A lawsuit was recently settled with the Colorado Center on Law and Policy (CCLP) and plaintiffs, but the problems continue.

For avowed capitalists who believe that government is the problem, incidents of this kind of government incompetence will add fuel to their fiery denouncements of government “solutions”. Capitalists will point to the advantages of a competitive marketplace where a dissatisfied consumer can shop elsewhere. For a dissatisfied citizen, there is no competition to their local, state or federal government.

Over the past decades, however, the ideal of the free and competitive marketplace has become less a reality as cable companies, like the telephone companies of an earlier age, have been given exclusive franchises to charge high fees while providing inferior service. In an attempt to be competitive, many banks and credit card companies have adopted similar cost cutting customer service systems. A bank customer dissatisfied with $40 fees and a phone labyrinth for customer service can take their money elsewhere only to find a similar level of service at the new bank. Credit card companies abound like ladies in a red light district, teasing new customers with low, low rates on transfer balances. The unwary customer who neglects the fine print discovers that subsequent purchases are charged at a rate exceeding 25%.

Google’s corporate motto is “Don’t be evil,” and to the folks at Google, “it’s about providing our users unbiased access to information, focusing on their needs and giving them the best products and services that we can. But it’s also about doing the right thing more generally – following the law, acting honorably and treating each other with respect.”

The recent and ongoing real estate and credit meltdown was not only a failure of honor and respect, but a failure of good sense by many parties. A lot of smart and not so smart people did some really stupid things. Our new American motto, both in the private market and the government sector, should be “Don’t be stupid!”

Debt, Household

In his “Ahead of the Tape” column in WSJ 3/11/09, Mark Gongloff reports that 3rd quarter household debt recorded its first decline since recordkeeping began in 1952. Even with the decline, household debt was a whopping 96% of GDP. In 1998, it was 66% of GDP. The Fed releases 4th quarter data on 3/12/09.

Why were many of us taking on more debt? Easy credit is one answer. The other is less income. The median income has been decreasing, not increasing. The Grandfather Economic Report presents several pictorial and informative analyses of economic trends for families by a NASA physicist with postgraduate work in business and economics. Milton Friedman liked it.

In an op-ed in WSJ 3/12/09, Daniel Henninger reviews a “Top 1% earners” chart that shows the net that the top 1% of earners took home over the past decades. It is a part of Obama’s recently released budget. Henninger notes some of the flaws of this chart, it’s primary flaw being that it is a tool of “progressives.” Whatever its flaws, this summary of median income data shows that the trend is real. Henninger says that the “primary goal [of the Obama budget] is a massive re-flowing of ‘wealth’ from the top toward the bottom.” Henninger denies any “reflowing” of wealth from the bottom to the top in the past few decades.

There is no set of facts that can sway the path of a herd ideology, whether it be on the right or left.

Income Redistribution

Dodge ball is a game where two teams on either side of center line throw a soccer ball at each other, trying to hit a member of the opposite team. In the playing field of political punditry, those on the left and right of the center line throw the epithet of “income redistribution” at the other team, accusing them of this heinous crime.

According to a June 27th, 2008 Gallup Poll “Americans’ lack of support for redistributing wealth to fix the economy spans political parties: Republicans (by 90% to 9%) prefer that the government focus on improving the economy, as do independents (by 85% to 13%) and Democrats (by 77% to 19%). This sentiment also extends across income groups: upper-income Americans prefer that the government focus on improving the economy and jobs by 88% to 10%, concurring with middle-income (83% to 16%) and lower-income (78% to 17%) Americans.”

In their “Currents” feature of 3/10/09, the WSJ reported that “In a recent WSJ/NBC News poll, the highest-ranked peeve, named by 35% of those polled, was bank executives taking large bonuses while receiving taxpayer funds.” This is income redistribution to the rich. However, IRS data shows that the top 25% of income earners paid 86.3% of income taxes, so it is more a case of redistribution of income from some well off people to other very well off people.

Some conservatives rail at Obama’s tax hikes, accusing him of Robin Hood economics and warning of a descent into European socialism. Under Obama’s plan, a person earning $300,000 would pay an additional $1200 in taxes than under the current system. It is a relatively paltry sum hardly deserving the degree of complaint from these conservative critics, but it is true that some of that money would go to lower income earners so this is income redistribution to the poor.

By nature, progressive tax systems are redistributive. A redistribution of a tax burden is a redistribution of income. An overwhelming majority of people do not favor redistributive schemes. It has been almost 100 years that the progressive income tax has been in effect.

Housing Crisis

Blame for the housing crisis rests with George Bush, who pushed for an “ownership society” and simultaneously underfunded regulatory agencies. No, wait. It was the Democrats, particularly Maxine Waters and Barney Frank, who resisted regulation of Fannie Mae and Freddie Mac, and wanted relaxed lending criteria for people with marginal credit. No, the blame is on the homeowners who bought houses they couldn’t afford. No way! It was the Federal Reserve’s policy of low interest rates that were kept low for too long after 9/11. No, it was the unscrupulous mortgage brokers who conned homebuyers into dangerous mortgages that were ticking time bombs. No, wait! It was the Wall Street fat cats who made a killing by bundling all these bad mortgages. No! It was Fannie and Freddie that distorted the private marketplace and forced Wall Street to take risks that they normally wouldn’t have! No, it was the Republicans who repealed the Glass-Steagall Act and let the Wall Street banks put this garbage together in the first place!
Or maybe, just maybe, it was all of the above.

A little background. Fannie Mae and Freddie Mac are government sponsored enterprises (GSE) that were created to underwrite mortgages. How do they work?

Fannie Mae and Freddie Mac stand behind mortgages in two ways: The first method is to purchase mortgages, bundle them together, and then sell claims on the cash flows to be generated by these bundles. These claims are known as mortgage-backed securities (MBS). The second method involves Fannie’s and Freddie’s purchasing mortgages or their own mortgage-backed securities outright and financing those purchases by selling debt directly in the name of the GSE. Both methods create publicly traded securities and thus permit a wide variety and large number of purely private investors to fund mortgages. (Footnote to a Fed Reserve testimony)

Here’s Alan Greenspan, then Chairman of the Federal Reserve, before a Committee on Banking, Housing, and Urban Affairs hearing on Feb. 24, 2004:
“The expansion of homeownership is a widely supported goal in this country. A sense of ownership and commitment to our communities imparts a degree of stability that is particularly valuable to society. But there are many ways to enhance the attractiveness of homeownership at significantly less potential cost to taxpayers than through the opaque and circuitous GSE paradigm currently in place.”

Alan Greenspan cheered on the role of GSEs in the mortgage market : “Securitization by Fannie and Freddie allows mortgage originators to separate themselves from almost all aspects of risk associated with mortgage lending.” Mr. Greenspan thought this was a good idea at the time. He has probably revised this opinion.

“The GSEs’ special advantage arises because, despite the explicit statement on the prospectus … that they are not backed by the full faith and credit of the U.S. government, most investors have apparently concluded that during a crisis the federal government will prevent the GSEs from defaulting on their debt.”

“…the existence, or even the perception, of government backing undermines the effectiveness of market discipline.”

“Because Fannie and Freddie can borrow at a subsidized rate, they have been able to pay higher prices to originators for their mortgages than can potential competitors and to gradually but inexorably take over the market for conforming mortgages.”

“While the rate of return reflects the implicit subsidy, a smaller amount of Fannie’s and Freddie’s overall profit comes from securitizing and selling mortgage-backed securities (MBS). “
Later in the year, Fannie and Freddie were about to gobble up the MBS market.

Greenspan then cited a study by Fed Reserve economist, Wayne Passmore, which “suggests that [Fannie and Freddie] pass little of the benefit of their government-sponsored status to homeowners in the form of lower mortgage rates.”

“A substantial portion of these GSEs’ implicit subsidy accrues to GSE shareholders in the form of increased dividends and stock market value. “

“Unlike many well-capitalized savings and loans and commercial banks, Fannie and Freddie have chosen not to manage that risk by holding greater capital. Instead, they have chosen heightened leverage.”

“I should emphasize that Fannie and Freddie, to date, appear to have managed these risks well and that we see nothing on the immediate horizon that is likely to create a systemic problem. But to fend off possible future systemic difficulties, which we assess as likely if GSE expansion continues unabated, preventive actions are required sooner rather than later. “
“…the GSE regulator must have authority similar to that of the banking regulators.”

Barney Frank, of Massachusetts, summed up the problem at a hearing in 2004, “the tension is between safety and soundness on the one hand, financial stability, and on the other hand getting into housing.”

Later in this blog entry, you’ll read a quote from Ron Paul that may prompt you to ask for his pick to win in the upcoming March Madness basketball tournament.

The following is from a clip of a congressional hearing, probably in 2004. There had been an accounting scandal at Freddie Mac in 2003. The Offfice of Federal Housing Enterprise Oversight, which regulates Fannie Mae, had also found some irregularities and improper campaign contributions. I haven’t been able to find the date or transcript of the hearing.

Chris Shays of Connecticut expressed his concerns that Fan Mae had a capital withholding reserve of 3%, less than the 4% minimum required of banks and savings and loans.
Franklin Raines, then Chariman and CEO of Fannie Mae, responded: “These assets [houses] are so riskless that their capital withholding should be under 2%.” In hindsight, we laugh at this “riskless” assessment but Raines’ comment reflects the thinking of many who thought that housing prices simply would not go down.

Maxine Waters, of California, has been a tireless fighter for affordable housing. Her passion for affordability often outweighs any doubts about the financial stability of a program: “We do not have a crisis at Freddie Mac, and particularly at Fannie Mae, under the outstanding leadership of Franklin Raines.”
Lacy Clay, of Missouri, called the hearing a lynching of Raines.

This is an example of blind allegiance. Frank Raines stepped down in the latter part of 2004. In 2006, he was charged with “accounting irregularities” that falsely inflated Fannie Mae’s earnings. In 2008, he settled with the government for a small fraction of the $90 million that he “earned” in bonuses as head of the company.

Barney Frank, of Massachusetts, is more mindful of financial soundness than Waters, but said “I don’t see anything in this report that raises safety and soundness problems.”

Maxine Waters: “What we need to do today is focus on the regulator and this must be done in a manner so as not to impede [Fannie and Freddie’s] affordable housing mission, a mission that has seen innovation flourish, from desktop underwriting to 100% loans.” Like Greenspan, Ms. Waters may have revised her opinion somewhat on loose underwriting standards and 100% loans.

At an oversight hearing of the Dept of Housing and Urban Development on May 20, 2004, Ms. Waters again asserts her full commitment to affordability at the expense of financial soundness,
“I join with anybody who is interested in expanding low-income housing opportunities. Let me must say that the no downpayment, low downpayment, all of that, that is good stuff, but it is a drop in the bucket.”

At a House Review of OFHEO, the regulator of Fannie Mae, on 7/13/04, the Republicans renewed their call for regulation.
Sue Kelly, of New York: “While we are pleased with the tremendous strides that OFHEO and the Finance Board have taken to strengthen their oversight role, the two agencies really remain ill-equipped to handle the oversight of the GSEs.” She is echoing the view of Alan Greenspan and others that their needs to be a banking regulator overseeing the GSEs.

Paul Kanjorski, of Pennsylvania: “I am very concerned about the failure of the Bush Administration to appoint directors to serve on Fannie Mae’s and Freddie Mac’s boards. As a result of this decision, each board has five fewer individuals to serve than they usually had.” Had the board positions been filled, there would presumably been greater board oversight of Fannie and Freddie. As Thomas Frank has documented in “The Wrecking Crew”, Bush regularly understaffed federal agencies.

David Scott, of Georgia: “There is general agreement that OFHEO needs to be strengthened in order to ensure the safety and soundness of these GSEs as they expand rapidly and rely on complicated accounting methods. As we know, legislation has stalled which would consolidate the
functions of OFHEO and the Federal Housing Finance Board at the direction of the Administration.

Richard Baker, of Louisiana: “GSEs credit loss ratios have declined due to improvements in their underwriting and risk management, meaning they are not taking as many poor people as they used to take, apparently,while loan loss reserves in the same period of review have declined principally attributable to reduced losses.”

Barney Frank, of Massachusetts: “the tension is between safety and soundness on the one hand, financial stability, and on the other hand getting into housing.” Frank is pushing for more lending in manufactured housing, even though it is more likely to be financially vulnerable. “I do not think every individual product line has to be profitable. We want a cumulative profit, so I hope we would also say, look, if there is a danger of things not going too well in the one area in the affordable housing area, that can be made up for elsewhere.”

Ron Paul, of Texas, is eerily prescient: “The only discouraging thing about our discussions that we have here in the committee is for the most part we talk about the technical solutions, the job you have as regulators, and believing that it is a technical problem. I think it is much, much more fundamental.”

Ron Paul continues: “your responsibility is to provide safety and soundness, I mean, I see it as practically an impossible task if this things starts to unwind, and I believe it is going to unwind. It involves trillions of dollars and derivatives. It is just a huge monstrosity.”

Later, Paul asks the regulators: “do you think there is a possibility of a puncture of a bubble?”
Armando Falcon, Director of OFHEO, answers: “Our economists do track it and are aware of the historical trends and causes of price bubbles. My economists who have looked at this with lots of experience, believe that we do not currently have a price bubble in home prices.”

Kanjorski asks about the criteria for selecting directors of the regulatory boards.
Alicia Castaneda, Chairman of the Federal Housing Finance Board, responds: “I think those appointments should be based on the qualifications and the skills of the individuals.”
Kanjorski responds: “Is it peculiar in your mind that maybe out of 60 or 70 appointments, that 97 percent come from one party and only about 3 percent from the other party?”
Castaneda responds that she is not aware of those figures.

Edward Royce, of California, continues his push for more regulation: “Over the past year or so, this committee has spent a great deal of its time looking at the 14 housing government-sponsored enterprises. Last year, I authored legislation to create one regulator for Fannie Mae and Freddie Mac and the federal home loan banks. I felt such legislation was needed because the GSEs are too large and too important to our nation’s housing and financial markets not to have world-class regulation.”

In 2003, the Bush Administration had called for more regulation. Republicans at these hearings in 2004 were calling for more regulation. The Republicans controlled both houses of Congress and the White House. Bills were introduced and referred to committee. None made it into law.