There is a misconception, unfortunately reinforced occasionally by press reports, that the failure to enact legislation to increase the federal government’s debt limit leads to a government shutdown. This is not true. Government shutdowns occur due to a failure to enact legislation granting the federal government the authority to spend money.
This confusion was reinforced by the government shutdown during the Clinton Administration when a failure to pass appropriation bills or continuing resolutions (“CRs”) occurred simultaneously with a failure to increase the debt limit, which the Treasury was bumping against.
Currently, the specter of a government shutdown looms because the federal government is operating under CR. Congress typically enacts CRs when it has failed to pass the yearly appropriation bills. CRs are usually for a limited time; the current one expires on December 3. The lame-duck Congress will have to pass another CR in order to avoid a shutdown. It is expected to pass one of short duration, but then will have to pass another one before it adjourns, unless it passes a spending bill.
In a debt limit crisis, the government continues to operate normally unless there is a concurrent lapse in spending authority. The Treasury begins to take some extraordinary actions to avoid breaching the debt limit but retaining enough cash to meet current expenditures. The fear during a debt limit crisis is that Congress or the Administration may carry the charade too far, and the Treasury will not have enough cash to make an interest payment or to make payments, such as the large Social Security payments at the beginning of each month. This has never happened.
In the past, when Treasury has reached the debt limit and Congress has not passed an increase, the Treasury has found a way to keep the government funded. For example, one of the first actions Treasury takes is to disinvest certain government trust funds (the securities in these funds count against the debt limit), such as the Exchange Stabilization Fund (“ESF”) and certain trust funds, such as the G Fund which is part of the Thrift Savings Plan (“TSP”) for government employees and invests in non-marketable Treasury securities. This frees up room to issue more securities to the market and thus raise cash.
To show how ridiculous this is, by law when the G Fund is disinvested, it is credited with the interest it would have received if it had been fully invested. The ESF, on the other hand, loses out on the interest.
In an exercise of spin, the Treasury has called such maneuvers as disinvesting the G Fund “a statutory tool” for managing a debt limit crisis. In fact, the reason for the legislation that reimburses the G Fund for missed interest due to it being disinvested during a debt limit crisis is to protect federal employees.
The first director of the TSP was Francis X. Cavanaugh, who had a long career at Treasury and had been the director of an office at Treasury which was responsible for, among other issues, managing the public debt. (I reported to Mr. Cavanaugh for about six years during the 1980s.) He knew that the Treasury would likely disinvest the G Fund during a debt limit crisis and asked Congress to pass legislation to protect federal employees when that happened.
Once Treasury has used a particular maneuver to remain solvent during a debt limit crisis, Congress knows about it and expects Treasury to use it again. Meanwhile, Treasury starts sending increasingly frantic letters to the Hill asking for an increase.
While this is all theater, and everyone knows that Congress will eventually do the right thing and pass debt limit legislation, it is not costless. There are market effects as Treasury cancels auctions and takes other actions such as suspending sales of special securities to state and local governments. Also, top Treasury officials, including the Secretary, have to spend an inordinate amount of time monitoring the level of the debt, the Treasury’s cash balance, and the daily projections of cash inflows and outflows. They also have to consider how to deal with the political problem. This time drain diverts them from dealing with real issues, because of the requirement to handle this artificial crisis.
The debt limit does not lead to a government shutdown. If the Treasury ever did run out of cash and began defaulting, all bets are off, but, as I recall Secretary Rubin saying in 1995, default is “unthinkable.”
Tuesday, November 30, 2010
Tuesday, November 16, 2010
I have never liked what has commonly become called “spin.” For me, detecting spin is tantamount to detecting an insult – how stupid do they think I am? Whether or not to call people on spin when that is possible is a judgment call. Sometimes it seems not worth it and, letting it pass noncommittally, may leave the spinners wondering whether or not their message has been accepted in its entirety.
Given my attitude towards spin, I have not been happy to come across incidents of – how can we say this nicely? – the Treasury coloring or sometimes obscuring the facts. Readers of this blog know that I have criticized Treasury from time to time for this. (For a specific example, see my first post to this blog.)
I do admit to some sympathy to Treasury Secretaries who have to reaffirm that the U.S. has a “strong dollar” policy while at the same time encouraging certain countries to let their currencies appreciate. Everyone knows that there is little meaning to this statement and that, in this context, the meaning of the word “strong” approaches infinite elasticity. But if the Secretary tries to say something with more meaning, as I recall Paul O’Neill tried to do, then foreign exchange traders go berserk, acting as if something fundamental has changed. Treasury Secretaries seem compelled to repeat periodically the “strong dollar” mantra. (For an example of a recent incantation, click here.)
I am less forgiving of spin than that when Phyllis Caldwell, the Treasury’s “Chief of the U.S Treasury's Homeownership Preservation Office,” said at a recent hearing of the TARP Congressional Oversight Panel: “At this point in time there is no evidence that there is systemic risk to the financial system.” (Click here for quote.) In fact, there is no point in time when there is no systemic risk; the question is how much risk there is. If the risk is deemed to be too high, then the task is to identify and to take measures to reduce it. Despite pleas from one of her questioners to modify her statement, since such statements may look particularly bad in the future, Ms. Caldwell refused. She was clearly uncomfortable, but probably felt she could not go beyond what she had been authorized to say when she was preparing for her appearance back at the Treasury.
I am also less understanding of another apparent PR maneuver of the Treasury Department. Recently, I was searching the Treasury’s website for information about the Office of Financial Stability, which administers TARP. I was particularly interested in finding out who had replaced Herb Allison as Assistant Secretary for Financial Stability. I searched in vain for a press release announcing Herb Allison’s resignation or about his replacement. Also, the Office of Financial Stability had disappeared from the Treasury’s website, even though the Office reports (or reported?) to the Treasury Under Secretary for Domestic Finance. Finally, in reply to my inquiry, a reporter I know directed me to another government website, FinancialStability.gov, where one can find that Tim Massad is Acting Assistant Secretary for Financial Stability and Chief Counsel.
While the TARP program has ended in the sense that no new money is being committed, there are existing investments to manage as the program is wound down. What is the point of trying to hide the existence of this office? It is almost as if someone wants to dump it down an Orwell memory hole.
These are perhaps small points, but they do not provide any confidence that the Treasury currently possesses the PR savvy to deal with what will be a much harsher political climate for it next year. While senior Treasury officials no doubt believe their harshest critics on policy issues are wrong, they should not leave themselves open to charges of prevarication. It is much better to have good policies you believe in and then to tell that story.
Monday, November 15, 2010
Early on in my career in the Domestic Finance section of Treasury, my then boss, a career civil servant who even by that time had been at Treasury for a long time, told me that it was the Fed’s policy to keep the maturity structure of its permanent portfolio similar to what the Treasury had issued, so as not to impact debt management. I did not run the numbers at that time to check if what my boss had told me was correct, but it is clear that this is not current Fed policy.
The Treasury is of course aware of this but seems to want to minimize the issue. In the November 3 quarterly refunding press conference, Assistant Secretary for Financial Markets Mary J. Miller made a point of saying that Treasury decisions with respect to debt issuance are made independently of the Fed and even quoted a Treasury Borrowing Advisory Committee (“TBAC”) member as saying that the Fed should be just considered as a big investor.
I am more inclined to agree with the sentiment of the TBAC member, who, according to the minutes, said that “the Fed's purchase of longer-dated coupons via increasing reserves was economically equivalent to Treasury reducing longer-dated coupons and issuing more bills.”
Of course, that is not quite right. Not only is the Fed reducing the amount of Treasury notes available to the market, it is reducing the total amount of debt securities needed to be in the market in order to keep the government financed. As for bills, their relative importance to debt management is increased, but not necessarily their quantity.
With respect to T-bills, though, I note that the Treasury continues to have issued bills it does not need to keep the government financed in an amount of nearly $200 billion. The proceeds of these bills are deposited in the Supplementary Financing Program Account. Treasury’s issuance of bills to borrow money it does not need and depositing it at the Fed serves to drain banking system of reserves. Why Treasury is still doing this when the Fed has an announced policy of increasing reserves is not clear, but I am sure that, even with all the talk of Treasury independence from the Fed, the Treasury and the Fed from time to time discuss this program. (It is noteworthy that Treasury is emphasizing its independence from monetary decisions, not the Fed insisting on its independence from Administration policy.) One can be sure, though, that when the Treasury bumps up against the debt limit next year and the likely debt limit theater again puts on one of its periodic performances in Washington, the Supplementary Financing Program Account will be tapped. (Previous comments of mine on the Supplementary Financing Program Account and Treasury cash can be found here and here.)
I am not going to assess the wisdom of the Fed’s new policy here. What I would like to note, though, is that, while the Fed is not permitted by statute to lend to the Treasury, it is effectively monetizing the deficit by buying record amounts of Treasury securities in the secondary market. While the Federal Reserve Banks are technically private institutions, there is no way other than to view them as part of the government for policy analysis. They are not just another investor, albeit large. The interest the Treasury pays on the securities the Fed owns comes back to Treasury in the form of “interest on Federal Reserve notes.” The Fed subtracts its expenses from the amount it remits to the Treasury. This used to mean that Treasury got virtually all the interest it paid on securities newly acquired by the Fed, since the Fed’s increasing its balance sheet did not affect its expenses. Now it does, since the Fed pays 25 basis points on bank reserves, but there will still be funds remitted to the Treasury from the notes the Fed acquires under the new program.
Of course, at some point, the Fed will want to drain bank reserves from the banking system. It is unclear when that will happen, but, when it does, Fed sales of Treasury notes will compete with the Treasury’s own sales.
While it is true that the Treasury, not the Fed, makes the final decisions about what the Treasury will auction, it is silly to claim that the Fed is just another investor and to give the impression that Treasury debt management is not impacted by Fed actions of the current magnitude. Much of the audience for the quarterly refunding press conferences knows this; what is the point of pretending otherwise?
John Carney, a senior editor at CNBC.com, posted an article on Friday with the headline, “Get Ready for the Great MERS Whitewash Bill.” Mr. Carney concluded: “I wouldn't be at all surprised if Congress manages to pass a bill that bails MERS out of its legal issues.” Today, Carney posted another article, “Do the Enemies of MERS Know What They Are Asking For?” In this later article, Carney argues that it is not a foregone conclusion that the courts will destroy MERS, given the practicalities involved. (This AP article discusses the costs to banks if the legal attack on MERS for avoiding the payment of local recording fees is successful.)
One way or another, a way will be found to avoid the worst consequences to banks that the legal attacks on MERS imply. This may involve addressing some tax issues concerning the trusts underlying mortgages which have been securitized, if that is indeed a problem, as well as the more obvious legal issues surrounding foreclosures.
If legislation with retroactive applicability is deemed necessary, then there will be legislation passed with bipartisan support. Most (but probably not all) legislators with a fondness for quoting the Tenth Amendment to the Constitution would probably be silent on that point. They would effectively assent to arguments that mortgages are traded across state lines and therefore the Interstate Commerce Clause grants the Congress the power to legislate on this issue, even though real property, by its very nature, stays put. The Supremacy Clause might also be invoked by proponents as meaning any federal statute on this subject will preempt any state or local laws governing recording requirements and associated fees. (Given the amounts of money involved with these fees, California and other states might challenge the constitutionality of any such legislation to the Supreme Court, which would prove interesting.)
On the other side, many legislators usually concerned with unfair practices of banks towards consumers also would likely not oppose MERS legislation if it is deemed necessary by the Administration. They would be swayed by arguments made by the Administration and financial institutions. For example, proponents of legislation could argue that, if MERS is not granted legal certainty, then there would potentially be enormous costs to financial institutions, which could require another bailout or sink the economy into another recession.
Carney suggests that those arguing for struggling homeowners should not aim for total victory against MERS in the courts but should negotiate a global “Spitzer-style” settlement. In Carney’s words, this “would involve a trade-off of mortgage modifications in exchange for forgiving the flaws and frauds MERS allegedly enabled.” (Carney credits Trace Alloway of ft.com/Alphaville for suggesting a Spitzer-style settlement. See “The mother-of-all MERS fixes” and “The Spitzer settlement for mortgages.”)
Whatever the resolution of the legal uncertainty surrounding MERS, it is clear that those setting up MERS years ago brushed away any legal concerns. The foreclosure mess underlines the importance for the financial community to make the necessary investments to minimize legal and operational risks, rather than acting as if extreme events never happen.
Thursday, November 4, 2010
Officials at the Mortgage Electronic Registration Systems (“MERS”) have been attempting to dismiss the concerns that have been raised about whether their system conforms to local laws governing real estate. Though the company, whose motto is “process loans, not paperwork,” is putting on a brave front, one suspects that there are some very worried people at its Reston, Virginia headquarters.
An article in The Washington Post last month, “Reston-based company MERS in the middle of foreclosure chaos,” provides some useful background to this company, which was until recently little-known, even though, according to the Post article, it “tracks more than 65 million mortgages throughout the country.” MERS was created in the 1990s to reduce the paperwork involved in transferring mortgages, especially those which had become securitized. The system started operations in 1997. MERS states that its “mission is to register every loan in the United States” on its system.
Legal issues are now being raised about whether the MERS system actually works. Christopher L. Peterson, a law professor and associate dean at the University of Utah, S.J. Quinney College of Law, has posted online a working draft for a forthcoming issue of Real Property, Trust and Estate Law Journal – “Two Faces: Demystifying the Mortgage Electronic System's Land Title Theory.” Floyd Norris of The New York Times has a good summary of the issues in his article: “Some Sand in the Gears of Securitizing.”
Mr. Peterson points out that some boilerplate legal language MERS uses “is confusing to courts, borrowers, and even foreclosure attorneys.” It states that “MERS is a separate corporation that is acting solely as nominee for Lender and Lender's successors and assigns. MERS is the mortgagee under the Security Instrument.” Peterson remarks: “It is axiomatic that a company cannot be both an agent and a principal with the same right.”
He goes on to say that there are “significant legal problems” whether MERS is an agent or the actual mortgagee. If it is the agent, this may run afoul of state land title recording acts, whose point is “to provide a transparent, reliable, record of actual – as opposed to nominal – land ownership.” If it is the mortgagee, then the mortgage has been separated from the promissory note. An 1872 Supreme Court case (Carpenter v. Logan) held that a mortgage assigned without the note “is a nullity.” That would seem to mean that MERS has no right to bring a foreclosure action.
Moreover, in this time of constrained local budgets, local governments are not happy that recording fees have not been paid on mortgages in the MERS system that have been assigned. This issue presents another legal challenge to MERS.
MERS seems to be blowing smoke in defending itself. For example, see its comment to Mr. Norris, which he quotes on his blog. (Those interested in a detailed summary of court cases involving MERS can find one here.)
The U.S. Treasury Department, seems to be trying to minimize the MERS issue. In an appearance before the Congressional Oversight Panel, a Treasury official with the peculiar title “Chief of the Homeownership Preservation Office,” Phyllis Caldwell asserted that regarding MERS litigation “at this early stage, it does not appear to be a fundamental legal risk.”
Well, perhaps, but the handwriting on the wall for MERS is becoming clearer; for example, James Dimon has announced that J.P. Morgan Chase will no longer use MERS for foreclosures. Also, in a recent development, the outgoing Attorney General for the District of Columbia, Peter Nickles, has issued a statement saying that MERS does not meet the legal requirements to commence foreclosure proceedings in the District.
It must be galling to officials at the Treasury and at financial institutions that MERS has created this legal problem with foreclosures. After all, the people who are being foreclosed on have defaulted on their mortgage loans.
But if Peterson is right, at a minimum foreclosures will be slowed down as financial institutions endeavor to prepare paperwork that will satisfy legal requirements. (There are of course other issues such as "robosigning" that have been widely reported on.) In some cases, Peterson argues that the true loan owner could be treated as holding “an equitable mortgage,” but he says “it is likely that an equitable mortgage could be avoided in bankruptcy.” The effect of this will give homeowners in default more bargaining power. Peterson comments: “The judicial threat of invalidating mortgages and replacing them with less tactically useful equitable mortgages could decrease court's dockets by forcing securitization trustees and servicers to the negotiating table.”
This may not be the worst result, but there may be concern in some quarters on the effect of this on financial institutions. The Treasury Department after all at times gives the impression to have substituted “Wall Street” for “General Motors” in Charlie Wilson's famous statement about what is good for the country, or maybe the Treasury has just added Wall Street to the statement. (I'm sure, though, that some in the financial community do not have this impression, since they are not happy with some Treasury actions and some provisions of the Dodd-Frank legislation.)
There is also another possible issue with MERS, though I should note that I have not researched this. There may be questions regarding whether the requirements of tax law facilitating the creation of various types of asset backed securities have been met with mortgage loans where the mortgage is recorded in MERS and not in local offices.
It is hard to imagine that when MERS was set up that at least some lawyers involved did not recognize that there were some troublesome legal issues. There were probably told, at least implicitly, to keep their reservations to themselves by hard charging business people wanting to set this up because of the efficiencies and lower costs MERS would provide. Now the financial institutions may be betting on the courts not wanting to upset a system this significant to the financial community. There are, however, a lot of local courts and federal bankruptcy courts to convince of this.
Also, it is not clear how much the federal government can do about this if court decisions regarding MERS appear to harm financial institutions. It would seem that laws regarding real property are the province of state and local governments, not the federal government.
For those interested in this subject, another good article can be found in Bloomberg Businessweek, “Mortgage Mess: Shredding the Dream.”