Friday, July 29, 2011

President Carter Vetoed Debt Limit Legislation

In June 1980, the Congress attached a measure rejecting President Carter's attempted imposition of an oil import fee to debt limit legislation. When the legislation reached the White House, Carter vetoed it. Though both houses of Congress had Democratic majorities, the Congress easily overrode the veto. In reporting this, most of the press was focused on the oil fee issue, not the debt limit. Treasury, though, had its attention on the debt limit. The override of the veto served to increase the debt limit.

Attaching the oil fee provision to a debt limit increase was an attempt to force Carter to accept the legislation. It did not work, but the easy veto override indicated that Congress could have gotten its way without attaching it to the debt limit bill.

The Debt Limit: Have We Ever Been on the Verge of Default Before?

The answer is yes. The closest we came during my time at Treasury was in November 1985. Treasury had performed some accounting maneuvers, including disinvesting some securities in the Social Security trust funds, but then it had indicated it was out of tricks. The November 15 interest payment date was looming. President Reagan was insisting on more than a small increase in the debt limit along with a Congressional commitment to balance the budget in five years. On November 14, the Congress passed an $80 billion increase in the debt limit, enough to last until around December 11, along with appropriation legislation funding the government until December 12. President Reagan signed it that night.

The linking of the debt limit with pressure to cut domestic spending sounds very familiar these days. Note though that we went right to the eve of an interest payment date in 1985. There was no payment prioritization, as it talked about now.

Reagan was a tough negotiator, but he knew when to compromise.

When people say that the all debt limit increases are routine, this is of course not true. Memories are short.

The latest fiasco, though, is good evidence why the debt limit should be repealed and the Treasury should simply be given authority to issue debt in order to keep the government funded, based on the tax and appropriation decisions of Congress and the effect of the economy on expenditures and receipts. Otherwise, we are likely to suffer self-inflicted wounds in the future, given our polarized politics.

Wednesday, July 27, 2011

ISDA Clarifies the Terms of CDS on U.S. Sovereign Debt

ISDA posted on their website today a Q&A on CDS on Treasuries, which clarifies the three day grace period and other matters.  They needed to do this, given the confusing news articles and a television interview on this subject.

How Serious is the Debt Limit Impasse?

The New York Times has a quite good Q. and A. about the debt limit, which explains the seriousness of the situation and the implications of prioritizing payments. For a sobering look at the implications of not raising the debt limit, also see the presentation of the Bipartisan Policy Center. One of the authors of the Bipartisan Policy Center presentation is Jay Powell, who was Treasury Under Secretary for Domestic Finance in the George H.W. Bush Administration and for whom I used to work.

The Bipartisan Policy Center makes the point that what we are facing if Congress does not act is quite different than government shutdowns due to a failure to enact appropriation legislation. The Center's paper says that during the 1995-1996 shutdown that "mandatory spending continued without interruption" and "disruption of government services was modest." That would not be the case if Treasury does not have enough cash to meet all its obligations.

There would also be problems for state governments, which is why, for example, the conservative Republican governor of Virginia, Bob McDonnell, says he is "exasperated with Washington" over this issue. Virginia's AAA credit rating is at risk because of Virginia's reliance on federal spending.

With regard to state and local governments, the NYT article says: "States, still recovering from the downturn, could be hurt in two ways. First, if the federal payments they rely on for everything from Medicaid to highway construction are interrupted, states that are still recovering from the recession could face serious cash-flow problems. Second, the broader economic disruptions of a default could lower tax collections again as they are still rebounding from the dive they took during the Great Recession."

Arguments that a failure to raise the debt limit before Treasury runs out of enough cash to meet all its obligations is not that big a deal or just like a government shutdown due to a failure to enact appropriation legislation are based on misinformation, ideology, or, perhaps, antipathy to the current Administration.  In some cases, they may be simply spin engaged in  for political purposes.  Congressional leaders know all this, which is why the odds are that something will be worked out.

There is, though, some doubt that August 2 is the date by which the debt limit must be increased. One can understand why Treasury wants to keep the pressure on by sticking to that date, but according to some analysts the actual date could be later. I do not know if their analyses are correct, but I think that the analysts at Nomura, Wells Fargo, and Barclays are saying this because they believe it and not out of any political agenda. If they are correct, Treasury should issue some kind of announcement, embarrassing as that might be, if it wants to be credible. There are a lot of good analysts poring over the Treasury Daily Statement and tracking expenditures and tax receipts.

ISDA on Treasury CDS: Three Day Grace Period for Treasury Interest Payments

According to a Reuters report, Steven Kennedy, ISDA's global head of communications in the New York office, said that the U.S. Treasury would have a three day grace period to make missed interest payments without causing a credit event triggering credit default swaps on Treasury securities. He indicated that this grace period is in the underlying CDS documents.

The ISDA website makes no mention of this, at least that I could find. It does link to the Bloomberg Television interview with David Geen, General Counsel of ISDA, during which he makes no mention of a grace period. (The YouTube link here seems to work better than the Washington Post link to the interview on the ISDA site.) I would think that ISDA would want to clarify this issue on its website rather than rely on news articles.

More Problems for MERS

Reuters is reporting that, in addition to Massachusetts, Delaware is investigating MERS. The attorney general of Delaware is Beau Biden, the Vice President's son. Some in the Administration and at federal regulatory agencies may not be happy by the aggressive pursuit of MERS issues by some states.

A useful summary of MERS legal difficulties in various states has been posted to the Washington Post's website.

Tuesday, July 26, 2011

Massachusetts Attorney General Coakley and MERS

It has been some time since I have written on the Mortgage Electronic Registration System, about which legal issues abound. Keeping up with all the conflicting court decisions would be a full time job.

I was interested to read today, though, that Massachusetts Attorney General Martha Coakley has written a letter to the registers of deeds in Massachusetts stating that her office is "investigating creditor misconduct in connection with unlawful foreclosures, including failure to establish the right to start a foreclosure as well as filing false or misleading documents with registries in the Commonwealth." In addition, with regard to the federal and state negotiations for a settlement with large banks on mortgage issues, Coakley writes: "Massachusetts will not sign on to any global agreement with the banks if it includes a comprehensive liability release regarding securitization and the MERS conduct."

For its part, MERS issued a press release in response, which states: "The assertions about MERS are without merit. We will cooperate with the investigation and look forward to the opportunity to respond to the Massachusetts Attorney General's request. The use of MERS has been litigated in Massachusetts courts, and judges have upheld the legality of the MERS business model in the Commonwealth."  The press release cites three federal court decisions in Massachusetts concerning MERS, but fails to mention the Ibanez case, which went to the Massachusetts Supreme Judicial Court, whose decision in that case did not favor MERS. (I wrote about the Ibanez case here. Note that the links to the "foreclosureblues" website in that post no longer work.)

The case law involving MERS is totally confused at this point, and federal regulators appear to want the whole problem to go away. It appears that they may not get their wish.

(Yves Smith discusses Martha Coakley's letter at greater length on her "naked capitalism" blog.)

Some Thoughts on Debt Limit Politics

As has becoming increasingly clear, President Obama has been trying to follow President Clinton's playbook and tried to triangulate. That is, he has tried to take positions that are different from the majority view in his own party but are not entirely that of the opposing party. In this regard, it appears that he was trying to make a deal with the Republicans that would include raising the eligibility age for Medicare to 67 and adopting an indexing methodology for Social Security that would produce lower benefits in the future. These are not policies many Democrats would favor.

While some Republican commenters think that the Republicans in Congress should have compromised on the tax reform issues and declared victory for making changes to these two entitlement programs, it is clear that the new Republican members in the House are unwilling to compromise with Obama. From their policy perspective, this is a mistake. There has to be some compromise.

The default threat, interestingly, is pressuring all sides. While Obama is criticized by some Republicans who think he is exaggerating the possibility of default or exaggerating the consequences of defaulting on the debt to pressure them, the default threat also was serving to pressure Democrats to endorse any deal Obama made with the Republicans. The Democrats in Congress must be relieved that it is likely that they will not have to decide on how to vote on a debt limit package that includes cutting Social Security and Medicare. Some may be secretly cheering Tea Party recalcitrance.

Given Obama's rhetoric during these debt limit/budget negotiations, Democrats need to entertain the possibility that Obama is not as liberal as they once thought. It may be that not only does he want to strike a deal that includes entitlement reform with the Republicans out of political necessity but that he really wants to do this and was trying to use the debt limit crisis to pressure members of his own party to accept changes to two major domestic achievements of previous Democratic Presidents – Franklin Roosevelt and Lyndon Johnson. Also, Obama apparently believes that cutting current government spending in an economy with an unemployment rate over nine percent is a good idea. Former Obama economic advisors, such as Larry Summers, do not agree and fear that we will be repeating the policy mistake of 1937. The surviving member of the original economic team, Secretary of the Treasury Geithner, seems to have less faith in fiscal stimulus than the economists who have left the Administration. Many Democrats in Congress also believe fiscal stimulus can be effective and do not want to have to vote for a pro-cyclical fiscal policy, which reducing current spending would be.

In other words, there is disarray among the Democrats as well as the Republicans. This is making the debt limit crisis very difficult to resolve. I believe that a way will be found not to default on the debt, which would have terrible consequences if it happened, but the ability for anything constructive to be done prior to the 2012 elections seems low. One can expect an enormous game of political spin designed to confuse and gain political advantage, which over time will make the public more cynical about Washington than they already are. And, if the economy does not improve, this will add significantly to the unhappiness with how Washington operates.

ISDA Appears to Backtrack on Treasury CDS

David Geen, General Counsel of ISDA, tells Bloomberg today that, if Treasury missed an interest payment, that would be a trigger credit event for credit default swaps on U.S. Treasury securities.  This is different from what Reuters yesterday quoted him as saying.  One can only speculate about why he changed his position.

Click here for the Bloomberg video.

Monday, July 25, 2011

Debt Limit and Credit Default Swaps: ISDA Hedges

Reuters has an interesting article about credit default swaps on U.S. Treasury securities. In the event of a U.S. default on its debt, there are two areas where there is some confusion about whether CDS sellers would be required to pay according to David Geen, general counsel of the International Swaps and Derivatives Association ("ISDA"). The first is whether any grace periods apply, though apparently the contracts on U.S. Treasuries, unlike those on corporate securities, do not specify a grace period. ISDA is "researching" this issue.

The second issue seems totally imaginary. David Geen is quoted as saying: "In order for there to be a credit event there has to be publicly available information that says this payment was due on this day and it wasn't made, and that may not be that easy to demonstrate." One wonders what he is talking about. It will be very clear if Treasury misses a payment. For example, the Daily Treasury Statement details payments day by day, if one did not want to rely on other Treasury press releases and the statements of holders of Treasury securities that they had not received interest.

I am sure it is reassuring to buyers of CDS on Treasuries that a committee of ten dealers and five asset managers will make the determination about whether payments need to be made in the event of a Treasury default.

There is also an issue about CDS on Greek debt. You have to wonder what the point of buying a CDS is if the contracts are this murky.

Thursday, July 14, 2011

Debt Limit Politics – Disarray on the Right

As the deadline for increasing the debt limit that the Treasury has set, August 2, get ever closer, the pressure is getting harder to bear. Senator Mitch McConnell, mindful of the epic confrontation between President Clinton and Newt Gingrich in 1995, has apparently come to the conclusion that the Republicans cannot use the threat of default to achieve their policy goal of reducing the size of the government. He has consequently come up with a clever way to shift the political responsibility for raising the debt limit to the President. From his point of view, this accomplishes two main goals. From a public policy perspective, it ensures that the U.S. government will not default. It seems that Wall Street and other business leaders have given the Republican leadership an earful about the necessity to increase the debt limit, and these business interests are, of course, correct. The proposal also shields the Republicans from taking political responsibility for increasing the debt limit, freeing them to use the increasing public debt as a way to attack the Administration and other Democrats in the elections next year.

In an editorial yesterday, The Wall Street Journal supports McConnell proposal. While earlier editorials had taken the position that a "technical" default would not be that bad, the editors now write: "The tea party/talk-radio expectations for what Republicans can accomplish over the debt-limit showdown have always been unrealistic. As former Senator Phil Gramm once told us, never take a hostage you're not prepared to shoot. Republicans aren't prepared to stop a debt-limit increase because the political costs are unbearable. Republicans might have played this game better, but the truth is that Mr. Obama has more cards to play."

Liberal Democrats, such as Nancy Pelosi, are intrigued by the McConnell proposal. The liberals are worried that any "grand bargain" between the Republicans and the Administration would cut programs, such as Social Security and Medicare, more than they could support. From their point of view, the McConnell proposal would mean that would not happen, at least not now, and the nation (and the world) would be spared a default on the debt.

The more interesting political dynamics are on the right. Many of the House Republicans do not like the proposal because it does not achieve the spending cuts they want. While I would not phrase it this way, the WSJ editors are right when they write: "The entitlement state [?] can't be reformed by one house of Congress in one year against a determined President and Senate held by the other party. It requires more than one election."

On the other hand, the Republicans may be in a race against time, and some of them may realize it. As more of the baby boomers either become eligible for Social Security and Medicare or old enough to really care about these programs, they will be more difficult to cut. In addition, while some would like to characterize this issue as generational warfare, this ignores the demographic changes in the U.S. that do not favor certain Republican positions on other issues. Young people are, in general, quite socially liberal. For example, who would have thought ten or fifteen years ago that the movement to legalize same-sex marriage would have reached the point that it has today? Polls show that many young people are more accepting of gay marriage than their elders. Also, the growing Hispanic population is not supportive of the position of many Republicans (George W. Bush being a noticeable exception) on immigration issues. (That many young people are socially liberal is incidentally a distinct change from the Reagan years, when more first time voters were registering as Republicans than as Democrats. That cohort has helped the Republicans immensely and countered the more liberal baby boomers who came of age during the civil rights movement and the Vietnam War.)

Another problem for Republicans is that, if the U.S. remains in an economic slump, the support for social safety net programs will increase. While it is true that poor people are not major contributors to political campaigns and may not vote in the numbers that better-off people do, a prolonged slump will mean that more people who do not need programs such as Medicaid, unemployment insurance, and food stamps will personally know someone who does. It will also increase the fear of many people that they might lose their jobs and become dependent on these programs.

As far as the upcoming Presidential election is concerned, it is way too early to tell. President Obama has turned out to be more conservative on some issues than many of his more liberal supporters would like. It is hard to see the degree of enthusiasm for Obama from them that they manifested in 2008. The Republicans, though, do not have an inspiring set of politicians vying for the nomination. The candidate who would seem to have the best chance to beat Obama by appealing to independents and some Democrats is Jon Huntsman, but it is difficult to see how he can win the Republican nomination. Romney certainly has a chance, though he is suspected by those on the right, I believe correctly, as being less "conservative" than he pretends. His record in Massachusetts belies that.

But however the Presidential election turns out, the Republicans face some long-term problems, which may be why they are pressing so hard on government spending. They are probably making a mistake in not compromising a bit on revenue issues with Obama, since this may be the best chance they have. This may also be why liberal Democrats are intrigued by McConnell's proposal.

Tuesday, July 12, 2011

Others Chime in on Peter Kramer and Antidepressants

Peter Kramer's New York Times article defending antidepressants has generated some debate. Felix Salmon, who blogs mostly on economic issues for Reuters, criticizes Kramer's article ("The antidepressant debate"). He concludes: "Does that mean I now believe that antidepressants do no good at all? No — as a good Bayesian, I'm not going to let a single article do that. But I was looking forward to a strong response to Angell. And the weakness of Kramer's essay only serves to confirm my suspicions that Angell and the anti-antidepressant crowd really are onto something.")

Robert Whitaker, the author of Anatomy of an Epidemic: Magic Bullets, Psychiatric Drugs, and the Astonishing Rise of Mental Illness in America, criticizes Kramer's article in detail on his Psychology Today blog ("The New York Times' Defense of Antidepressants"). I criticized Whitaker's book in a previous post for relying on too many horror stories about patients and drugs, but, otherwise, the book does present much disturbing information. If Whitaker is wrong about some facts, then, now that the debate has been joined, someone should point that out.

Also, John Horgan on his Scientific American blog, criticizes Kramer's article and his previous work ("Are Antidepressants Just Placebos With Side Effects?"). No fan of Kramer, Horgan writes: "The Brave New World envisioned by Kramer was always a complete fantasy." He concludes, though, with a more moderate tone: "I sometimes suspect that psychiatric drugs work, to the extent that they do, simply by making people feel different. The suffering person interprets this difference as an improvement, in the same way that someone who is in a rut may feel better by traveling to another country. But does that mean that any psychoactive drug—Caffeine? Beer? Antihistamines? Psilocybin?—can in principle produce the same benefits as an SSRI, as Angell and Kirsch seem to suggest? Even for a skeptic like me, that seems hard to believe. We clearly need more research not only on alternatives to antidepressants (yoga, meditation, jogging, reading groups, journal-writing) but also on the drugs themselves, to understand why some people benefit so much from them while others don't. But more research will be helpful only if the results are reported—as all medical data should be but too often aren't—with absolute candor and transparency."

I am glad that there is an open debate on this subject. If antidepressants and other mind-altering drugs are prescribed too much, then this should be stopped. I am not qualified to opine on whether antidepressants should ever be used, but I think that, when we see advertisements that suggest that shyness is a medical disease ("social anxiety disorder") that should be treated with drugs, things have gone too far. (In their defense, I am sure that the psychiatric establishment would argue that the drugs are only for severe anxiety in social situation, however that is defined.)

Also, those who believe that the free market is always the best answer for healthcare issues should study how the pharmaceutical companies have essentially encouraged "opinion leaders" with lucrative contracts to tout their drugs to doctors and read the stories about how those who refused to play along suffered damage to their careers. Government has its problems too, and those conservatives who warn about the problem of captured regulators are raising a very real and valid concern. However, there is nothing like an open debate among experts and others to get at the truth. That is why this debate on the efficacy of antidepressants, and their potential harmful effects, is one that should be welcomed.

Senator Warner’s Misleading Framing of the Debt Limit Issue

Last week I watched Senators Mark Warner (D., Va.) and Mike Crapo (R., Id.) discuss the debt limit and the negotiations to resolve the impasse on the Charlie Rose show. They are both members of the Senate "Gang of Six" (now five), which has been meeting to try to hammer out a compromise that they could sell to their colleagues.

Nothing Senator Crapo said surprised me, since his ideological position is clear. But I was disappointed in some of what Senator Warner had to say, which was misleading. In summary (I am writing this from memory), he said we need to fix the fiscal situation because a U.S. government default would be disastrous.

This confuses two different things, the statutory debt limit and the longer-term fiscal situation of the federal government. The reason that the possibility of a government default next month has arisen is not due to the size of the current deficit or debt of the U.S. government, large as they are. The Treasury currently has no problem borrowing money, currently at historically low interest rates. Rather, the possibility of default has to do with a statute that limits the amount of debt the Treasury can issue. Once that statute is amended to increase the amount the Treasury can borrow, the Treasury will have no problem keeping the government financed. In other words, the U.S. is not in the same situation as Greece, which has borrowed in a currency it does not control and whose ability to meet its euro-denominated obligations is in serious doubt.

The longer-term fiscal situation is what the negotiations are really about. But there is no economic reason that this needs to be tied to the debt limit increase. The link between the two is a political choice that the Republicans initially made and that President Obama has now embraced. Senator Warner seemed to be saying that if there is no plan to deal with the fiscal situation, the government might default, but he did not clarify that this is a political judgment, not an economic one. If his point had been that there was a political necessity to come up with some kind of long-term plan, I would not be making this criticism. But making it sound like the markets would go haywire if there is no compromise soon is misleading. The markets will go haywire if the Treasury defaults, and that would be due to a failure of the Congress to increase the debt limit, not because it failed to restructure Medicare and Social Security, cut defense spending, and reform the tax code in the next few weeks. In any case, I don't see default happening; I continue to believe that at some point the imminent specter of a government default will force some kind of resolution.

It was also galling that both Warner and Crapo were trying to present themselves as eminently reasonable. But threatening to put the U.S. into default unless a long-term fiscal plan is enacted is hardly the tactic of reasonable people. Charlie Rose should have called them on it. As it was all three men were pretending to have a serious discussion, with the two Senators often smiling, in my view inappropriately.

Monday, July 11, 2011

More Controversy on Antidepressants

Given that in a previous post I wrote that I had not seen any persuasive rebuttals to Marcia Angell's New York Review of Books articles on antidepressants and Irving Kirsch's book, The Emperor's New Drugs: Exploding the Antidepressant Myth, I thought that I should note that a rebuttal has since appeared in the Sunday New York Times. The article, "In Defense of Antidepressants" was written by Peter Kramer, who is a professor of clinical psychiatry at Brown University, and the author of the 1993 book, Listening to Prozac. He may have a special reason to feel aggrieved by Kirsch's book. The title of the first chapter is "Listening to Prozac, but Hearing Placebo."

Catchy as it is, that title may be a touch misleading. No one argues that antidepressant drugs don't do anything; they are in fact powerful drugs. The issue is whether what they do is beneficial and whether they may do more harm than good, as some have charged. The online comments to Kramer's articles show that there are patients who feel they have been a life-saver; there are also more negative comments from other patients.

I did not find Kramer's article convincing, but then I have read Kirsch's book, where he addressed the criticisms of his research that Kramer repeats in this article. Since I have no particular expertise in this subject though, readers who care about this can read the book, which is not very long, as well as Kramer's article and judge for themselves.

One argument Kramer makes is that the unpublished research studies that Kirsch included in some of these analyses were not well done. It should be noted, though, that the studies were paid for and submitted by the pharmaceutical companies to the FDA and were performed in order to get FDA approval of the drugs. The burden of proof that a particular antidepressant drugs works should be on the drug companies. It should not be the burden of others to prove that they do not work in obtaining FDA approval.

Also, Kirsch does not address the arguments that Kirsch makes that there is no evidence that depression is the result of a chemical imbalance in the brain, nor does Kramer address concerns about the long-term effects of these drugs.

Of course, part of the problem in doing research on the efficacy of antidepressant drugs is that it is much more subjective than other areas of medical research. It is after all much easier to determine whether an antibiotic works than it is an antidepressant.

While this subject is somewhat outside the context of this blog, it is related to the policy issue of what to do about Medicare and healthcare generally. Pharmaceutical companies have introduced many useful drugs that have improved healthcare. However, the financial and other means they use to influence doctors are disturbing. Examining how they influence doctors and the medical consensus should be part of the process of reforming health care, as well as the price U.S. patients pay for non-generic prescription drugs.

Until recently, those raising doubts about these drugs could be dismissed as being on the fringe, but that is less possible with Angell and Kirsch. Kramer has decided he cannot ignore them; he should do a better job at defending his position than with an article that is sandwiched by an anecdote about a particular case in which he believes an antidepressant were very helpful.

Arguing with anecdotal evidence is not very convincing. Kramer does it in his article, but on the other side, another book reviewed by Angell, Anatomy of an Epidemic: Magic Bullets, Psychiatric Drugs, and the Astonishing Rise of Mental Illness in America by Robert Whitaker, also relies too much on horror stories about patients who have taken antidepressant, antipsychotic, or tranquillizer drugs. There is no way to judge from these anecdotes whether they are representative.

However it turns out, it is good that a serious debate appears to have been initiated on antidepressant drugs.

Wednesday, July 6, 2011

Book Review: Reckless Endangerment by Gretchen Morgenson and Joshua Rosner

Another book, which has received favorable reviews, has been added to the growing list of books that seek to explain the financial crisis. This one is Reckless Endangerment by Gretchen Morgenson and Joshua Rosner. Morgenson is a business reporter and columnist for The New York Times and Rosner, according to the jacket cover, is a housing and mortgage-finance consultant for "global policy-makers and institutional investors." In the Introduction, the authors state: "Investigating the origins of the financial crisis means shedding light on exceedingly dark corners in Washington and on Wall Street. Hidden in these shadows are people, places, and incidents that can help us understand the nature of this disaster so that we can keep anything like it from happening again."

The book is disappointing. It was obviously written in a hurry, which shows in its organization, which is haphazard, some minor factual errors, and its writing style. Most of the book is about Fannie Mae, but the authors veer off from time to time to criticize the Federal Reserve, among other targets, for issues not directly related to Fannie Mae. This would have been a much better book if it had only been about Fannie Mae (and, perhaps, Freddie Mac) and if the authors had not exaggerated the role Fannie Mae played in causing the financial crisis.

Given that the book seeks to explain the origins of the financial crisis (the subtitle is "How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon") and that most of it is about Fannie Mae, the impression is left that Fannie Mae was the biggest single cause of the financial crisis. Fannie Mae and Freddie Mac did not lead the private market into subprime mortgages; they followed it after they figured out how they could. They were latecomers to the party. Morgenson's colleague at the Times, Joe Nocera, who coauthored a much better book, All the Devils are Here: The Hidden History of the Financial Crisis, pointed this out in a column criticizing a "primer" put out by the Republican commissioners of the Financial Crisis Inquiry Commission. (My review of All the Devils are Here can be found here and my discussion of the Republican primer, here.)

While I disagree with the book's large assignment of blame to Fannie Mae, I agree with many of the criticisms the authors make of that institution. Usually, the Treasury Department, both in Democratic and Republican administrations, has had a somewhat tense relationship with Fannie Mae and Freddie Mac. As a career Treasury employee whom I worked for in the 1980s liked to say, the executives at Fannie and Freddie paid themselves private sector salaries without taking private sector risks. Also, there was the sense that Fannie and Freddie debt securities competed with Treasuries. The Treasury would always insist that Fannie and Freddie securities were not backed by the full faith and credit of the U.S. government, which was true, but everyone assumed that if Fannie and Freddie, or any of the other government-sponsored enterprises ("GSEs"), got into trouble, holders of their debt obligations would somehow be protected, though owners of their equity securities could lose. That assumption has been proven correct.

In fact, it was the "implicit" government guarantee that allowed Fannie Mae to grow its way out of serious financial trouble that it experienced in the 1980s. In the 1980s and before, Fannie Mae was similar to giant savings and loan in that it financed long-term mortgage loans with shorter term debt. The mismatch in the duration of its assets and liabilities caused financial distress as interest rates rose significantly as the Federal Reserve embarked on severe tightening in order to end inflation. This eventually put a large number of savings and loans out of existence. Fannie Mae survived without direct government assistance because the implicit government guarantee enabled it to have continued access to the financial markets. New management under David Maxwell decided both to start issuing mortgage-backed securities (MBS) and to match better the duration of its liabilities and the mortgages it held in its portfolio. With MBS, Fannie did not bear interest rate risk, though it still had credit risk, and better managing the duration of its assets and liabilities served to reduce interest rate risk. The strategy worked, and Fannie began growing rapidly and seemed to have a target for return on equity of 20 to 30 percent beginning in the late 1980s.

Morgenson and Rosner are certainly right that Fannie played a political game in Washington, including a powerful lobbying operation, strategic hires, enough support for low-income housing to buy off key members of Congress, and initiatives in key Congressional districts. This was not, though, something that was hidden in the "shadows," everyone who paid attention to GSEs knew this. From my point of view, it made it very frustrating to work on GSE issues; on the narrow set of issues they were interested in, it was difficult, if not impossible, to accomplish much.

The authors are wrong, though, to say that this behavior began with Jim Johnson, who was CEO of Fannie Mae from 1991 to 1998. Fannie Mae under David Maxwell was plenty aggressive, as I can attest to, since I worked from time to time on GSE issues during the George H.W. Bush Administration.

Mr. Johnson is made out to be the principal villain in the book, perhaps because he did not agree to talk to the authors. There is plenty for which one can criticize Johnson, but it is wrong to leave the impression that he was the individual most responsible for the financial crisis. The authors probably do not think that (though I am not sure), but the way their book is written, it leaves that impression.

As for Freddie Mac, the book mentions this GSE in passing, but it considers that its CEO during much of the period, Leland Brendsel, was more passive because he "was not a politician." My impression was that Freddie Mac was playing a clever political game.

By way of background, before the 1989 enactment of the law cleaning up the Savings and Loan crisis ("The Financial Institutions Reform, Recovery, and Enforcement Act" or "FIRREA"), Freddie Mac stock was owned by the Federal Home Loan Banks and its board of directors were the members of the Federal Home Loan Bank Board ("FHLBB"), which also regulated S&Ls and the Federal Home Loan Banks, and it managed the Federal Saving and Loan Insurance Corporation, which insured deposits at S&Ls. FIRREA abolished the FHLBB and distributed its various functions to other government agencies, some newly created. It also made Freddie Mac similar to Fannie Mae, with a federal government charter and stock publicly traded on the New York Stock Exchange.

Fannie Mae had been part of HUD until 1969 when its stock was sold to the public. In this transaction, which enabled the Johnson Administration to report a budget surplus even while the Vietnam War was raging, the government retained the Government National Mortgage Association, which is still part of HUD. In other words, Fannie Mae had become more independent of direct control of the federal government much earlier than Freddie Mac. Not surprisingly, Freddie Mac chose to follow a less confrontational strategy.

But Freddie Mac did not have to be confrontational as long as Fannie Mae was willing to play the heavy. When it came to government policy, the interests of the two corporations were aligned, and Freddie made similar policy arguments as Fannie. Being the nicer GSE could work to Freddie's advantage in having a less strained relationship with federal government policymakers, and it was probably an easier strategy to follow.

The authors do not discuss this. Another issue that they totally miss is the relationship of Fannie and Freddie with the Treasury Department. During the George H.W. Bush Administration, the Treasury argued that Fannie and Freddie should be required to have a triple AAA credit rating ignoring the implicit government guarantee. This proposal was vociferously opposed by the Fannie and Freddie and did not go anywhere, which is what Treasury career staff expected. There were also serious questions about how the rating agencies would come up with this hypothetical rating. In fact, Standard and Poor's got a contract from Treasury to perform this analysis, which was published, but Moody's did not think there was any way to perform this analysis. Given the recent performance of the credit agencies, more problems with this idea, which was well-intentioned because of worry that these two GSEs posed systemic risk and could require, with likely legislation, a government bailout if they got into trouble, are now obvious.

Another issue in the Treasury-GSE relationship that the authors do not discuss is the requirement that Fannie and Freddie debt securities needed to be approved by Treasury. In the 1980s, Treasury used this mainly to make sure that not too many GSE securities and Treasury securities were being sold on the same day. Treasury called this a "traffic-cop" function. Treasury did, though, use the authority to prevent Fannie Mae from issuing securities for tax purposes. For example, Fannie Mae was blocked from using a Netherlands Antilles subsidiary to issue securities in the Eurobond market free from the 30 percent foreign withholding tax that applied to interest payments at that time. (There was also at least one other deal that was tax motivated that Treasury blocked in the early 1980s, though I have forgotten the details.)

However, Treasury never used the authority on debt issuance to force Fannie and Freddie to reduce the size of their portfolios, even though this was considered. The authors might have reported on this timidity. Were there questions about Treasury's legal authority to do this or was there a fear of a ferocious lobbying campaign and an angry reaction from certain important members of Congress? (In the end, though, while this would have reduced Fannie and Freddie earnings, it would not have prevented their financial troubles, which were due to credit risk, not the interest rate risk that caused Fannie problems in the 80s.)

When the authors discuss the Federal Reserve, they are certainly right that the Fed published numerous research studies that argued that there was no national housing bubble. If the authors wanted to discuss this, they should have focused more on why Fed economists wrote these studies and why Chairman Greenspan chose to do nothing about abusive practices of mortgage lenders in making subprime loans, over which the Fed had regulatory authority, even when warned about this by another Fed governor, Ed Gramlich. The authors are critical of Tim Geithner, as president of the Federal Reserve Bank of New York, for not being a strong enough regulator, but this is hardly balanced. Geithner, for example, was the key official who forced the banks and other financial institutions to clean up sloppy back office practices with respect to OTC derivatives. The Fed was, in general, not tough enough on the banks, but other regulators, including the Office of the Comptroller of the Currency, the Office of Thrift Supervision, and the SEC also failed. If the authors wanted to discuss regulatory failure, they could have gone into the reasons. After all, Jim Johnson was not lobbying the OCC and the Fed to go easy on Citigroup.

Also, in discussing primary dealer surveillance, the authors make it seem like the New York Fed was shirking its responsibility. This is not the whole story. The New York Fed had set up a dealer surveillance unit because, prior to 1986, many of the primary dealers were not subject to any regulatory authority. In 1986, the Government Securities Act brought all government securities brokers dealers under regulation, with Treasury, the SEC, and the bank regulators all playing a role, depending on the type of institution. This made the dealer surveillance function of the New York Fed less necessary. The authors do not mention this, nor is it clear why they discuss this issue at all. It was not trouble in the government securities market that caused the financial crisis.

While the authors are critical of the Fed, when it comes to Fannie and Freddie, the Fed is a fount of wisdom. It is true that the Fed criticized the GSEs, as did the Treasury. While the Fed was right about some things and wrong about others, this book does not do nuance – there are white hats and black hats, no grey ones. It is somewhat jarring, then, when the Fed changes hats, with no explanation.

The authors' thesis that Fannie Mae and Jim Johnson and government policies encouraging home ownership have a very large responsibility for the financial crisis is far from a full explanation of the development of the housing bubble and its end, nor does it explain what happened in other countries. For example, one of the first financial failures was not a U.S. institution, but Northern Rock in the U.K., a bank which made mortgage loans. There was a classic run on this bank in 2007, reminiscent of the lines of depositors wanting to withdraw money at U.S. banks during the depression. As a result, the U.K. government decided that it would back all the deposits and nationalized the institution. U.S. housing policy and Fannie Mae could not have been responsible for this episode, nor, for that matter, the housing bubble in the U.K.

The authors would have written a better book if they had just concentrated on Fannie and Freddie and presented a balanced view of their role in the financial crisis. Morgenson certainly has journalistic skills and Rosner appears to know a great deal about U.S. housing policy and mortgage issues. One wishes they had devoted more time thinking through the issues, rather than dumping all the facts they had uncovered into the book, whether or not they really fit, and putting white hats and black hats on the characters they discuss.