Paulson Announces GSE Initiatives, Henry Paulson

Fannie Mae and Freddie Mac play a central role in our housing finance system and must continue to do so in their current form as shareholder-owned companies. Their support for the housing market is particularly important as we work through the current housing correction.

GSE debt is held by financial institutions around the world. Its continued strength is important to maintaining confidence and stability in our financial system and our financial markets. Therefore we must take steps to address the current situation as we move to a stronger regulatory structure.

In recent days, I have consulted with the Federal Reserve, OFHEO, the SEC, Congressional leaders of both parties and with the two companies to develop a three-part plan for immediate action. The President has asked me to work with Congress to act on this plan immediately.

First, as a liquidity backstop, the plan includes a temporary increase in the line of credit the GSEs have with Treasury. Treasury would determine the terms and conditions for accessing the line of credit and the amount to be drawn.

Second, to ensure the GSEs have access to sufficient capital to continue to serve their mission, the plan includes temporary authority for Treasury to purchase equity in either of the two GSEs if needed.

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Parsing Paulson: The Fannie and Freddie Bailout, Felix Salmon

Hank Paulson is a tough guy. He's no pushover: just look at that phone call to Jamie Dimon, telling him that anything over $2 a share was altogether far too much money to pay for Bear Stearns. So what are we to make of his statement regarding Fannie Mae and Freddie Mac? With apologies to Jack, here's the parse:

Paulson: Fannie Mae and Freddie Mac play a central role in our housing finance system and must continue to do so in their current form as shareholder-owned companies. Their support for the housing market is particularly important as we work through the current housing correction.

Translation: We can't afford for Fannie and Freddie to go bust, and we're Republicans, so there's no way we're going to nationalize them. And no one could conceivably afford to buy them. Which leaves only one option: somehow maintaining the status quo. Which is not going to be easy, seeing as how their trillions of dollars in assets are imploding daily in the biggest US housing crunch since the Great Depression.

Paulson: GSE debt is held by financial institutions around the world. Its continued strength is important to maintaining confidence and stability in our financial system and our financial markets. Therefore we must take steps to address the current situation as we move to a stronger regulatory structure.

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Phil Gramm Is Right, Amity Shlaes

"In serious consideration for ambassador to Belarus." That's the role John McCain joked that former senator Phil Gramm might have in a McCain administration. Gramm is McCain's most senior economic adviser, the one best qualified to lead the finance team of a McCain presidency. Now, however, Gramm faces political exile because he made the mistake of telling the truth.

What prompted the abrupt demotion? The short answer is what might be called Campaign Econ. Campaign Econ says the American economy is a certain way because Americans think it is. Campaign Econ competes with real economics and often wins -- with damage that extends way beyond, say, the political career of either Phil Gramm or John McCain.

Consider what happened this week. While speaking with the Washington Times, Gramm said that the country was not in a true recession but a "mental recession." He also said, "We have sort of become a nation of whiners" and "You just hear this constant whining, complaining about a loss of competitiveness, America in decline."

Gramm was right about the recession and stood by his recession comments on Thursday. A recession is two consecutive quarters in which the economy shrinks, and last quarter it grew. But no matter. Voters feel they are in a recession, and so they are, at least according to Campaign Econ.

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Are We A Bunch of Whiners?, Mark Thoma

Amity Shlaes says Phil Gramm is right, people really are whiners. This annoys me. Comments below:

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So people are irrational in their beliefs? Must be how we got Bush as president. Anyway:

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She doesn't know what she is talking about, or she is being intentionally misleading. That's not how a recession is defined. But you don't have to believe me, here's the NBER - the people who formally date recessions:

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Back to the article which, I hope you can see, is based upon a false premise due to her apparent lack of understanding of how recessions are dated. (I would have thought she'd know this claim isn't right, it's been written about so much most people who write about these issues know the NBER procedure by now, so there's a chance this is an intentional deception. If it's not intentional, if she doesn't know how recessions are dated, then she has no business writing about it.) Her claim is that because there hasn't been two consecutive declines in GNP, the economy can't be having problems. Therefore, people are nothing but whiners.

She says you can't tell people the truth, that they really are nothing but whiners, because it hurts their feelings:

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High Oil Prices: It's All Speculation, Ed Wallace, BusinessWeek

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Today, while energy prices are crushing American families, I think we'd all benefit by reflecting on what happened with energy in 2001. Seven years ago, Enron was fleecing California, extorting its people for electricity to the tune of billions of dollars. As is true today, some voices in the Administration claimed that supply shortages, not manipulation, formed the core of California's soaring electricity prices. Yet, now that we know the whole story of Enron's criminal manipulations, many menbers of the media have forgotten how in 2001 the White House deflected any blame for California's suddenly stratospheric electrical costs away from their Houston friends.

Likewise, our Energy Secretary has a real problem discussing issues with facts. Like a broken record, he continues to maintain that in no way has speculation had anything to do with today's high oil prices. No, to hear Sam Bodman tell it, they are now and always have been caused by too many buyers chasing too few barrels of oil. But, while that might have been true in 2004, things have changed. And so I give you just one week of news from the oil market. To be more exact, it's the oil news from the seven days preceding our Energy Secretary's comments about supply and demand.

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In Praise of Oil Speculation, Peter Coy, BusinessWeek

Dear Ed,

You've written some great columns for BusinessWeek.com about oil prices and speculation (BusinessWeek.com, 6/27/08), and you've gotten barrels of positive reaction from readers—one recent example: "Ed Wallace is my hero." I buy gasoline, too, so I sympathize with your impulse to get to the bottom of why we're suddenly paying over $4 a gallon. I even agree with you that speculation is probably playing a role in driving up prices, and we need smart regulation of the energy markets.

But I can't work up much passion for blaming speculators and manipulators for the predicament we're in. My faith in human nature, especially when it comes to energy traders, is shallow. However, my faith in the power of financial gravity is bottomless. If speculators and manipulators have somehow managed to get prices too high, then those prices will come back to earth as surely as apples fall from trees and meteors land in Arizona. The price decline will inflict billions of dollars of losses on those speculators and manipulators—just deserts.

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Recession Is Not The Worst Possible Outcome, Wolfgang Münchau, FT

If this had been a mere financial crisis, it would be over by now. The fact that we are suffering its fourth wave tells us there might be something at work other than merely financial euphoria and bad regulation. Maybe this is not a Minsky moment after all. Hyman Minsky, the 20th century US economist, formulated the long forgotten, and recently rediscovered, financial instability hypothesis, according to which capitalist economies, after a long period of prosperity, end up in a vicious circle of financial speculation. The Minsky moment is the point when what economists call this “Ponzi game” collapses.

But there might be better explanations. As the Bank of International Settlements said in its latest annual report, subprime might have been the trigger for this crisis, but not the cause. We do not have a full understanding yet of what happened but the BIS suggested that fast expansion of money and credit must have played a role. I would go further and say this is not primarily a crisis of financial speculation, but one of economic policy. Its principal villains are therefore not bankers, but economists – not in their role as teachers and researchers, but as policy advisers and policymakers.

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With 100% Certainity, Muchau's Remedy Won't Happen, Yves Smith, Naked Capitalism

Wolfgang Munchau, in his latest Financial Times comment, "Recession is not the worst possible outcome" takes up a theme near and dear to our and many readers hearts: that policies to avoid recessions do more damage in the long run than letting slumps run their course.

Munchau is hard on economists, but not the purely academic type, but policymakers who endeavor to road test theories. A central element of Munchau's piece is that central bankers rely heavily on the so-called "dynamic stochastic general equilibrium model" which as he discusses at some length, fails to incorporate elements many observers would regard as important.

Note Munchua's Eurointelligence co-blogger (and fellow FT contributor) Paul De Grauwe gave a longer-form treatment of this topic recently. However, another FT writer, John Dizard, noted late last year that Bernanke discussed the Fed's efforts to improve its DSGE models and indicated that the Fed does not rely solely on them. Nevertheless, Dizard seemed underwhelmed by its choice of alternatives (Dizard later argued that the Fed's efforts to improve liquidity in banking markets were a departure from DSGE, but doomed to fail).

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