And ironically the more of these types of loans that

Info icon This preview shows pages 58–61. Sign up to view the full content.

View Full Document Right Arrow Icon
financing due to the implicit government guarantee. And ironically the more of these types of loans that they purchase, the more likely that the implicit guarantee becomes even stronger. A poor loan here or there, a distortion once in a while, is not disastrous; but the implicit guarantee of the U.S. government allowed the GSEs to grow unencumbered for decades. The light regulatory capital requirements - 2.50% for portfolio holdings and 0.45% for default
Image of page 58

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
57 guarantees – may have seemed reasonable when set back in 1992 (although they were lower than the comparable capital requirements for banks and thrifts, as was explained in Chapter 1), but the mortgage-backed assets of the GSEs of 2007 had a far riskier credit profile than those of 15 years earlier. In 1996, a Congressional Budget Office (CBO) study entitled “Assessing the Public Costs and Benefits of Fannie Mae and Freddie Mac” made the case for full privatization of the GSEs but recognized the problem of doing so when the economy had become so reliant on them. And this was back in 1996, not 2007. The report provides the analogy of the bear in the canoe with which we started this chapter.” 29 4.1.3 Running for the Exit Since the GSEs are currently under the conservatorship of the government, it would be crazy not to kill off the “bear” and move forward with a model that did not again create a too-big-to-fail, and more likely a too-big-to-reform, monster. A senior executive at the now defunct Salomon Brothers used to say that when trading, never panic; but if you do panic, panic first. A few months after the financial crisis had started, on September 14, 2007, a curious thing began to happen at the 76 branches of the UK-based firm Northern Rock. Right out of a scene from the Jimmy Stewart movie “It’s a Wonderful Life”, lines began to develop outside the bank branches as people began to withdraw their life savings. It was a classic run on the bank. The triggering event was ironically the revelation that the Bank of England was going to provide financial support to Northern Rock. To regulators at the time, this financial support was intended to calm markets, and their view was that Northern Rock customers were panicking. But the truth is that, with any uncertainty about bank solvency or timely administration of the government support, it is rational for customers to “panic” first, withdraw their funds, and place them elsewhere. Of course, everyone thinks that way, and a run starts. In an article describing the run on Northern Rock in The Sunday Times , this point is perhaps best illustrated by one particular savings customer lining up outside a branch: “I don’t want to be the mug left without my savings.” 30 As Fannie and Freddie were running aground in early September 2008, and the issue was whether or not to confirm what everybody knew – their government guarantee – Fannie and Freddie had $1.73 trillion in debt outstanding. Of this, $520 billion had a maturity of less than one year. Of course, when a financial firm gets into trouble, the likelihood of creditors’
Image of page 59
58 rolling over their debt to new debt becomes small. Because one-third of their debt had
Image of page 60

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Image of page 61
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern