March 11, 2003
Everyone out of the Poole
Can’t Keep a Good Crisis Theory Down
“I especially want to commend OFHEO for its recent report entitled, "Systemic Risk: Fannie Mae, Freddie Mac and the Role of OFHEO." This report displays an impressive depth of scholarship in reviewing a large body of professional literature on the subject. It deserves careful study by every economist interested in issues of financial stability and every policymaker with an interest in housing and housing finance.” Fed Poole
Perhaps Mr. Poole should have commended Armando Falcon instead of the OFHEO? After all, Mr. Falcon published the report in question, and he no longer works for OFHEO. Rather, Mr. Falcon was asked by President Bush to resign the same day the ‘Systemic Risk’ report was released.
Regardless, Poole could not have picked a worse time to give a ‘GSEs are Dangerous’ speech. To be sure, the markets already had enough to worry about with regards to Iraq, North Korea, and Buffett (derivatives fears).
“If the market value of GSE debt were to fall sharply, because of ambiguity about the financial soundness of GSEs and about the willingness of the federal government to backstop the debt, what would happen? I do not know, and neither does anyone else.” Poole
I commend Mr. Poole for his frank discussion of what could potentially be a serious problem. Question is, will the powers that be also commend his opinions?
It is a good thing that the St. Louis Fed doesn’t hold an FOMC vote, or Poole would possibly have to polish up some market calming lies that contradict some of his GSE concerns. After all, when, and if, a systemic type calamity is developing, it will the heads of the Federal Reserve Board that tell everyone to remain calm; that the window is open; that everything is going to be alright. Something tells me if some large financial institutions were on the verge of default Fed Poole saying ‘I do not know what is going to happen to the financial system, and neither does anyone else’ wouldn’t go over to well.
GE 10K
GE didn’t break any rules when they reported that pension gains contributed to earnings even as pension fund assets dropped significantly. Nevertheless, this is entirely the point: GAAP should not allow corporate assumptions to take precedence over financial realities.
From 1999-2001 GE’s average annual increase in pension gains was +13.4% -- a total well above the company’s +9.5% assumption. Yes, shareholders are informed of financial realities when they are beneficial to GE’s bottom line, but corporate assumptions takeover when times are tough.
GE is going to adopt FIN 46 – Consolidation of Variable Interest Entities – on July 1, 2003. The company stated that ‘Even assuming the legal provisions controlling these SPEs are not changed between now and the July 1 effective date of FIN 46, the very complexity of the new consolidation rules and their evolving clarification make forecasting that July 1 effect impracticable.’ You can thank the FASB for this unneeded level of ‘complexity’.
-- GE booked only 0.8 billion in ‘gain on sales’ to SPEs in 2002, versus $1.3 billion in 2001. Total GE SPE receivables dropped from $43.0 billion to $42.2 billion.
-- In 2002 GE added nearly $9 billion in net equity. However, backing out the nearly $15 billion the company added in intangibles/goodwill, GE’s balance sheet actually slipped in 2002. As for GE’s ‘other assets’ (up $13 billion), a $6.2 billion increase in real estate assets padded this impressive gain (note 17).
All that can be said about GE is ‘I don’t get it, and neither does anyone else’. To get through GE’s assets you have to plow through 9 different notes, understand a plethora of confusing derivatives/hedge information, ascertain potential liabilities from credit downgrades, etc. Suffice it to say, whatever ‘it’ is, we are going to get a lot more of it after July 1, 2003.
Everyone out of stocks
Yesterday’s selling was not confined to Fannie, Freddie (roughly 6% decline each), and GE. Rather, every Dow component dropped, every S&P sector dropped, and even gold stocks declined.
A continued drop in gold stocks could warrant attention. To be sure, although gold is likely to retreat if geopolitical tensions subside, some producers are nearing attractive levels even if you assume the POG retreats and holds at $320 an ounce. Unlike GE’s potentially overly optimistic pension assumptions, $320 an ounce is roughly the same level gold was at in 4Q02 (producer valuation assumptions can be carried forward with a high degree of predictability).
Everyone out paper?
As for Poole’s worries about GSEs - a topic I didn’t really cover - do these mortgage consuming giants pose a systemic risk to the financial system? Let’s just say that when the Fed began printing unbacked paper any discussion of ‘systemic risk’ became a discussion of the Federal Reserve Board. To be sure, Buffett’s derivatives warning and Poole’s concerns about GSE’s are in reality contemplations over the sustainability of the Central Bank.
-- If a derivatives blow-up poses a systemic risk only the Fed can save the day.
-- If a GSE blow-up poses a systemic risk only the Fed can save the day.
Quite frankly, the contention by Fed members that the government does not back GSEs and/or that no bank ‘is too big to fail’ is not unlike a boxer verbally assaulting his opponent before fight night: it is largely pointless rhetoric. In the case of the Fed, its rhetoric and fear riddled statements are aimed at scaring GSEs and derivative players into cautious self regulation. The threat being – ‘look after your financials or we will regulate you!’
During the 1987 Crash the Fed saved the day with a single statement. Essentially this statement was: ‘whatever money financial institutions need we are willing to give them’.
What if during the next crisis Fed liquidity cannot successfully engineer a bailout and/or the size of the bailout is so ridiculously large that a complete financial collapse of a firm like JP Morgan threatens to spark a financial contagion like none seen before? Well, “I do not really know, and neither does anyone else”…
However, what is known is that sometimes people don’t just leave stocks (like they did yesterday). Rather, sometimes people leave paper currency. Little do Poole, Greenspan, and Buffett realize and/or admit, that this is what their concerns are really all about.
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