The Cost of the Fannie Mae and Freddie Mac Bailouts

Sources:
The Financial Times: Fannie & Freddie ‘Could Cost US $363bn’
BBC News: Freddie Mac and Fannie Mae Bailout ‘To Double’
The Wall Street Journal: Fannie, Freddie Elicit Grim Forecast
The Wall Street Journal: Regulator for Fannie Set to Get Litigious
Wikipedia: Fannie Mae

Some of the United States public has recently criticized the Federal Government over the bailouts of Fannie Mae and Freddie Mac. Fannie Mae and Freddie Mac are mortgage finance companies that operate within the United States. Fannie Mae and Freddie Mac provide a secondary market for mortgage loans. They buy mortgages from big U.S. banks, totaling billions of dollars. Fannie and Freddie then repackage the loans and sell them to investors with a guarantee. The majority of investors believe that there is an implicit federal guarantee of both Fannie Mae and Freddie Mac’s securities, and in the event of a default the Federal Government would intervene. Fannie Mae and Freddie Mac were severely affected during the global financial crisis; they sustained massive losses on the delinquent and defaulted mortgages which they had underwritten.

In 2008, in the midst of the financial crisis, the Federal Government set up a conservatorship for the entities, meaning that the Government pledged to subsidize Fannie Mae and Freddie Mac, enabling the entities to whether the crisis. In return, the entities promised to pay 10% dividends on the subsidized funds. The Government subsequently poured around $148 billion into Fannie Mae and Freddie Mac.

Last February, the White House’s Office of Management estimated that the U.S. Treasury would have to provide another $160 billion to Fannie Mae and Freddie Mac in order for them to stay afloat until 2019. The White House noted that in order for this figure to be accurate, the U.S. economy would have to continue to recover from the financial crisis. However, by this August the Congressional Budget Office had already increased the estimate of the needed federal subsidies to around $390 billion. This week, the Federal Housing Finance Agency (FHFA), Fannie and Freddie’s regulator, stated that the lowest amount possible that the entities would need is an additional $221 billion. The FHFA also stated that in the worst-case scenario, Fannie Mae and Freddie Mac would need around $363 billion. The actual amount of funds the entities will need largely depends on the strength of the economy and many other factors, such as interest rates, unemployment rates, and the housing market.

As Fannie Mae and Freddie Mac try to stabilize their operations and regain their independence, there may be repercussions for the banks that caused many of Fannie and Freddie’s problems. The FHFA subpoenaed some of the financial institutions this July, trying to discover exactly how much information the banks had on the mortgages they sold to Fannie and Freddie. The FHFA then selected a well-respected law firm to investigate whether a lawsuit would be successful against the banks for selling toxic loans to Fannie and Freddie. A suit would likely allege that the banks breached promises to Freddie and Fannie about the quality of the mortgages they were selling to the entities. If the FHFA can show that the banks breached their promises to Freddie and Fannie, the court would force the banks to buy back the loans at their original value, leading to the recovery of billions of dollars. If the FHFA is successful in its lawsuit against the major banks, it could open the door for other investors to pursue similar claims.

Discussion:
1. Why do the amounts of funds the Federal Government estimates Fannie Mae and Freddie Mac need greatly vary?
2. Besides opening the door to similar lawsuits, what would be some consequences of Fannie Mae and Freddie Mac bringing a successful lawsuit against major lending financial institutions?
3. Should the U.S. Government continue to provide Fannie and Freddie with funds? What would happen if the Federal Government decided to terminate the funding

European Pipelines: Austria to Azerbaijan

Sources:
The Economist: The Abominable Gas Man
IFC News: EBRD, EIB and IFC Start Appraisal of Nabucco Pipeline
Trend: Managing Director: Nabucco Conducts Works to Attract International Financial Institutions’ Iinvestments
UPI: Europe Eyes Norwegian Gas Supplies

One of the main threats to European stability is Europe’s dependency on Russian natural gas. In January 2009 Europe experience an energy shortage when Russia turned off the gas on a pipeline that went through the Ukraine. Ukraine and Russia had a price dispute, and Russia responded by stopping the flow of gas to Ukraine. As Europe learned, having 80% of Russia’s gas flow through Ukraine leaves Europe vulnerable. Europe’s main solution to decrease dependence on Russian gas is the Nabucco pipeline, officially backed by the European Union.

Construction on the Nabucco pipeline is slated to begin in 2011 when the piping will be laid 2,000 kilometers from Turkey to Baumgarten, a province in Austria. In 2014−15, the second and final phase of construction will be completed when the pipeline is built through Turkey to Iraq, Azerbaijan, and Turkmenistan. About 75% of the Nabucco line will use existing piping, which considerably lessens the effort needed to connect with Turkmenistan. Gas should start flowing in 2015 with a target of 31 billion cubic meters (bcm) a year.

Building the Nabucco pipeline is a massive effort that will require both public and private funds. The European Investment Bank (EIB), the International Finance Corporation (IFC), a subsidiary of the World Bank, and the European Bank for Reconstruction and Development together gave the project $5 billion in loans. The five billion dollar commitment is less than the previously considered package of €4 billion by about half a billion dollars.

In addition to simply financing the endeavor, the $5 billion loan makes companies more comfortable in investing in the Nabucco pipeline. Six companies have the rights to the pipeline, each with a 1/6 stake. Although there is still hesitancy about investment in a slow growing economy, only two of the six have postponed their contributions in Nabuccountil next year when private-sector lenders will have made formal commitments.

Although the Nabuccu pipeline is the biggest pipeline in development, there are other projects to diversify Europe’s sources of natural gas. One of the projects is to develop the Tyrm natural gas fields in the Norwegian North Sea. The EIB is loaning DONG Energy, a large energy group in northern Europe, $210 million to develop the Tyrm oil fields. The money will be for drilling and expanding underwater pipelines. The rise in natural gas prices in recent years has made it profitable to develop the fields.

Discussion:
1. Iraq is going to be a major source of natural gas for the pipeline. Was this one of the goals of the American invasion of Iraq in 2003?
2. The pipeline must pass through all of Turkey to get to Azerbaijan and Austria. How will this increase Turkey’s bargaining position in its effort to enter the E.U.?
3. Is there any credibility to Russian (or Iranian) claims that the United States and Europe are conspiring to decrease their reliance on Russian natural resources by initiating wars in Iraq and Afghanistan?

Protests in France Heat Up Over Pension Reform

Sources:
NYT: French Police Begin Breaking Up Fuel Depot Blockades
WSJ: Pension Protests Heat Up
WSJ: Unions Threaten New Actions
NYT: Editorial: France, the Unions and Fiscal Reality

Nicolas Sarkozy, the President of France, recently proposed a pension overhaul that would raise France's retirement age from 60 to 62. Sarkozy claims that this reform is "essential" and that he will go through with it, despite the public outcry. France has a mandatory state-run pension system, and as the population continues to live longer, it puts more and more pressure on the system. The 2008 recession pushed the system to the brink, and this year its shortfall is expected to reach €32 billion ($44.72 billion). This year alone the system has lost $15 billion. If the government was to leave the system as is, the deficit would increase tenfold in the next forty years. It is entirely possible that this reform will not be enough to resolve all of the problems with the pension system and the government will have to make additional reforms.

In spite of the necessity of pension reform, the public response towards Mr. Sarkozy's proposal has been turbulent. Protests and strikes have disrupted day-to-day activities across France for six weeks. Unions argue that rather than raise the retirement age, Mr. Sarkozy should increase corporate taxes. However, France's tax rates are among the highest in the world, while the country's retirement age is among the lowest. (Compare France's 60-year-old retirement age with the retirement age in the United States, which is 66, and the European Union average of 64.)

Nevertheless, the protests have continued to gain intensity. Workers have gone on strike at all of France's 12 oil refineries, resulting in serious fuel shortages. Because of these shortages, France had to cancel one-third of all incoming and outgoing flights from French airports last Tuesday. Truck drivers joined the protests as well, conducting "snail operations," a tactic where the truck drivers drive very slowly in order to slow down traffic. High school students have also joined the protests, and classes were disrupted or cancelled at between five and ten percent of French high schools.

The rioting has also led to several incidents of violence. In Lyon, for example, police resorted to tear gas when protestors looted stores and set fire to cars. The Interior Ministry reported that approximately 1,500 people have been arrested. But Sarkozy vows to see his proposed reform through, and a vote is expected to take place next week. France "loves a good demonstration," and social protests have become a part of their culture. France's Prime Minister, Francois Fillon, said that the protests will taper off once the law is in place, as has been the case with other pension reforms passed in the 1990's and 2000's that saw similar protests prior to becoming law.

Discussion Question: Is the proposed pension reform reasonable, or do French citizens have good reason to be protesting?
Do the French earn the right to early retirement by paying such high taxes during their working years?

South Africa Must Address Gender Inequalities In Private Employment Sector Before It Can Meet Millennium Development Goals

Sources:
The Economist: Women in South Africa Walking Several Paces Behind
Commission for Gender Equality
BBC News: Global Health Declaration – Ten Years On
United Nations Development Programme: South Africa Millennium Development Goal 3

Leaders from across the globe gathered together around a decade ago and to develop the Millennium Development Goals (MDGs). The MDGs are a set of eight goals for the development of social and economic programs across the world. World leaders hoped that countries would be able to satisfy all of the goals by 2015. One of the MDGs http://www.blogger.com/img/blank.gifthat world leaders committed to was the promotion of gender equality and the empowerment of women. Ten years after the MDGs announcement sub-Saharan African nations, even more developed ones such as South Africa, are still struggling to reach the MDGs.

South Africa, in theory, should be leading the African nations when it comes to equalizing the playing field between men and women. South Africa’s Constitution, written in 1996, specifically prohibits sexism and equates it with racism. However, even with such a strong government textual commitment to women’s rights, the country still needs to make significant improvements in order to fulfill the MDGs.

Since the implementation of the MDGs, South Africa has progressed towards the goal of gender equality. When evaluating the number of women in leadership roles in the government, South Africa is impressive. Forty percent of its Parliament members are women, which is the third highest proportion in the world. Women also make up 43% of all Cabinet members and 40% of all local government leaders.

While South Africa exemplifies equality in the government sector, it is struggling to achieve gender equality within its private sector. Despite the Employment Equity Act Parliament passed over a decade ago, white men still dominate South African private companies. The Employment Equity Act mandates that companies with over 50 employees had to hire and promote women, blacks, and the disabled in proportion to their representation in the South African population. The Women’s Business Association reports that only 10% of board members and directors are female. Women represent almost one half of the working population, but most females work in domestic services. In addition, women only get paid about a third of what men receive from employers. Women in South African are also much more likely than men to be unemployed. If South Africa is dedicated to meeting the MDG of establishing gender equality, it is obvious that the country must do something to address the inequalities in its private employment sector. Even if the nation acts, there is a question of whether the five years remaining on the MDG timeline is long enough for South Africa to reform the disparities in its private employment sector.

Discussion:
1.What can South Africa do to fix some of the gender inequalities in the private sector?
2.Why do you think South African women have thrived in the public sector but not the private sector?

Global Investors Set Sights on India

The Economist: Business in India: A Bumpier but Freer Road
The Economist: India's Economy: India's Surprising Economic Miracle
The NYT: India A Hit for Foreign Investors

Financial investors from around the world have recently been making more investments in Indian markets. The United States and Europe have been hit by a severe recession and recovery has proven difficult. India's economy, however, paints a very different picture. India is generally considered to be an "emerging market," but its economy is very unique and doesn't easily fit into any one category.

India's economy is growing quickly–– analysts predict that its GDP will grow by 8.5 percent this year alone. The Sensex Index (India's version of the Dow Jones) is up 114 percent since the end of 2008. In the next three to five years, may analysts expect India's economy to begin outpacing China (though it will be a much longer time before India has a larger economy than China, as China's economy is currently four times larger). While much of the world is starved for growth, India seems to be the exception. One reason for India's rapid growth rate is the large population of young workers in India. According to Morgan Stanley, India's working-age population is expected to increase by 136 million in the next ten years, while China's is only expected to grow by 23 million. India has also reaped the benefits of pro-business economic reforms that took place in the early 1990s. Prior to these reforms, government regulations often restricted Indian companies' growth, but now, they are competing with world's largest and most successful businesses.

For many of these reasons, more foreign financial investors have been investing in India. In fact, foreign investors have put $28.5 billion in Indian stocks and bonds in this year alone, which is more than twice the level that had been invested at this time in 2009. Foreign investors are moving money to India and other emerging markets to reap the benefits of the difference between the United States' near zero Federal Discount Rate, and interest rates in India, where the Reserve Bank of India has set a key benchmark rate at 6 percent. As this difference increases, investors will make more money by borrowing dollars and investing them in high yield stocks and bonds in India.

In spite of its strong economy and workforce, not everything is rosy in India. One serious problem in the country is its infrastructure and inefficient utilities. At the 72-nation Commonwealth Games, held in India this week, India earned less than favorable reviews–– critics cited things like ineffective security and poor sanitation. Another problem facing India is a lack of education. Public schools are poorly run and underfunded. While it may have a large, young workforce, 40% are illiterate and nearly half of Indian children under the age of five are malnourished. There is also political instability in India, which makes some foreign investors nervous. The government is now attempting to correct some of these problems. For example, it will invest $500 billion on infrastructure. Although public schools are still not good, affordable private schools have become more prevalent and more parents have come to recognize the value of a good education, encouraging their children to stay in school rather than having them work in the fields.

Discussion Questions:
1) Is India's economy getting "dangerously frothy"? Some analysts are still skeptical of the Indian market. Do you think that foreign investors are making a smart move by investing so heavily in India?
2) Could the flow of investments from developed countries like the United States to Indian markets be potentially damaging? For example, the U.S. Government is injecting money into the Indian economy at low interest rates in an attempt to help it recover. However in India, this flow of money could raise the value of its currency, making exports less competitive and causing inflation.

"Swiss Finish" to New Global Capital Rules

Sources:
Economist: First Mover
Financial Times: Swiss urge capital boost for banks
NYTimes: 2 Swiss Banks Facing Higher Capital Standards
WSJ: UBS, Credit Suisse Face Tough New Capital Rules

Last month, global regulators reached an agreement on new capital rules for banks. Under the new Basel III rules, banks are required to hold core capital of minimum 7 percent of risk-weighted assets. The Basel Committee on Banking Supervision also recommended that the top 30 global banks should hold more capital in addition to the minimum requirement. On October 4th, Switzerland made the first move. The proposals by the Commission of Expert (Commission) require the two "systemically important" banks, Credit Suisse and UBS, to hold 19 percent of risk-weighted assets (10 percent in the form of common equity plus 9 percent of contingent convertible bonds (CoCos)). CoCos are similar to bonds but convert to equity if core capital ratios falls below a predefined level. The Commission, appointed by the government, was comprised of representatives from the central bank, industry, etc. If the Parliament approves the proposals, the two banks must comply with the new rules by 2019.

The proposed rules will "significantly mitigate the too big to fail problem in Switzerland and thus reduce the risk for the Swiss economy," said Philipp M. Hildebrand, Chairman of the Swiss National Bank (SNB) Governing Board. According to the Commission, the total capital requirement of 19 percent makes sense given the size of Credit Suisse and UBS and their potential impact on the economy. The balance sheets of the two banks amount to around six times the nation's gross domestic product. Also, during the financial crisis (from the last quarter of 2007 to the first quarter of 2009), UBS incurred losses of 13 percent of risk-weighted assets.

Both Credit Suisse and UBS confidently say that they can meet the heightened requirement by 2019. However, experts disagree over the practicalities of CoCos. John Cryan, UBS's financial director doubts whether a CoCo market would emerge or whether banks can use it. Only two banks, Lloyds and Rabobank, have used CoCos so far, issuing around $16.4 billion last year. Credit rating agencies have not been willing to rate CoCos. On the other hand, Thomas Jordan, director of the SNB, is confident that investors will buy CoCos. According to the Economist, CoCos can be viewed as "a kind of catastrophe insurance for which a premium is received in return for a small chance of a big loss," and banks will be able to use CoCos. The Commission estimates that if Credit Suisse and UBS use CoCos to raise 9 percent of their risk-weighted assets, the amount would be approximately SFr 72 billion.

Discussion:
1. Jose-Maria Roldan, head of banking regulation for the Bank of Spain, said that CoCos are "brilliant ideas but... preferred shares and subordinated debt also looked great before the crisis and they were totally useless. Why do we think financial innovation will work this time around?” What are the benefits and disadvantages (or risks) when banks use CoCos to raise capital?

2. The Commission heightened the capital requirement, but did not propose to break up the two biggest banks or limit their size or activities (e.g., proprietary trading) Should the Commission have suggested breaking up the two banks or limiting their size or activities in order to address the too-big-to-fail problem?

Lima Looks to Future

Sources:
Correoperu.pe: Empiezan estudios para el metro de Lima
Elcomercio.com.pe: ¿Es factible un metro subterráneo en Lima? Harán estudios de factibilidad para comprobarlo

The mayor of Lima, Peru, Luis Castañeda, announced this week that the French government will give the city $900,000 USD to finance studies about the feasibility of a subterranean train in the capital city. The studies will take between 3–4 years and will be undertaken in two phases. First, the two foreign companies in charge of the studies (the American firm Systra and French firm Ingerop) will determine what areas of the city are in the most need of subway access based on population movement patterns. The second phase will identify the exact routes the trains will follow, as well as the more technical aspects of the project like cost, financing, environmental impact, etc.

By the time the studies are completed, Mr. Castañeda will no longer be the city’s mayor. He is currently leading early polling for presidential elections that will take place next year. The plan will likely need the support of the central government to help fund the project, which the central government appears currently able to do with increased revenues resulting from robust economic growth. Unfortunately Peru is still a largely undeveloped country so there is much need across the country for potential government development dollars. With most of the country’s poor residing in the central highlands or the Amazon basin, many would claim that the money would be better spent on infrastructure in those regions instead of in the more affluent coastal capital that is already building an extensive bus and electric train system to serve its population.

The second problem facing the project is that it would require the support of the future mayor. The city recently held elections and is still awaiting the final results. One candidate supported the idea of a subway system for the city throughout her campaign, though her challenger (and leader in the count so far) did not. Either candidate will have to cater to a constituency that includes many poor residents concerned more with first getting a job than finding transportation to a job, but an informal poll on a Peruvian newspaper’s website shows 93% of votes in favor of the idea.

Discussion:
1) Peru is one of several countries in Latin America currently experiencing robust growth and in need of extensive development if that growth is to continue. What should these countries be doing with the increased government funds? Considering that few, if any, parts of Latin America are fully developed, does it matter where government development is targeted? Should development be targeted mostly for the areas that need it the most (like the highland and rainforest areas in Peru)?

Obama Vetoes Foreclosure Bill, Citing the Need for Greater Consumer Protections

Sources:
The Los Angeles Times: General Freeze on Home Seizures Sought
CNN Money: Obama Vetoes Bill to Speed Foreclosures
The White House: Why President Obama is Not Signing H.R. 3808
The New York Times: Obama to Veto Bill That Could Speed Foreclosures

White House officials announced this week that President Obama would veto H.R. 3808, the Interstate Recognition of Notarizations Act of 2010 (IRON). Obama’s veto will send the bill back to the House of Representatives. The White House cited its concern about the impact of the bill on consumers as the reason for the President’s use of veto power. Before and during his presidency, Obama has voiced his concern for consumer protections. Earlier this year he urged Congress to pass the Wall Street Reform and Consumer Protection Act. Although he ultimately vetoed the bill, Obama promised to work with Congress to reform the bill in order to ensure IRON adequately protects consumers.

IRON tried to clear the backed up judicial dockets by making it easier for courts to approve foreclosures. IRON would have compelled courts to recognize foreclosure records that were notarized in other states. Critics of the bill argue that IRON would make it harder for consumers to dispute the accuracy of such documents. Critics argue that this would be an unfortunate obstacle for consumers, especially when at the present time there have been increasing reports of improper foreclosures.

Recently consumers and consumer advocate groups have made allegations that in thousands of cases loan servicers have not been verifying required legal documents. The Center for Responsible Lending indicated their belief that the improper foreclosures are a result of the lenders’ flawed infrastructure and the lack of employees capable of dealing with homeowners who default on their mortgages. Because of these accusations of improper foreclosures, consumers and government leaders have pressured banks in the United States to halt further foreclosures.

Several major lenders, such as JP Morgan Chase and Bank of America, have decided to freeze foreclosures in the twenty-three states that mandate their judicial systems approve foreclosures. In the other states, foreclosures continue. The banking industry warns that the halt of foreclosures will hurt the housing market’s recovery. With IRON back on the House agenda, lawmakers will be forced to attempt to balance the interests of the banking industry and consumers if they desire IRON to become law.

Discussion:
1. What are some of the benefits of having a bill similar to the Interstate Recognition of Notarizations Act of 2010 becoming law? What are some disadvantages?
2. What are some reasons why states might require judicial approval of foreclosures? Are there downsides to this procedure?
3. Should the government force lenders to put a moratorium on foreclosures until investigators clear any allegations of improper foreclosures? Why or why not?

Currency Wars

Sources:

Bloomberg: Geithner Says Japan Isn't to Blame for Global Currency Tension

M and C News: U.S.-China Tension Evident in Futile House Currency Bill

Money Morning: World Finance Ministers Aim to Quell Currency Tensions (1st Lead)

One of the basic fundamentals of economics is that devaluing currency will help economic growth. This works because of exchange rates. Lowering a country’s currency value lowers the price of its goods to foreign buyers, stimulating exports and thus the economy. Because of countries’ recent manipulation of their currencies, some fear that the world is entering a currency war.

In a currency war, each nation tries to keep its currency undervalued to increase its exports. Timothy Geithner, the United States Secretary of the Treasury, warned “that emerging powers were putting the global recovery at risk unless they showed more willingness to let their currencies rise.” By keeping currency values low, the developing nations limit their own citizen’s purchasing power of international good and limit the ability of developed nations to export. This is because currency devaluation acts like a tariff against goods from developed nations, making those goods more expensive to consumers than they would be without manipulation.

Currency tension is the major subject at the upcoming G-20 meeting in October, 2010, and of the meeting of the world finance ministers at the IMF on October 8^th. While Mr. Geithner did not mention China specifically, China is the main target of Mr. Geithner’s accusation of currency devaluation. The Canadian Finance Minister added that it was up to China to let its currency rise if other countries are going to let theirs rise. The IMF managing director and president of the European Central Bank both issued statements urging currencies to reflect economic fundaments to avoid a currency war.

Getting China to change will be challenging because some nations are less willing to pressure China. China is by far the largest developing power and some developing powers will follow China’s lead. Brazil will not confront China at the G-20 because China is a major importer of Brazilian goods. Furthermore, many developing Asian nations are resistant to force China to change because they see Chinese success as something they can latch onto, catching a free ride to the developed world.

However, the United States does not feel all current currency devaluation is hurting the world economy. Japan recently devalued its currency, but because the economic recovery is slow in the United States and Europe is saddled with public debt, many investors view Japan as the safest place to store their money in the developed world. Mr. Geithner actually said that the Japanese Central Bank’s intervention in the currency market on September 15^th to lower the value of the yen was a justifiable act.

Congress has placed significant pressure on China and President Obama to deal with the currency devaluation issues by passing The Currency Reform for Fair Trade Act in the House of Representatives. Although it recommends punishments for countries that undervalue their currencies, it will not have any practical effect because the punishments listed are illegal according to WTO laws. However, the bill does specifically mention the Chinese yuan, an important political statement regarding the Chinese government.

Congress is not alone in feeling wary of China’s economic power. Robert Samuelson, the contributing editor of the Washington Post, gave a stark warning. He said the U.S. had a choice to resist Chinese ambitions and risk a trade war, or do nothing and set a precedent that the basic rules of the world economy and free trade are optional, adding, “The first would be dangerous; the second, potentially disastrous." The United States may have options, but neither of these sound good in the long run.

Discussion Questions:

1. Is there a moral argument that the United States should yield an economic advantage to developing countries to help them develop more quickly?

2. Brazil has a trade surplus with China and the United States has a trade deficit. Why such a divergent trading pattern?

3. Is China’s currency manipulation likely to be effective in the long run, or will it simply make Chinese industry unfit for global competition if the yuan is allowed to be properly valued?

4. Why is the United States Congress becoming so involved with currency disputes, and how could the November elections be affecting Congress’s involvement?