May 07, 2004

Fannie tries restating, and clearing up the rate confusion

The problem with owning an asset that's actually someone else's promise to pay is that…well sometimes they don't. According to an article in today's Wall Street Journal, Fannie Mae may be forced by its regulator to restate earnings—to the tune of $500 million—because of higher loan defaults that it has so far reported. The Journal article says, "The order affects Fannie's $8 billion portfolio of securities backed by manufactured-housing loans, as well as $300 million of securities backed by aircraft leases. The manufactured-housing securities have deteriorated in quality because of a surge of defaults by buyers of mobile homes in recent years. Fannie so far has made write-downs on the manufactured-housing securities totaling about $217 million, but some analysts argue that much bigger write-downs would be in order, based on actions taken by holders of similar securities." Manufactured housing loans…securities backed by aircraft leases…what’s next? Single family homes? In the meantime, let me clarify what I've been saying about interest rates. First I say the Fed can't raise rates. Then in the housing report, I say interest rates are almost certain to rise. Am I saying two different things? Nope. The Fed controls short term interest rates, not long-term rates. For example, the average rate on a 30-year fixed mortgage is 6.12%...the highest level in 8 months. It's risen seven straight weeks. The bond market can move long-term rates up no matter what the Fed does. And it's been doing just that. This is the bond market telling the Fed it sees inflation in producer and wholesale prices...and that it wants the Fed to raise the Fed funds rate. The bond market yells. The fed shuts its ears. Long term rates go higher. Can the bond market force the Fed's to raise short term rates? No. It can make the Fed look foolish and out of touch. It can drive yields even higher. But the Fed need not react. First, the inflationary pressure in commodity prices is coming from Chinese consumption of raw materials...not overheating U.S. consumers (there is a whole other species of inflation in the health care, education, and other services...but I'm not sure what the source of that is...I'd say the cost of government regulation and insurance premiums being passed on to consumers...or just a bubble in the perceived value of higher education). Can the Fed make a token gesture and raise 25 basis points and say something banal before the election like, "The economic recovery continues to pick up pace and appears to be self-sustaining, while growth in the labor market seems to have turned the corner. Though the risks between inflation and deflation remain roughly balanced, the committee believes a modest increase in the funds rate will hold inflationary pressures in check without impeding economic growth." Sure. But will the bond market buy it? We'll see. But as I've said before, the Fed hasn't caused inflation in consumer incomes...and without's going to be awfully hard to raise short term rates meaningfully without doing even more damage to the consumer. In other words, the Fed is increasingly irrelevant...U.S. monetary policy is controlled in China and Japan now


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