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Why It's Time to Abolish the Fed

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Regulators only act in hindsight.

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Please consider The Next Fannie Mae.
"Last week, Ginnie announced that it issued a monthly record of $43 billion in mortgage-backed securities in June. Ginnie Mae President Joseph Murin sounded almost giddy as he cheered this 'phenomenal growth.' Ginnie Mae's mortgage exposure is expected to top $1 trillion by the end of next year -- or far more than double the dollar amount of 2007. Earlier this summer, Reuters quoted Anthony Medici of the Housing Department's Inspector General's office as saying, 'Who would have predicted that Ginnie Mae and Fannie Mae would have swapped positions' in loan volume?

"Ginnie's mission is to bundle, guarantee and then sell mortgages insured by the Federal Housing Administration, which is Uncle Sam's home mortgage shop. Ginnie's growth is a by-product of the FHA's spectacular growth. The FHA now insures $560 billion of mortgages -- quadruple the amount in 2006. Among the FHA, Ginnie, Fannie and Freddie, nearly 9 of every 10 new mortgages in America now carry a federal taxpayer guarantee.

"Herein lies the problem. The FHA's standard insurance program today is notoriously lax. It backs low down payment loans, to buyers who often have below-average to poor credit ratings, and with almost no oversight to protect against fraud. Sound familiar? This is called subprime lending -- the same financial roulette that busted Fannie, Freddie and large mortgage houses like Countrywide Financial.

"On June 18, HUD's Inspector General issued a scathing report on the FHA's lax insurance practices. It found that the FHA's default rate has grown to 7%, which is about double the level considered safe and sound for lenders, and that 13% of these loans are delinquent by more than 30 days. The FHA's reserve fund was found to have fallen in half, to 3% from 6.4% in 2007 -- meaning it now has a 33 to 1 leverage ratio, which is into Bear Stearns territory. The IG says the FHA may need a 'Congressional appropriation intervention to make up the shortfall.' "
Would Regulation Have Prevented The Crisis?

We can appoint all the regulators in the world but what good will it do? How many people turned in Bernie Madoff only to have the SEC look the other way? If the proposed framework for SIFI was in place 3 years ago, would it have done any good?

More than likely, not a damn thing would have been accomplished by this regulation 3-5 years ago. The reason is all the models were flawed from Moody's, Fitch, and the S&P on down, and as noted, Bernanke never saw this coming.

Hells bells, the adverse scenario for the Fed's Stress Tests were wildly optimistic on housing and unemployment and that model was made well after these problems were in full light of day.

Please see Optimistic Unemployment and Housing Forecasts Looking Downright Silly for a discussion of the Fed's baseline and adverse scenarios for 2009 and 2010.

Any guesses as to what the "adverse scenario" would have looked like 3 years ago? I'll take a stab at 6.5% unemployment and a short V-shaped recovery; in other words, a big yawn that wouldn't have been acted on.

Regulation Always Late


The market has long ago taken matters into its own hands. Foreclosures and bankruptcies are soaring. Lending standards have tightened across the board, except of course those created by regulation: Ginnie Mae and the FHA.

In a free market, Fannie, Freddie, the FHA, HUD, and Ginnie Mae wouldn't even exist. In a free market, interest rates would never have gotten to 1% with credit running rampant. In a free market, the Fed wouldn't exist. In a free market with sound money, housing would never have gotten this far out of hand. In a free market, there's no such thing as too big to fail. In a free market, there wouldn't be FDIC and banks like Bank United and Corus Bank would never have gotten funds to build all of those condo towers that are now imploding.

On the surface, this regulation sounds good. The reality is it will fail some point down the line because the next crisis won't be the same as this one. There will always be a failure to regulate because the next crisis will not be the same as the last, and at best, the only thing regulation ever does is act in hindsight to prevent the last crisis, long after the market has already acted.

Instead of a 3-tiered framework for addressing SIFI, how about a 3-phased plan to abolish the Fed and fractional reserve lending along with it?
No positions in stocks mentioned.
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