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Willy Weasel

More Analysis From Jackson Hole

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http://www.econbrowser.com/archives/2007/0...nts_on_hou.html

An interesting analysis of how the asset bubble in the US was created. From the article:

This acquisition of mortgages was enabled by issuance of debt by the GSEs which currently amounts to about $1.5 trillion. Investors were willing to lend this money to Fannie and Freddie at terms more favorable than are available to other private companies, despite the fact that the net equity of the enterprises-- about $70 billion last year-- represents only 5% of their debt and only 1.5% of their combined debt plus mortgage guarantees. If I knew why investors were so willing to lend to the GSEs at such favorable terms, I think we'd have at least part of the answer to the puzzle.

And I think the obvious answer is that investors were happy to lend to the GSEs because they thought that, despite the absence of explicit government guarantees, in practice the government would never allow them to default. And which part of the government is supposed to ensure this, exactly? The Federal Reserve comes to mind. I'm thinking that there exists a time path for short term interest rates that would guarantee a degree of real estate inflation such that the GSEs would not default. The creditors may have reasoned, "the Fed would never allow aggregate conditions to come to a point where Fannie or Freddie actually default." And the Fed says, "oh yes we would." And the market says, "oh no you wouldn't."

It's a game of chicken. And one thing that's very clear to me is that this is not a game that the Fed wants to play, because the risk-takers are holding the ace card, which is the fact that, truth be told, the Fed does not want to see the GSEs default. None of us do. That would be an event with significant macroeconomic externalities that the Fed is very much committed to avoid.

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mutualy assured destruction economics.

MADE up economics....

risk takers: you won't push the 'R' button....

Ben: ...You've got to ask yourself one question: 'Do I feel lucky?' Well, do ya punk?”

risk takers: “Who are you going to believe, me or your own eyes?”

Ben: “If you want a guarantee, buy a toaster.”

risk takers: “Go ahead, make my day”

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Jackson Hole! There is no more appropriate venue for the bunch of cowboys known as the Federal Reserve Board. Those who have been there will know what I am talking about!

Best,

L

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