"It is hard for us, without being flippant, to even see a scenario within any kind of realm of reason that would see us losing one dollar in any of those transactions."
Joseph J. Cassano, a former A.I.G. executive back in August 2007
Tuesday, September 30, 2008
Wednesday, September 24, 2008
Ben's testimony before the U.S. Senate
Testimony
Chairman Ben S. Bernanke
U.S. financial markets
Before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate
September 23, 2008
Chairman Bernanke presented identical testimony before the Committee on Financial Services, U.S. House of Representatives, on September 24, 2008
Chairman Dodd, Senator Shelby, and members of the Committee, I appreciate this opportunity to discuss recent developments in financial markets and the economy. As you know, the U.S. economy continues to confront substantial challenges, including a weakening labor market and elevated inflation. Notably, stresses in financial markets have been high and have recently intensified significantly. If financial conditions fail to improve for a protracted period, the implications for the broader economy could be quite adverse.
The downturn in the housing market has been a key factor underlying both the strained condition of financial markets and the slowdown of the broader economy. In the financial sphere, falling home prices and rising mortgage delinquencies have led to major losses at many financial institutions, losses only partially replaced by the raising of new capital. Investor concerns about financial institutions increased over the summer, as mortgage-related assets deteriorated further and economic activity weakened. Among the firms under the greatest pressure were Fannie Mae and Freddie Mac, Lehman Brothers, and, more recently, American International Group (AIG). As investors lost confidence in them, these companies saw their access to liquidity and capital markets increasingly impaired and their stock prices drop sharply.
The Federal Reserve believes that, whenever possible, such difficulties should be addressed through private-sector arrangements--for example, by raising new equity capital, by negotiations leading to a merger or acquisition, or by an orderly wind-down. Government assistance should be given with the greatest of reluctance and only when the stability of the financial system, and, consequently, the health of the broader economy, is at risk. In the cases of Fannie Mae and Freddie Mac, however, capital raises of sufficient size appeared infeasible and the size and government-sponsored status of the two companies precluded a merger with or acquisition by another company. To avoid unacceptably large dislocations in the financial sector, the housing market, and the economy as a whole, the Federal Housing Finance Agency (FHFA) placed Fannie Mae and Freddie Mac into conservatorship, and the Treasury used its authority, granted by the Congress in July, to make available financial support to the two firms. The Federal Reserve, with which FHFA consulted on the conservatorship decision as specified in the July legislation, supported these steps as necessary and appropriate. We have seen benefits of this action in the form of lower mortgage rates, which should help the housing market.
The Federal Reserve and the Treasury attempted to identify private-sector approaches to avoid the imminent failures of AIG and Lehman Brothers, but none was forthcoming. In the case of AIG, the Federal Reserve, with the support of the Treasury, provided an emergency credit line to facilitate an orderly resolution. The Federal Reserve took this action because it judged that, in light of the prevailing market conditions and the size and composition of AIG's obligations, a disorderly failure of AIG would have severely threatened global financial stability and, consequently, the performance of the U.S. economy. To mitigate concerns that this action would exacerbate moral hazard and encourage inappropriate risk-taking in the future, the Federal Reserve ensured that the terms of the credit extended to AIG imposed significant costs and constraints on the firm's owners, managers, and creditors. The chief executive officer has been replaced. The collateral for the loan is the company itself, together with its subsidiaries.1 (Insurance policyholders and holders of AIG investment products are, however, fully protected.) Interest will accrue on the outstanding balance of the loan at a rate of three-month Libor plus 850 basis points, implying a current interest rate over 11 percent. In addition, the U.S. government will receive equity participation rights corresponding to a 79.9 percent equity interest in AIG and has the right to veto the payment of dividends to common and preferred shareholders, among other things.
In the case of Lehman Brothers, a major investment bank, the Federal Reserve and the Treasury declined to commit public funds to support the institution. The failure of Lehman posed risks. But the troubles at Lehman had been well known for some time, and investors clearly recognized--as evidenced, for example, by the high cost of insuring Lehman's debt in the market for credit default swaps--that the failure of the firm was a significant possibility. Thus, we judged that investors and counterparties had had time to take precautionary measures.
While perhaps manageable in itself, Lehman's default was combined with the unexpectedly rapid collapse of AIG, which together contributed to the development last week of extraordinarily turbulent conditions in global financial markets. These conditions caused equity prices to fall sharply, the cost of short-term credit--where available--to spike upward, and liquidity to dry up in many markets. Losses at a large money market mutual fund sparked extensive withdrawals from a number of such funds. A marked increase in the demand for safe assets--a flight to quality--sent the yield on Treasury bills down to a few hundredths of a percent. By further reducing asset values and potentially restricting the flow of credit to households and businesses, these developments pose a direct threat to economic growth.
The Federal Reserve took a number of actions to increase liquidity and stabilize markets. Notably, to address dollar funding pressures worldwide, we announced a significant expansion of reciprocal currency arrangements with foreign central banks, including an approximate doubling of the existing swap lines with the European Central Bank and the Swiss National Bank and the authorization of new swap facilities with the Bank of Japan, the Bank of England, and the Bank of Canada. We will continue to work closely with colleagues at other central banks to address ongoing liquidity pressures. The Federal Reserve also announced initiatives to assist money market mutual funds facing heavy redemptions and to increase liquidity in short-term credit markets.
Despite the efforts of the Federal Reserve, the Treasury, and other agencies, global financial markets remain under extraordinary stress. Action by the Congress is urgently required to stabilize the situation and avert what otherwise could be very serious consequences for our financial markets and for our economy. In this regard, the Federal Reserve supports the Treasury's proposal to buy illiquid assets from financial institutions. Purchasing impaired assets will create liquidity and promote price discovery in the markets for these assets, while reducing investor uncertainty about the current value and prospects of financial institutions. More generally, removing these assets from institutions’ balance sheets will help to restore confidence in our financial markets and enable banks and other institutions to raise capital and to expand credit to support economic growth.
At this juncture, in light of the fast-moving developments in financial markets, it is essential to deal with the crisis at hand. Certainly, the shortcomings and weaknesses of our financial markets and regulatory system must be addressed if we are to avoid a repetition of what has transpired in our financial markets over the past year. However, the development of a comprehensive proposal for reform would require careful and extensive analysis that would be difficult to compress into a short legislative timeframe now available. Looking forward, the Federal Reserve is committed to working closely with the Congress, the Administration, other federal regulators, and other stakeholders in developing a stronger, more resilient, and better regulated financial system.
Footnotes
1. Specifically, the loan is collateralized by all of the assets of the company and its primary non-regulated subsidiaries. These assets include the equity of substantially all of AIG's regulated subsidiaries.
Chairman Ben S. Bernanke
U.S. financial markets
Before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate
September 23, 2008
Chairman Bernanke presented identical testimony before the Committee on Financial Services, U.S. House of Representatives, on September 24, 2008
Chairman Dodd, Senator Shelby, and members of the Committee, I appreciate this opportunity to discuss recent developments in financial markets and the economy. As you know, the U.S. economy continues to confront substantial challenges, including a weakening labor market and elevated inflation. Notably, stresses in financial markets have been high and have recently intensified significantly. If financial conditions fail to improve for a protracted period, the implications for the broader economy could be quite adverse.
The downturn in the housing market has been a key factor underlying both the strained condition of financial markets and the slowdown of the broader economy. In the financial sphere, falling home prices and rising mortgage delinquencies have led to major losses at many financial institutions, losses only partially replaced by the raising of new capital. Investor concerns about financial institutions increased over the summer, as mortgage-related assets deteriorated further and economic activity weakened. Among the firms under the greatest pressure were Fannie Mae and Freddie Mac, Lehman Brothers, and, more recently, American International Group (AIG). As investors lost confidence in them, these companies saw their access to liquidity and capital markets increasingly impaired and their stock prices drop sharply.
The Federal Reserve believes that, whenever possible, such difficulties should be addressed through private-sector arrangements--for example, by raising new equity capital, by negotiations leading to a merger or acquisition, or by an orderly wind-down. Government assistance should be given with the greatest of reluctance and only when the stability of the financial system, and, consequently, the health of the broader economy, is at risk. In the cases of Fannie Mae and Freddie Mac, however, capital raises of sufficient size appeared infeasible and the size and government-sponsored status of the two companies precluded a merger with or acquisition by another company. To avoid unacceptably large dislocations in the financial sector, the housing market, and the economy as a whole, the Federal Housing Finance Agency (FHFA) placed Fannie Mae and Freddie Mac into conservatorship, and the Treasury used its authority, granted by the Congress in July, to make available financial support to the two firms. The Federal Reserve, with which FHFA consulted on the conservatorship decision as specified in the July legislation, supported these steps as necessary and appropriate. We have seen benefits of this action in the form of lower mortgage rates, which should help the housing market.
The Federal Reserve and the Treasury attempted to identify private-sector approaches to avoid the imminent failures of AIG and Lehman Brothers, but none was forthcoming. In the case of AIG, the Federal Reserve, with the support of the Treasury, provided an emergency credit line to facilitate an orderly resolution. The Federal Reserve took this action because it judged that, in light of the prevailing market conditions and the size and composition of AIG's obligations, a disorderly failure of AIG would have severely threatened global financial stability and, consequently, the performance of the U.S. economy. To mitigate concerns that this action would exacerbate moral hazard and encourage inappropriate risk-taking in the future, the Federal Reserve ensured that the terms of the credit extended to AIG imposed significant costs and constraints on the firm's owners, managers, and creditors. The chief executive officer has been replaced. The collateral for the loan is the company itself, together with its subsidiaries.1 (Insurance policyholders and holders of AIG investment products are, however, fully protected.) Interest will accrue on the outstanding balance of the loan at a rate of three-month Libor plus 850 basis points, implying a current interest rate over 11 percent. In addition, the U.S. government will receive equity participation rights corresponding to a 79.9 percent equity interest in AIG and has the right to veto the payment of dividends to common and preferred shareholders, among other things.
In the case of Lehman Brothers, a major investment bank, the Federal Reserve and the Treasury declined to commit public funds to support the institution. The failure of Lehman posed risks. But the troubles at Lehman had been well known for some time, and investors clearly recognized--as evidenced, for example, by the high cost of insuring Lehman's debt in the market for credit default swaps--that the failure of the firm was a significant possibility. Thus, we judged that investors and counterparties had had time to take precautionary measures.
While perhaps manageable in itself, Lehman's default was combined with the unexpectedly rapid collapse of AIG, which together contributed to the development last week of extraordinarily turbulent conditions in global financial markets. These conditions caused equity prices to fall sharply, the cost of short-term credit--where available--to spike upward, and liquidity to dry up in many markets. Losses at a large money market mutual fund sparked extensive withdrawals from a number of such funds. A marked increase in the demand for safe assets--a flight to quality--sent the yield on Treasury bills down to a few hundredths of a percent. By further reducing asset values and potentially restricting the flow of credit to households and businesses, these developments pose a direct threat to economic growth.
The Federal Reserve took a number of actions to increase liquidity and stabilize markets. Notably, to address dollar funding pressures worldwide, we announced a significant expansion of reciprocal currency arrangements with foreign central banks, including an approximate doubling of the existing swap lines with the European Central Bank and the Swiss National Bank and the authorization of new swap facilities with the Bank of Japan, the Bank of England, and the Bank of Canada. We will continue to work closely with colleagues at other central banks to address ongoing liquidity pressures. The Federal Reserve also announced initiatives to assist money market mutual funds facing heavy redemptions and to increase liquidity in short-term credit markets.
Despite the efforts of the Federal Reserve, the Treasury, and other agencies, global financial markets remain under extraordinary stress. Action by the Congress is urgently required to stabilize the situation and avert what otherwise could be very serious consequences for our financial markets and for our economy. In this regard, the Federal Reserve supports the Treasury's proposal to buy illiquid assets from financial institutions. Purchasing impaired assets will create liquidity and promote price discovery in the markets for these assets, while reducing investor uncertainty about the current value and prospects of financial institutions. More generally, removing these assets from institutions’ balance sheets will help to restore confidence in our financial markets and enable banks and other institutions to raise capital and to expand credit to support economic growth.
At this juncture, in light of the fast-moving developments in financial markets, it is essential to deal with the crisis at hand. Certainly, the shortcomings and weaknesses of our financial markets and regulatory system must be addressed if we are to avoid a repetition of what has transpired in our financial markets over the past year. However, the development of a comprehensive proposal for reform would require careful and extensive analysis that would be difficult to compress into a short legislative timeframe now available. Looking forward, the Federal Reserve is committed to working closely with the Congress, the Administration, other federal regulators, and other stakeholders in developing a stronger, more resilient, and better regulated financial system.
Footnotes
1. Specifically, the loan is collateralized by all of the assets of the company and its primary non-regulated subsidiaries. These assets include the equity of substantially all of AIG's regulated subsidiaries.
Tuesday, September 16, 2008
To Our Clients
Dear Clients,
In view of the tumultuous developments in the U.S. and foreign financial markets, we felt it appropriate to give you our overview of the current situation and an explanation of what we think will be the ultimate outcome.
While the Federal Reserve has taken significant steps to provide liquidity to the financial institutions (commercial banks, investment banks, insurance companies, etc.) which hold mortgage-backed assets of questionable value, there is a high degree of unwillingness for investors to make capital commitments to these institutions. This has resulted in a crisis of confidence which, in turn, has wreaked havoc on the prices of the equities of those financial institutions.
Before the financial markets begin to recover, the weaker participants--who had contributed to the excess lending capacity in the mortgage market--will be either absorbed or eliminated. This process will require sacrifice, ingenuity, patience and perseverance. Then, at some point in the not-too-distant future, expectations of a return to financial stability will take hold and markets should recover.
At the foundation of our belief in the ultimate resolution of the financial market problems are the facts that central banks are taking the correct steps and that the economies of the world will continue to grow, albeit at a slower rate than had been experienced in recent years. The recent decline in energy and related commodity prices, as well as the stabilization of the Dollar, coupled with reduced inflationary expectations, afford the opportunity to correct the malaise.
Finally, we want to assure you that we continue to monitor the developments impacting the markets, as well as the securities in your portfolio(s) and will be certain to make any adjustments deemed necessary as conditions continue to evolve. Please feel free to contact us with any questions.
Very truly yours,
Gofen and Glossberg, LLC
In view of the tumultuous developments in the U.S. and foreign financial markets, we felt it appropriate to give you our overview of the current situation and an explanation of what we think will be the ultimate outcome.
While the Federal Reserve has taken significant steps to provide liquidity to the financial institutions (commercial banks, investment banks, insurance companies, etc.) which hold mortgage-backed assets of questionable value, there is a high degree of unwillingness for investors to make capital commitments to these institutions. This has resulted in a crisis of confidence which, in turn, has wreaked havoc on the prices of the equities of those financial institutions.
Before the financial markets begin to recover, the weaker participants--who had contributed to the excess lending capacity in the mortgage market--will be either absorbed or eliminated. This process will require sacrifice, ingenuity, patience and perseverance. Then, at some point in the not-too-distant future, expectations of a return to financial stability will take hold and markets should recover.
At the foundation of our belief in the ultimate resolution of the financial market problems are the facts that central banks are taking the correct steps and that the economies of the world will continue to grow, albeit at a slower rate than had been experienced in recent years. The recent decline in energy and related commodity prices, as well as the stabilization of the Dollar, coupled with reduced inflationary expectations, afford the opportunity to correct the malaise.
Finally, we want to assure you that we continue to monitor the developments impacting the markets, as well as the securities in your portfolio(s) and will be certain to make any adjustments deemed necessary as conditions continue to evolve. Please feel free to contact us with any questions.
Very truly yours,
Gofen and Glossberg, LLC
Monday, September 1, 2008
How bad is the bank crises?
If you read the common buzz concerning the current financial crisis you would get the impression that this is the worst crisis ever to hit the economy. Yet, on Friday the FDIC announced only the 10th bank failure for 2008. With over 8,000 banking institutions in the U.S., 10 failures seem a long ways away from a crisis. Here is some of the data to see how “big” the banking crisis has become. Here are a few points of interest:
- The 10 banks taken over by the FDIC had just under $40 billion of assets in total.
- The total assets of the 10 largest banks in the U.S. is a combined $6 trillion.
- Total assets of all 8,451 FDIC insured institutions is $13.3 trillion.
- Percentage of failed assets, year to date, of total: 0.3%. Or written as a decimal: 0.003 of all banking assets were in failed banks so far this year.
In comparison, during the Savings and Loan debacle of the 1980s and early 1990s there were over 1,000 federally insured S&L’s dissolved. The Resolution Trust Corp. took down 747 institutions over 6 years, or a rate of 125 per year. The current situation is showing no signs of getting anywhere near those levels.
The current situation has most banks taking severe write downs on any asset that has any chance of being impaired. If these assets under-perform less than anticipated, many banks could be recouping the write downs as outsized profits in the next few years.
Many believe we are just at the beginning of a major financial crisis in the U.S. This is a financial system where home prices peaked almost 3 years ago and the mortgage meltdown started in earnest over a year ago and we still have only 10 bank failures and less than 1/3 of 1% of banking assets taken over by the feds. Bank failures are not accelerating this late in the game as the economy starts to recover and the housing market is showing signs of a pending bottom.
Is this a glass half full or half empty? Do we include Fannie and Fredie in this collection of "banks?" And what about Bear Stearns? Is there fear out there...rescuing Fannie and Freddie will put the bail-out numbers into the trillions. Just a thought.
- The 10 banks taken over by the FDIC had just under $40 billion of assets in total.
- The total assets of the 10 largest banks in the U.S. is a combined $6 trillion.
- Total assets of all 8,451 FDIC insured institutions is $13.3 trillion.
- Percentage of failed assets, year to date, of total: 0.3%. Or written as a decimal: 0.003 of all banking assets were in failed banks so far this year.
In comparison, during the Savings and Loan debacle of the 1980s and early 1990s there were over 1,000 federally insured S&L’s dissolved. The Resolution Trust Corp. took down 747 institutions over 6 years, or a rate of 125 per year. The current situation is showing no signs of getting anywhere near those levels.
The current situation has most banks taking severe write downs on any asset that has any chance of being impaired. If these assets under-perform less than anticipated, many banks could be recouping the write downs as outsized profits in the next few years.
Many believe we are just at the beginning of a major financial crisis in the U.S. This is a financial system where home prices peaked almost 3 years ago and the mortgage meltdown started in earnest over a year ago and we still have only 10 bank failures and less than 1/3 of 1% of banking assets taken over by the feds. Bank failures are not accelerating this late in the game as the economy starts to recover and the housing market is showing signs of a pending bottom.
Is this a glass half full or half empty? Do we include Fannie and Fredie in this collection of "banks?" And what about Bear Stearns? Is there fear out there...rescuing Fannie and Freddie will put the bail-out numbers into the trillions. Just a thought.
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