Tuesday, July 22, 2008

F&F Mess: Cost of Bailout

from www.nytimes.com

July 23, 2008
Cost of Loan Bailout, if Needed, Could Be $25 Billion

WASHINGTON — The proposed government rescue of the nation’s two mortgage finance giants will appear on the federal budget as a $25 billion cost to taxpayers, the independent Congressional Budget Office said on Tuesday even though officials conceded that there was no way of really knowing what, if anything, a bailout would cost.

The budget office said there was a better than even chance that the rescue package would not be needed before the end of 2009 and would not cost taxpayers any money. But the office also estimated a 5 percent chance that the mortgage companies, Fannie Mae and Freddie Mac, could lose $100 billion, which would cost taxpayers far more than $25 billion.

The House is expected to act this week on housing legislation that includes the proposed rescue plan. Legislative language has not been finalized, but the Congressional Budget Office said its estimates were based on the plan by the Treasury Department and that it did not expect significant changes in the final bill.

According to the estimate, which was delivered in the form of a letter to the House Budget Committee chairman, Representative John M. Spratt Jr., Democrat of South Carolina, the director of the budget office, Peter R. Orszag, predicted that “a significant chance, probably better than 50 percent, that the proposed new Treasury authority would not be used before it expired at the end of December 2009.”

Mr. Orszag, at a briefing with reporters, acknowledged that pinpointing the eventual cost of the package was impossible. “There is very significant uncertainty involved here,” he said.
The uncertainty runs in both directions, with some government officials and market analysts suggesting that Fannie Mae and Freddie Mac are fundamentally sound and will perform well over the long-term. Others, including some private equity managers, are pessimistic and predict heavy losses.

The rescue plan, put forward last week by the Treasury secretary, Henry M. Paulson Jr., would allow the Treasury Department to spend hundreds of billions of dollars to shore up the mortgage companies should they be at risk of collapse, either by extending credit or by purchasing equity in the companies, which are publicly traded.

Mr. Orszag said that the analysis by his office did not distinguish between the different forms of aid that might be offered — a credit line or a stock purchase — and that the analysis showed no short-term potential financial benefit for taxpayers even if Fannie Mae and Freddie Mac perform well.

But he said the analysis found substantial risk for taxpayers if the companies had steep losses and would not say if his office had analyzed the implications of a full government takeover of the companies.

How much the government will end up spending on a rescue, if one is needed, would depend on many factors, he said, including sentiment on Wall Street. “A key question becomes how does the market view the entities?” he said.

Fannie Mae and Freddie Mac are commonly referred to as government-sponsored entities, because of the long implicit guarantee that the federal government would step in to save them if they were ever in danger of collapse.

One thing that is certain as a result of the rescue proposal is that the guarantee of government aid is now much more explicit, and Mr. Orszag said that the government’s assurance that it would not let the companies fail would have to be included in any analysis of their long-term financial prospects.

Most immediately, the $25 billion cost estimate provides a precise amount that Congress will have to offset with spending cuts or tax increases if lawmakers intend to comply with “pay as you go” budget rules in the House. Lawmakers could also decide that the $25 billion should be viewed as emergency spending and simply added to the national debt.
There was little immediate reaction to the projections on Capitol Hill as lawmakers and staff members reviewed the complicated calculations and the various assumptions they were based on.

Mr. Spratt, the chairman of the Budget Committee, issued a statement praising the Congressional Budget Office for moving quickly to produce its analysis. “Estimating the fiscal impact of this proposal is complex and involves considerable uncertainty,” Mr. Spratt said. “And not everyone will necessarily agree with every aspect of C.B.O.’s analysis.”
But he added: “C.B.O. is performing its important institutional role by providing in a timely manner its best professional and independent assessment.”

The analysis by the Congressional Budget Office also offered a sobering assessment of the mortgage giants based on several different metrics.

Under generally accepted accounting principles, Mr. Orszag said that the net worth of the mortgage giants at the end of the first quarter of 2008 was about $55 billion. He also said that the companies held more than $80 billion in capital at the end of March and for regulatory purposes were considered to be "adequately capitalized" by the Department of Housing and Urban Development.

But on a fair value basis, the value of the mortgage companies’ assets exceeded their liabilities at the end of March by just $7 billion, a thin cushion considering liabilities at the time of $1.6 trillion, and an indication of why there have been numerous calls for the companies to raise additional capital. Mr. Orszag also noted that on July 11, before the Bush administration proposed its rescue plan, the total value of shares in Fannie Mae and Freddie Mac had fallen to a low of $11 billion. Shares in the companies are now worth about $20 billion.

The House is expected to vote on the larger package of housing legislation, including the rescue plan for the mortgage companies, as early as Wednesday, and the Senate is expected to quickly follow and send the bill to President Bush.

Among the issues that lawmakers have been debating is whether to exempt from the federal debt limit any expenditure that the Treasury Department makes on behalf of the mortgage companies. The current debt limit is $9.815 trillion and outstanding federal debt is roughly $9.5 trillion, leaving a cushion of $310 billion.

Congressional Democrats have expressed opposition to exempting the rescue plan from the debt limit, saying administration officials should come back to Congress for emergency authorization if additional spending is needed. Officials said it was probable that a compromise would be reached and the debt limit would still apply.

The housing legislation also includes the creation of a regulator for the mortgage companies, an agency apart from the Department of Housing and Urban Development, which oversees the mortgage giants.

Some critics have questioned whether the new regulator would have sufficient authority to swiftly increase capital requirements — the amount of cash that the mortgage companies need to maintain to protect against losses.

In his letter to Mr. Spratt, Mr. Orszag suggested that simply enacting the proposed rescue plan could bolster the confidence of Wall Street in Fannie Mae and Freddie Mac.

“Private markets might be sufficiently reassured to provide the GSE’s with adequate capital to continue operations without any infusion of funds from the Treasury,” he wrote. “during that time, it is possible that expectations about the duration and depth of the housing market downturn may brighten.”

But Mr. Orszag said his office had also consulted with market investors with a different outlook. “Many analysis and traders believe there is a significant likelihood that conditions in the housing and financial markets could deteriorate more than already reflected on the GSEs’ balance sheets,” he wrote, “and such continuing problems would increase the probability that this new authority would have to be used.”

Taking into account all of the different possibilities and sentiments, and measuring them against the budget “scorekeeping” rules, Mr. Orszag said his office had concluded “that the expected value of the federal budgetary cost from enacting this proposal would be $25 billion over fiscal years 2009 and 2010.”

25 bil huh? Try 10x that number....

Cost of College

from www.nytimes.com

July 21, 2008
With No Frills or Tuition, a College Draws Notice

BEREA, Ky. — Berea College, founded 150 years ago to educate freed slaves and “poor white mountaineers,” accepts only applicants from low-income families, and it charges no tuition.
“You can literally come to Berea with nothing but what you can carry, and graduate debt free,” said Joseph P. Bagnoli Jr., the associate provost for enrollment management. “We call it the best education money can’t buy.”

Actually, what buys that education is Berea’s $1.1 billion endowment, which puts the college among the nation’s wealthiest. But unlike most well-endowed colleges, Berea has no football team, coed dorms, hot tubs or climbing walls. Instead, it has a no-frills budget, with food from the college farm, handmade furniture from the college crafts workshops, and 10-hour-a-week campus jobs for every student.

Berea’s approach provides an unusual perspective on the growing debate over whether the wealthiest universities are doing enough for the public good to warrant their tax exemption, or simply hoarding money to serve an elite few. As many elite universities scramble to recruit more low-income students, Berea’s no-tuition model has attracted increasing attention.

“Asking whether that’s where our values lead us is a powerful way to consider what our values are,” said Anthony Marx, the president of Amherst College, who considered the possibility of using Amherst’s $1 million-per-student endowment to offer free tuition but concluded that it would make no sense, given Amherst’s more affluent student body and the fact that the college already subsidizes about half the cost of each student’s education.

“We’re not Berea, much as we respect them,” Mr. Marx said, adding there would be no social justification for giving free tuition to students from wealthy families.
Although this year’s market drop is taking its toll, the growth in university endowments in recent years has been spectacular. Harvard’s $35 billion endowment, Yale’s $23 billion, Stanford’s $17 billion and Princeton’s $16 billion put them among the world’s richest institutions.
Such endowments have helped make higher education one of the nation’s crown jewels. As Harvard’s president, Drew Gilpin Faust, said in her spring commencement speech this year, endowments at Harvard and other research universities help fuel scientific advances as government support is eroding, and help drive economic growth and expansion in a difficult economy.

Although most universities have only modest endowments, the wealth of the richest has made them increasingly vulnerable to criticism from parents upset about rising tuition costs, lawmakers pushing them to spend more of their money and policy experts arguing that they should be helping more needy students.

“How much do you need to save for future generations, and at what point are you gouging today’s generation?” said Lynne Munson, of the Center for College Affordability and Productivity in Washington.

In January, the Senate Finance Committee requested detailed endowment and spending data from 136 colleges and universities with endowments of at least $500 million, with a possible eye to forcing them to spend at least 5 percent of their assets each year, as foundations are required to do. Large, tax-free endowments “should mean affordable education for more students, not just a security blanket for colleges,” said Senator Charles E. Grassley, Republican of Iowa, who is reviewing the data.

The commissioner of the Internal Revenue Service’s tax-exempt section said this spring that he wanted his agency to be more aggressive in ensuring that universities made “appropriate use” of their endowments. And officials in Massachusetts are studying a proposal for a 2.5 percent tax on the part of university endowments greater than $1 billion — a threshold exceeded by nine of the state’s universities.

“The endowments have grown to such an astonishing extent that people are asking, if the wealth and the value of the tax exemption are increasing, is the public benefit increasing, as well?” said Evelyn Brody, a tax professor at Chicago-Kent College of Law.

This year, Ms. Brody said, the debate has entered new territory. Traditionally, discussion about endowments has focused on the balance between using the money for the current generation versus saving it for the benefit of future generations.

“Endowment spending has usually been a ‘when’ question, about when the money would be used for a charitable purpose,” she said. “But now, it’s also being viewed as a ‘what’ question. What is the money for? And I think that’s new.”

In part, it is simply a question of itchy fingers. When one sector amasses great wealth, other sectors find it irresistible.

“That’s why Henry VIII dissolved the monasteries in the 16th century,” Ms. Brody said. “In those days, it was real estate, which was not easy to hide. Now it’s the disclosure, which makes the universities’ wealth impossible to hide.”

The mounting scrutiny by lawmakers has already prompted some action. Dozens of wealthy colleges have increased their aid to low- and middle-income students, many substituting grants for loans. Many have announced plans to expand their student bodies, and some are doing broader outreach and working with nearby K-12 schools to improve academic preparation.
Nonetheless, according to 2002 data, only one in 10 of the students at the nation’s most selective institutions come from the bottom 40 percent of the income scale. And the proportion of low-income undergraduates at the nation’s wealthiest colleges has been declining, as measured by the percentage receiving federal Pell Grants, for families with income under about $40,000. At most top colleges, only 8 to 15 percent of students receive Pell grants.

At Berea, more than three-quarters of the students receive Pell grants.
Overall, Berea’s statistics speak worlds about the demand for affordable higher education; this year, the college accepted only 22 percent of its applicants. Among those accepted, 85 percent attended Berea, a yield higher than Harvard’s.

Berea can be a haven for the lower-income students at high schools where expensive clothes and fancy homes demarcate the social territory.

“When I first heard about Berea, I didn’t think I wanted to come here,” said Candice Roots, who will be a junior in the fall. “But I visited in my senior year, and as soon as I got here, I knew this was what I wanted. Everybody was like me. You don’t have to have all this money to fit in.”
With its hilly campus, Georgian president’s mansion and old brick buildings, Berea looks much like any elite New England college. But its operating budget is less than half that of Amherst, which has a $1.7 billion endowment and about 100 more students. Faculty pay is much lower, and the student-faculty ratio higher. With no rich parents and no legacy admission slots, fund-raising is far more difficult at Berea.

Lacking tuition, Berea receives 80 percent of its $43 million education and general budget, and about two-thirds of its $55 million operating budget, from the endowment income.
Families bringing a student to a campus interview may stay, free, in a four-bedroom house, complete with flat-screen television and handmade sleigh bed. Students who are single parents have their own residences.

To satisfy the work requirement, some students have jobs in the academic departments, administrative offices and labs, while others are assigned to the college farm, the workshops that make and sell traditional mountain crafts (its handmade brooms, especially, are well-known treasures) or the college-owned hotel, which anchors the town square.
Mr. Marx, in homage, keeps a Berea broom in his Amherst office.

While Mr. Marx is not trying to match Berea’s student population, he is proud of Amherst’s efforts to attract top students from all income brackets. The college has increased the proportion of Pell recipients to nearly 20 percent of its student body, from about 15 percent five years ago, for example. With more than half of Amherst’s students on financial aid, the college announced last year that it would replace loans in all aid packages with grants. A full-time staff member recruits community college graduates as transfer students. Admissions are need-blind, for both American and international applicants.

Although he, like other college presidents, opposes the idea of a required 5 percent payout, Mr. Marx said the current debate over the use of endowments was healthy.
“Congress, the media, the public all have an interest in knowing whether we’re using our resources to make sure the best students have access to the best education,” he said. “They should be asking, are we really affordable? Are we offering the highest quality education? Are we directing graduates to think about their social responsibilities?”

Berea’s president, Larry D. Shinn, also opposes a required 5 percent payout but wants colleges pushed to do more for needy students.

“You see some of these selective liberal arts colleges building new physical education facilities with these huge sheets of glass and these coffee and juice bars, and charging students $40,000 a year, and you have to ask, does this contribute to the public good, or is it just a way for the college to keep up with the Joneses?” Mr. Shinn said. “We are a tax-exempt institution, so I think the public has a right to demand that our educational mission be at the heart of all of our expenditures.”

I had applied to Berea as an international student from India back in 1991. If memory serves me right, I got a nice letter back from them saying that they appreciated my credentials but their policy was to reserve spots for US Citizens ideally from Appalachia. Even back then, Berea had a solid reputation and its model is very unique and ought to be emulated.

Be Patient!

from www.nytimes.com

July 23, 2008
Paulson Urges Americans to Be Patient on Economy

Treasury Secretary Henry M. Paulson Jr., said on Tuesday that Americans need to remain patient as the economy works through its problems, and he warned of “continued stresses” in the months ahead before a full recovery can be made.

“Our markets won’t make progress in a straight line, and we should expect additional bumps in the road,” Mr. Paulson said in remarks at the New York Public Library in Midtown Manhattan. “We have been experiencing more bumps recently, and until the housing market stabilizes further we should expect some continued stresses in our financial markets.”

Although Mr. Paulson acknowledged the need for broad reforms of the nation’s existing regulatory structure, he sought to assure Americans that he expects the nation to “work through this period,” and “emerge stronger and better poised for robust growth.”
“The American people have every reason to remain confident that the U.S. banking system is sound,” he said.

Mr. Paulson spoke just a week after the government announced a plan to help prop up Fannie Mae and Freddie Mac, the giant mortgage buyers that were recently at the center of widespread market anxiety. The episode, Mr. Paulson said, made it “all the more apparent” that systemic reforms are necessary.

“Now, more than ever, we need Fannie and Freddie out there, financing mortgages,” he said. “Their continued activity is central to the speed with which we emerge from this housing correction and remove the underlying uncertainty in our financial markets and financial institutions.”

Mr. Paulson said there were currently no plans for the companies to tap any federal money, even though the administration’s proposal calls for extending billions of dollars in credit if necessary. Asked about the effect of the plan on taxpayers, he said the credit lines offered a “flexibility” that “minimizes the likelihood they will be used.”

In his remarks, Mr. Paulson repeated his calls for greater transparency and effective regulation of the financial industry, saying such changes would “add to market stability and mitigate the likelihood that a failing institution can spur a systemic event.”

“We need to get to the point where large, complex financial institutions are not perceived to be too big or too interconnected to fail,” he said. He also singled out certain sophisticated markets — including over-the-counter credit derivatives — as particularly in need of greater oversight.

Mr. Paulson pointed to the recent failure of IndyMac Bancorp as an example of the government’s ability through the Federal Deposit Insurance Corporation to protect depositors when a large bank collapses. “No one has or will lose a penny of insured deposits,” he said. “The F.D.I.C. took over the bank on a Friday, worked effectively over the weekend, and on Monday morning the bank reopened for business as usual.”

In a question-and-answer session after his speech, Mr. Paulson tried to end the appearance on a more positive note. “As I look around the world, I don’t see other industrial nations, developed industrial nations that have better long-term prospects than we do,” he said.

Limited Role Seen for Fed

KING OF PRUSSIA, Pa. (Reuters) — The Federal Reserve has a limited role in a government plan to provide financial support for the ailing mortgage finance companies, Fannie Mae and Freddie Mac, the president of the Philadelphia Federal Reserve, Charles I. Plosser, said Tuesday.

“We were not the lead instigators” in the plan, Mr. Plosser said after a speech to local business leaders. “The Fed is not intentionally seeking to expand its powers.”

Mr. Plosser is a voting member this year on the Fed’s interest rate-setting Federal Open Market Committee and is known to be one of the Fed’s more hawkish members.

So... which large, complex, interconnected institutions is Paulson talking about really? List of suspects are well known.