Wilbur Ross: Federal Reserve Is Directly Funding the Federal Deficit; Consumer More Levered Than at the Peak of 2007
Optimisim has spiked the water on Wall Street with a cocktail of the GOP taking back the House, QE2 and the employment numbers. So what's the smart money banking on as we rapidly approach the end of 2010?
Billionaire, vulture investor extrodinaire Wilbur Ross, Chairman and CEO of W.L. Ross & Co, is always a step or two ahead of the pack. I decided to sit down and talk to Wilbur on his views of QE2, the future of the Bush Tax cuts and his outlook on the economy.
LL: Do you think QE2 is necessary despite the jobs numbers?
WR: I don't think QE2 will be all that affective. And the reason I don't is the following. The banks already have a trillion dollar in excess reserves and they have not lent it out. So what would make you think by giving them 600 billion more over time would make them suddenly lend out the next 600? I don't think the banks will change their behavior with QE2.
I think there will be some mild benefit to the degree it lowers the benchmark interest rates for mortgage loans and therefore drives mortgage rates lower and you might get a little more refinancing. If you do get some refinancing, it may put more cash in the consumer. Some portion of which would be spent and some of which would be saved.
The second thing that QE2 might very well do and QE1 already did this, is weaken the dollar. And that might in the longer term have an effect on the balance of trade.
In general, currency changes have to be in place for around six months to have an effect on the balance of trade because people make that commitment longer in advance. It would not be an instanious thing. I think that assumes that the other countries do not take an counter measures which is highly unlikely.
They probably will. At most, you're talking about an impact of a quarter of one percent on the GDP and I just don't that you can't even estimate GDP to within a quarter of a percent.
But what QE2 does have an effect on is its driving more and more capital into more speculative activity. It has been something like 150 billion flowing into emerging markets, into debt and equity debt and that's part of a problem because their currencies are getting too strong. So now you are seeing South Korea and others putting in currency controls.
They'd be taxing and withholding interest and maybe lengthening the holding period, maybe even restricting access to foreigners. Because with the problem that these other countries have when the dollar gets weak, is if they were to change their value to the dollar or the Renminbi the only thing they can do is buy dollars and that's fairly ineffective and the reason is foreign exchange trading is over four trillion dollars per day.
It's very difficult for countries that are trying to bring their currency down by moving the dollar up because the dollar market is such a big market. Therefore, there is a danger that they will put in these other kinds of restrictions and the danger with that is you start to muck around with real money supply and that could start to muck around with foreign trade and that could turn into a messy situation because what people forget when we monkey with the dollar is you are monkeying with the world's reserve currency.
The dollar is still 62 percent of all the reserves in all the central banks around the world so that's a big issue.
I think one of reasons why the Federal Reserve is doing QE2 is because its about the only tool they have left. They're trying to do something and that's why they're pushing out the duration.
Now, I think there is a real possible problem coming from it. The amount they are talking about buying is virtually equal to the projections to the total amount of new debt that the U.S. Treasuries are going to issue. So, in effect, what you have happening with these purchases, is the Federal Reserve is directly funding the federal deficit.
LL: There are a lot of unintended consequences when it comes to QE2.
WR: Yes, there are.
LL: Do you think the low interest rates could create another housing bubble?
WR: I don't think there will be another housing bubble because you don't have the sub prime lenders anymore. There is no one making sub prime loans. In fact, jumbo-loans are very, very hard to come by. Virtually all the mortgage lending is by Fannie and Freddie.
LL: Speaking of Fannie and Freddie, the U.S. taxpayers are backstopping the loans of Fannie and Freddie. What should be done with Fannie and Freddie?
WR: One good thing the President should do is merge Fannie, Freddie and possible FHFA all together. Their functions are largely duplicative, and there are overlapping bureacuries among them, so lumping them all together I thing would be a good thing to do. I think Congress should change their mandate.
I think you are aware they are actually required to do a certain amount of what I call "uncreditworthy" lending. And the real reason why they bought so much sub prime paper was that it was a fairly easy way to fulfill the Congressional mandate. Now Congress says they can't do that anymore and they need to make direct loans. But it hasn't made them sell the securitizations they have bought.
The problem is Fannie and Freddie not only lend out a certain percentage loan to value but they actually make loans north of 90 percent and then they buy private mortgage insurance.
Well, the private mortgage insurance have had huge losses and so for the most part, they are junk bond rated things. So if it turns out they can't pay on the excess over what Fannie and Freddie intended to lend, Fannie and Freddie are still on the hook for it.
That means the taxpayers are. So as far as I can tell, the reason why they continue to use the private mortgage people, even though they don't meet the agency's own credit requirements, is they are hoping that there is an eventual turnaround in the mortgage market. It may work, or it may not work, but its kind of a risky thing they are doing.
The other thing is, the biggest reasons why the credit sector is not doing mortgages is the United States is you can get a 30year fixed rate mortgage and prepay it at anytime without a penalty. And what that means in real simple terms is this is an unhedgable situation because you can't forecast when rates would change and its particularly a suckers game now a days because if rates go up then you get hit with a mark to market loss and if rates go down, you get called down at no premium and you have to reinvest the money at a lower rate.
So eliminating the optionality in those loans would open it up a lot more to the private sector. And I don't believe there is not one person in this country who wouldn't buy a house if they didn't have the option to prepay. I think what they should do is to have the proper mission of Fannie and Freddie be as a provider of low cost, fixed-rate, long-term financing to credit worthy borrowers who have a reasonable down payment (so the loan to value ratio is not too bad).
I know some Republicans will not like this, but I don't see anything wrong with the government saying we think its good to have people in houses, therefore we are going to make them affordable. But I don't think you are doing anybody a favor by sticking a low-income family into a house that's likely to be foreclosed. Because to me, there is nothing more traumatic to a family than being foreclosed out of your home.
I think it should be designed for the middle class family which would mean a reasonable loan to value and give them the benefit of the low interest rate. I think that's a fine thing to do. I don't think there is no need to force Fannie and Freddie into a gambling casino.
LL: Some of my contacts tell me we are just in the first couple of innings in this Put-Back Tsunami. Do you agree?
WR: I think there were a lot of loans that were improperly underwritten and I think they are right to put them back. Fannie and Freddie just like any lender, the originator were suppose to meet that criteria. If they didn't meet that criteria, it means it was not a legitimate loan so I think its appropriate the orginator has to eat it. What's hard to figure out is how big that number could get to be.
Not every loan that went bad was wrongly underwritten. But there is no question that there are plenty of loans out there that should not have been sold to Fannie and Freddie and Fannie and Freddie have no way of protecting themselves against that.
They didn't know if the mortgage originator fraudently filled out the form. This is not anti-private sector. The private sector insurance companies are doing the same thing. Fannie and Freddie should put-back those loans.
LL: Since the big loss, the President has seemed to soften his language on the Bush Tax Cuts. What's the likelihood of the cuts being passed this Congress or do you think we'll have to wait until January to see something done?
WR: The key votes being cast in this Congress will be by those who lost their election. And that's a pretty interesting phenomenon because I think its pretty clear that the tax cuts was one of the reasons why we had this big turn over in Congress. It feels to me as though the President is listening to that aspect of what the polls said and probably is also responding to reality.
One reality is it's doubtful the people in the Congress now want to go down as the people who forced tax increases on everybody. Second, its perfectly possible as I understand it, if no action was taken by this Congress that the new Congress could retroactively extend it. And I think therefore, its extremely probable they would do so and then it would go to the President. If he vetoes it just because it had full tax benefit for everybody, you are now in the middle of 2011.
This would become a campaign issue then in 2012. I think its extremely unlikely Obama would want this as a campaign issue. I think its much more likely he would sign it to avoid the tax cuts becomming an issue. So I think the issue of extending it a year or two would be an interesting one to get himself over the hurdle. Then. it would be very interesting because it would become another issue in the 2012 election.
One of the things I think is dead on arrival is decoupling- extending the cuts for the under 250 permanently or for an extended period. I would be very surprised if that gets the vote.
LL: Do you think the President can be more like Clinton and go to the middle or do you think he'll act more like Truman and not meet half-way?
WR: I think the country would be better off if Obama went to the middle. The other day I read he might even consider a corporate tax cut which I think is in the right direction and that would be excellent. Business would like to like him. He had a lot of support in the business community including Wall Street when he ran the last time. Now that didn't happen during the midterm election. The hedge fund kids contributed to Republicans if they did at all this cycle.
LL: Do you think the economy growing?
WR: It is but very, very slowly. Probably needs to grow something like three percent in order to start to cutting unemployment. Because my view is some of the unemployment is structural. Most businesses have learned to live with fewer incremental worker per incremental sales and that's not going to change. There is more productivity.
So I think it will take at least three percent growth to eat into unemployment. But I don't think we'll get there in the near term. My reasoning is 70 percent of our economy is consumer spending and our consumer have lost 11 trillion dollars in the housing price decline, consumer debt is only down a few hundred billion dollars.
So the fact is, the consumer is more highly leveraged now than in the peak of 2007. And that's a problem. So between the high unemployment and the leveraging, consumer spending will be hard. Now there was an optimistic figure released by the credit card companies who said in the third quarter it was almost back to the level of the third quarter of 2007, but that's not really great progress since it is not even back to the level of three years ago.
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A Senior Talent Producer at CNBC, and author of "Thriving in the New Economy:Lessons from Today's Top Business Minds."