Rescue Is Ugly, But Direction Is Right

Eric Jacobson: Hi, I'm Eric Jacobson. I'm a fixed-income specialist with Morningstar, and we're fortunate enough today to have a guest from BlackRock. Peter Fisher is the co-head of fixed-income at BlackRock, and also a member of their executive committee.

Prior to joining BlackRock, Mr. Fisher was the under-secretary for domestic finance of the United States Treasury Department. Peter, thank you very much for joining us today.

Peter Fisher: My pleasure, nice to be here.

Eric Jacobson: So, as you know Peter, the Treasury Secretary had a recent announcement that they were going to focus more of their attention on, I believe it was consumer finance, asset-backed securities, rather than sort of the large plug, if you will, of residential mortgage-backed to the degree that they are still on the balance sheets of the banks.

The original plan having been to buy some of those off the bank balance sheets. He quoted as saying that it's sort of a bigger task than is reasonable given the resources that they have and that it was going to make the shift.

Can you talk a little bit about that, whether it's a decision that you and/or other folks at BlackRock think was the right decision? Do you think that they're going to have to go back to housing again? Help us understand that.

Peter Fisher: Well, clearly the shifting of gears has been disruptive to market expectations. I think it would have been better if the Treasury could have stayed on a smooth path.

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Let me just go back a little bit. I think the Treasury from mid-September has been focused in the right direction. They have realized the scope of the problem.

The banking system as a whole is struggling to shrink itself, and that's a pretty ugly picture unless the government comes in and either buys assets or injects equity; otherwise the only way this system rebalances is by asset prices falling.

Now, they did suggest that TARP would be principally used to buy mortgage assets, presumably non-agency mortgages, the ones that don't qualify for purchase by Fannie and Freddie. Now, they've shifted gears and say they are focusing on the consumer sector of credit card receivables and other asset-backs.

Now, I think that we've got to remember that TARP is only one of the many things our government has been doing and going to be doing. So, there is the FDIC fund. Fannie and Freddie are out there buying mortgages.

There is the TARP, that is being used to recapitalize banks, and as we recapitalize banks, they don't have to sell as many mortgages to shrink their balance sheet, and we've got to worry about the consumer sector in the economy that's under a lot of strain here.

Credit card access, credit card availability being cut off to the consumer, that's going to hit the economy very hard. So, secretary Paulson has tried to juggle many things at one time, and it's not a pretty picture. It's certainly very disruptive to the non-agency mortgage market when they made the announcement.

In that sense, it's disturbing to investor expectations. I think they are headed generally in the right direction. A little choppy on execution, not many points for finesse here. Some demerits here for getting investors all expecting one thing, and then we get another.

But we do have to remember all the different programs they've got. The FDIC is going to be carefully managing the unwind of some of the banks that aren't going to make it.

They'll be looking for mergers, and then ending up holding some of the assets on the books of the FDIC deposit funds. Those won't have to clear the markets.

So, it's coming, but it's clearly been ugly, and it's been especially here against the pressure of year-end, as I was saying. It's gotten it very messy. But I do think, I kind of agree, they're headed in the right direction.

Now, I think Congress has been pretty clear. They expect the Treasury to do something directly to reduce foreclosures. They feel they put it in the bill, and they don't hear the secretary responding, that's more of a political drama than it is a market drama.

Eric Jacobson: Allow me then, if I could, to kind of circle back. I didn't think quite to ask it this way, but trying to put aside the politics for just a minute and put it this way.

There seems to be an expectation, and I may not be adequately speaking for the market as a whole, but let's just say that there's some voice out there. There are some expectations or fear, let's say, that housing may still have significantly more to fall, especially say if we don't see a massive kind of efficaciousness or response to the modification proposals.

I'm kind of throwing this to you as, do you have a sense at this point or is it perhaps an opinion you're still developing about how much farther we may have to go in terms of housing prices going down, perhaps what the risk is.

I know I'm throwing a lot in here, but all the talk about the economy especially, it seems that we're on this kind of pro-cyclical downward spiral, so I hear what you're saying.

Certainly, it sounds like the secretary understands what he is dealing with from a big picture. They are moving in the right direction. I don't know if you want to essentially quantify fear, but in terms of the housing thing, what do you think in terms of your expectations, your concerns and so forth?

Peter Fisher: Well, there is a lot going on here. Let me work my way up. I think we're not going to stabilize house prices in the housing market and the economy, until we stabilize debt-to-income in the household sector.

One of the challenges here, income is falling as we go into a recession and likely to be under pressure for some time, aggregate household income. Debt got pretty high. So, debt to income ratios decay unless we start marking down some of the debt.

Now, that's pretty disturbing to investors. We're realists about how some of the stuff is trading, but we've got investors I think in mortgage-backed securities understand that within the terms of the trust in which we invest, there is some leeway for the servicers to modify mortgages, as long as it's improving the net present cash flow value of investors.

We all want that to happen, because we don't want to have a further downdraft, a further vortex in house prices and foreclosures. So, there are some things we agree on, and I think there are a number of different programs.

What the FDIC has done in IndyMac I think is constructive. There are some elements of that I might tweak, but overall I think Sheila Bair and the FDIC are headed in the right direction.

But that doesn't change the underlying economic reality, that we got to stabilize income and stabilize debt to income in order to stabilize the housing market. So, stabilizing the economy is a piece of that.

We should do something to try to limit the damage on foreclosures and prudent modification of mortgages, but we also have got to realize that that's an insufficient response until we get the economy growing again, until we can see income rising. That's probably a number of quarters away.

But the government has got to start working on that. We are not going to stabilize housing. That's why I expect the incoming administration to have a rather large fiscal stimulus plan.

I guess 2% of GDP or $300 billion would be the floor that I would expect I think they are going to talk about much bigger numbers than that and try to find ways to stimulate the economy and make sure income doesn't fall too far.

Eric Jacobson: So, you sort of addressed part of what my next question was going to be, in terms of that future spending. Again, it maybe too early to even ask the question, but given that sense that there's going to need to be more spending with a stimulus in mind, do you think that it's likely that eventually we're going to need to see more allocation for additional programs like TARP or what have you, or is it too early to tell there?

Peter Fisher: I don't know. I mean we may, but there is still $300 billion that's going to be available for the next administration out of the $700. I think that's how the math works out.

That's a pretty big number. If you think of that all in the form of equity, if that were to be equity injected into the banking system for example.

The banking system at a 10-to-1 leverage would be able to hold $3 trillion worth of assets they wouldn't otherwise be able to hold, either in the form of buying credits off of other banks' books or in the form of new lending. So, that's a non-trivial sum that would help the banking system get back to health. So, I don't know--I think that's a pretty good place to start.

The Fed is also taking assets onto its books on a non-recourse basis in the commercial paper market. So, that's not really lending, that's really buying assets. They got $250 billion of commercial paper.

So, the programs they've got are doing a lot. I think it's really going to be a mix of those things, and a prudent management of those banks that are in stress by the FDIC, then together with a mixed fiscal package from the new administration, I think we'll see blocked grants to the state, so that's a possibility.

We'll see some tax cuts, try to stimulate income that way. There will be probably some reforms. Things like health-care reform, I think the administration is signaling they're going to put high on the list.

If we got a national health-care system, you might shed a lot of liabilities off of corporate balance sheets. That would make the burden easier on the private sector, help grow incomes.

So, I think it's going to be a mixed strategy. They are going to realize they've got to do a lot of different things at the same time, and eventually they may have to come back and get a bigger TARP, but I think they've got a good place to start. I don't think they need more in January when they hit the ground.

Eric Jacobson: Well, you've given us some actually very helpful details that I think don't always make it into the press everyday. So, that's great and as well as some of the more kind of economic concepts that haven't been getting as much press.

So, that's really helpful. We really appreciate you taking the time to talk with us today. Thank you.

Peter Fisher: Thank you very much, a pleasure to be here.