You can take Mr Potato Head out of the GSEs, but you can’t take the bogus accounting out so easily, it appears. From Fannie Mae’s recent 10K filing:

For example, we recently introduced a new HomeSaver Advance(tm) initiative, which is a loss mitigation tool that we began implementing in the first quarter of 2008. HomeSaver Advance provides qualified borrowers with an unsecured personal loan in an amount equal to all past due payments relating to their mortgage loan, allowing borrowers to cure their payment defaults under mortgage loans without requiring modification of their mortgage loans. By permitting qualified borrowers to cure their payment defaults without requiring that we purchase the loans from the MBS trusts in order to modify the loans, this loss mitigation tool may reduce the number of delinquent mortgage loans that we purchase from MBS trusts in the future and the fair value losses we record in connection with those purchases.

My translation: Rather than having to buy back and show a loss on a delinquent mortgage, we get the borrower to sign an unsecured personal note for the delinquent amount (which he owed anyway), make the payments for him, and call it square. This makes our credit losses seem much lower than they really are. Said unsecured personal note requires no payments or interest for the first six months, by the way, so there’s no way it can go delinquent for at least six months. And anything can happen in six months, right? Like we get our bonuses, eh?

From “The Big Picture,” the testimony that Mr Bernanke should have given to Congress (but didn’t):

Opening statement of the FOMC Chair, Senate Testimony
February 27, 2008:

Senators, we find ourselves in a very challenging situation.

Following the dot com implosion, my predecessor at the Fed slashed rates to a generational low of 1%; the FOMC then kept rates at 1% for over a year.

While that re-inflated the economy, it also set off a shock wave of inflation unseen since the 1970s. Houses doubled in price, Oil is up 5 fold, food stuffs have tripled, and the dollar has collapsed. Gold is at multi-decade highs.

As always happens, these price increases in hard assets attracted speculators, and that made the situation — especially in housing — much more complex. Even worse, the housing speculation contributed to a debacle, while these other assets are actually accelerating in price.

Further, as was the political fashion, deregulation and a lack of interest in the oversight role of the banking system allowed an unprecedented expansion of credit, including to the least credit worthy consumers. Additionally, derivative selling — at is heart, an unregulated form of insurance — expanded from a few billion dollars to $46 trillion dollars.

The credit crunch is unprecedented, far worse than the S&L collapse and Long Term Capital Management — combined.

All of these factors have combined to create our present situation. Inflation remains very elevated and worse, quite sticky. Growth continues to slide towards zero — and possibly beyond.

Like many others, our forecasts in these areas have been wrong. We expected the slowing economy to moderate inflation, and so far, that has not happened. Demand for commodities from China and India is keeping prices elevated. The weakening dollar — now at levels last seen in the 1960s — is forcing all dollar denominated commodities higher. I don’t necessarily believe in “Peak Oil,” but the fact that the Saudis are one of the world’s biggest investors in alternative energy research might tell you something.

The last time a slowing economy failed to moderate prices was the 1970s. Even as the economy slid into recession, we had major spikes in the prices of energy, food, clothing.

What is particularly worrisome to me is that as we have slashed interest rates 225 basis points, consumer loans — mortgages and revolving credit — have actually moved higher.

Gentleman, this is a major problem. And our internal, non-public projections forecast it is only going to get worse for the next 4 quarters . . .

Inflation is “always and everywhere a monetary phenomenon” according to Milton Friedman. But we do tend to use the word in different ways. When the money supply rises excessively, in the Latin American model, or the classical Weimar or Zimbabwe inflations, both wages and prices spiral higher. That is the kind of inflation Mr Friedman is talking about.

Here in the US, we have a different kind of inflation, and it is really a currency-driven price inflation. As Mr Bernanke cuts interest rates, or threatens to do so, the value of the dollar declines in foreign exchange markets. That means that more dollars are required to buy the goods and commodities that are traded internationally. Prices go up not only on imported goods, but also on goods produced and sold domestically that could (potentially) be sold on world markets. US buyers have to compete with the offers from overseas and the prices of domestic goods are often set by world prices. It is a big mistake to presume that the effect of the declining dollar is limited to goods that are actually imported.

Sure, the ethanol nonsense is driving up food prices. If you start paying farmers to burn their crop, it should be no surprise that the price of the unburnt portion increases. After all, that is why the ag lobby bribed made campaign contributions to Congress. But there is much more at work here, and while I remain a deflationista, I don’t rule out price inflation in some segments such as food and energy, even while overall wages and prices are declining due to high unemployment and deflating bubbles.

As I’ve said before and I will say again, it is essential the the Fed be stopped from attempting to manipulate the economy. Its sole mission should be to maintain a steady price level.

Mr Bernanke told the House today that he was open to further easing of interest rates. Well that’s a shock. And that avoiding recession was more important than avoiding inflation.

Why?

Recession temporarily reduces incomes and consumption as consumers rebuild their savings. Malinvestment is written off and productive investment eventually resumes. Inflation, on the other hand, steals from everyone, permanently, in the same way governments have been debasing the currency since classical times. Recessions are a necessary and healthy element of the business cycle and trying to avoid them by creating one credit bubble after another will eventually end in disaster. Either Zimbabwe-like inflation, or Depression-era deflation. It is probably too late to have just a mild recession to get savings, consumption and investment back into reasonable proportion. But maybe not. Economics isn’t a science, after all.

The City of Vallejo is reported to be on the verge of bankruptcy. Over the last few decades politicians have granted excessive wage and benefit increases in exchange for election support from city employee unions. Pensions and medical benefits are incredibly generous, even before accounting for schemes such as DROPs (Deferred Retirement Option Plans), which allow city employees to retire with six or seven digit lump sums in addition to their pension and medical benefits. Vallejo is simply the first city to hit the wall, as declining revenues meet increasing expenses, not counting San Diego which seems to have been malfeasance as much as anything else.