The de facto nationalization of the housing bust

Congress may be still debating a bailout bill, but the bailout of the housing market is already in progress.

Freddie Mac and its fellow GSE Fannie Mae are now financing more than 80 percent of all mortgages in the U.S., up from 40 percent a year ago.

As lenders rely on Freddie Mac to buy their loans, the company is charging higher prices and increasing market share. Freddie Mac, which has a $738 billion portfolio of mortgage bonds and guarantees $1.78 trillion in home loans, is raising prices next month for the fourth time.

"We are nearly the only game in town, and we think we are going to be able to enjoy that position for a number of years," Piszel said.

Considering the implied promise of taxpayer backing for these government-sponsored entities combined with the collapsing real estate market, this should scare everyone.
But it doesn't stop there.

Fannie Mae lost $2.2 Billion in the 1st quarter of 2008. This follows losses of $2.1 Billion in 2007. Freddie Mac only lost $151 million in the 1st quarter, but that followed losses of $4.5 Billion during the second half of 2007.
So how did Freddie Mac cut their losses so much? Did they get smarter and more efficient? No. They changed the way they calculated income.

Freddie said Wednesday its first-quarter earnings beat Wall Street expectations, but it also reported that the "fair value" of its net assets fell to negative $5.2 billion at the end of March from 12.6 billion dollars at the end of December. That reflected a drop of nearly 32 billion dollars in value for its mortgage assets and credit guarantees that did not affect the company's net income.

Even scarier is the fact that Fannie Mae has changed the way that it calculates its losses in order to hide them off the balance sheet.

Last week, as part of its earnings report, Fannie Mae revealed that the company had changed the way it calculates the credit loss ratio. Under the new method, Fannie Mae's annualized credit loss ratio was just 4 basis points in the first nine months of the year.

At first glance, four basis points looks to be at the low-end of Fannie Mae's full-year forecast. Problem is, because the company is using a new methodology, the previous estimate no longer makes sense to use.

So what would have happened if the company had compared apples to apples -- and stuck with the old method of calculating its loss ratio?

Under the previous method, Fannie Mae would have been well outside of its range. The company would have reported an annualized loss ratio of 7.5 basis points in the first nine months of this year.

For those with short memories, Enron-type accounting is no stranger to Fannie Mae or Freddie Mac.

There is also another problem of systemic risk from having just three entities dominating the entire real estate market. The concentration of risk and the cyclical nature of the market means that the GSE activities move the entire market. Thus when the GSE's want to sell, they will be selling into a falling market. When the GSE's want to buy, they will be buying into a rising market.
It has a destabilizing effect.

What do you think are the chances that the government would do nothing if these massive GSE's that dominate the real estate market got into trouble? And how long can the GSE's take these kinds of losses before they get into trouble?
Barron's came out and suggested a taxpayer bailout of Fannie Mae was in the works.

Barron's said the company, which lost $2.6 billion last year, has a balance sheet that appears loaded with "iffy" assets and understated liabilities that could leave the company ill-equipped to weather a serious financial crisis.

CNN called it the trillion-dollar mortgage time bomb.
In fact, a bailout of Fannie and Freddie would be so large that it would cost America its AAA debt rating. Losing the AAA rating would mean foreigners would fly from our Treasuries, thus bringing to an end the dollar's status as world's reserve currency.

The important point to note here is that the GSE's didn't get themselves in trouble all by themselves. They didn't become the dominant force in the housing market, even while the market implodes, all by themselves.
They were instructed to bail out the housing market by the Bush Administration.

By reducing the extra cushion of capital the two companies have been required to hold since 2004, the regulator, the Office of Federal Housing Enterprise Oversight, is enabling the companies to invest $200 billion more in home loans. In essence, the companies are being allowed to take billions of dollars that had been used as a reserve against possible further losses and invest that money now in the housing market.
At the end of 2007, Fannie Mae had $45 billion in capital and Freddie Mac had $37 billion, for a total of $82 billion between them. But that cushion supports more than $1.4 trillion of combined debt and debt guarantees.

"It’s a toxic brew. All the ingredients are there for the problem to escalate."
- Howard Glaser, former HUD general counsel

The FHA has no implied taxpayer backing because it has full taxpayer backing, and it is increasing market share as well.

For the past few months, nearly every loan that Laura Triplett has closed for customers at SunTrust Mortgage has been backed by the Federal Housing Administration.

"I've got another 20 people closing in June and most of them got FHA loans, too," said Triplett, a branch manager at the bank's Woodbridge office. "I don't know what we'd be doing without FHA."...

The FHA does not lend money directly. It provides mortgage insurance to borrowers through private lenders. That means the FHA will pick up the tab for defaulted loans using premiums it collects from all of its borrowers.

The agency lost relevance when home prices soared and borrowers turned to subprime loans with lower upfront costs. When those loans started defaulting at an alarming rate, many subprime lenders shut down and the FHA started slowly regaining its footing. Its market share is now about 10 percent, up from 2 percent in 2005, according to Inside Mortgage Finance, a trade publication.

So what's the big deal? Why shouldn't the government be taking up the slack when private enterprises can't or won't?
To answer that, let's look at the news from the FHA just a few days ago.

The Federal Housing Administration expects to lose $4.6 billion because of unexpectedly high default rates on home loans, officials said Monday. The projected loss is the highest in the home loan program since 2004, and officials said the F.H.A. had to withdraw $4.6 billion from its $21 billion capital reserve fund in May to cover the costs.
He said the mortgages had foreclosure rates three times those of traditional loans and would push the F.H.A. to the brink of insolvency.

“Let me repeat: F.H.A. is solvent,” Mr. Montgomery said on Monday in a speech at the National Press Club. “However, no insurance company can sustain that amount of additional costs year after year and still survive. Unless we take action to mitigate these losses, F.H.A. will soon either have to shut down or rely on appropriations to operate.”

New "appropriations" means taxpayer money. Now for the homeowner that is in trouble that might sound OK. But what about the +33% of Americans who are renters? Why should they pay to bail out a borrower that got in over his/her head?
And what about the other +25% of Americans who own their home free and clear. Why should they be subsidizing people who can't afford their lifestyle?
And why should the FHA be used in this way, rather than being used the way it was intended?

Like the GSE's, the FHA didn't get into this mess all by itself. It was put there by the Bush Administration.

The looming financial difficulties have not prevented the Bush administration from expanding the F.H.A.’s role to help ease the nation’s foreclosure crisis. Since September, more than 150,000 homeowners have refinanced through F.H.A. and officials hope that the number will increase to 400,000 by the end of the year.

It brings up the question of why is there such a bias towards getting people into homes? The "American Dream" is to own a home, not to "barely be able to make payments on a home". Constantly living on the edge of foreclosure and bankruptcy doesn't sound like an American Dream. It sounds like an American Nightmare.

What we are witnessing is a de facto nationalization of the nation's housing bust. Unlike a nationalization of the health care field, this form of nationalization will only help banks, mortgage lenders, and large landholders. The reason is because the only part of the housing market that is being nationalized is the risk. The profits are still being privatized.
In other words: socialism for the rich, capitalism for the poor.



On the good side of all of this

Loss of AAA credit rating and the fall of the dollar from reserves will hurt our horribly imbalanced import/export market- possibly to the point that manufacturing will return to the United States as the price of cheap Chinese engineering goes through the roof.

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Maximum jobs, not maximum profits.

That's like saying

"Sorry that you lost your legs, but on the good side you lost a whole bunch of weight too so you don't have to diet anymore."

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Help Me! I lost my legs and can't get up!

I suspect the damage because of the massive debt held by foreigners in this country would outweigh any advantages in terms of the trade deficit.

Even worse are other countries, like China, their companies will not import us as foreign labor or offshore outsource their core manufacturing. They were never that dumb.

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socialism for the rich, capitalism for the poor

I think we should make this a buzz phrase, for ain't it the truth on multiple issues?

socialism for the rich, capitalism for the poor

I'd be fine with helping those with predatory loans as well as some sort of ease down if people plain bought houses outside of their ability to afford them, although some consequence should happen with that, for I certainly didn't go out and get a house I knew I couldn't afford because some enthusiastic real estate agent describes new "mortgage vehicles".

This is a great post midtowng, is there anyplace the US middle class and poor are not getting soaked?

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Great meme....

Frankly, I have no problem with the gummint stepping in to stabilize things...

As long as the policy makers don't make the mistake of thinking this intervention can be a permanent thing. That it is a 'solution' when in reality it's only a stopgap.

The real solution is changing the economy to that real incomes for the consumer stop falling.

That is, reward word and entrepreneurship not financialization and outsourcing.

FDR understood this. I say whack the top income earners at +5 million with a 90% tax rate, clean up the bs going on with corporate taxes and, taking the trillions so generated, start a massive infrastructure rebuild. Include the Solar Grand Plan and any other scheme that looks promising. Start a new WPA for the homeless and unemployed and build an energy sustainable economy before we hit the Olduvai Gorge and that becomes impossible.

I really suggest we get started before they have to shut the banks like they did in '32.

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'When you see a rattlesnake poised to strike, you do not wait until he has struck to crush him.'