The Mechanism For Diverting Bank Losses to the US Taxpayer

The GSEs made many bad loans during 2008 and 2009. Loan buyback clauses in mortgage-backed securities deals insured by the GSEs is how these loans will become the responsibility of US taxpayers.

Irvine Home Address … 28 BELMONTE Irvine, CA 92620

Resale Home Price …… $675,000


Oh baby, baby

How was I supposed to know

That something wasn't right here

My loan losses are killing me

I must confess, I still believe

When I'm not in homes I lose my money

Give me a sign

Hit me baby one more time

Britney Spears — Baby One More Time

Fannie Mae, Freddie Mac, Ginnie Mae and the FHA all insure loans against default. Investors that buy mortgage-backed securities pools from the GSEs or other governmental agencies know that if the loans in the pools go bad, the insurance will kick in and the insuring entity will either make up the payment or buy the loan back from the pool and make the investor whole. This buyback clause is the mechanism by which bad loans become the responsibility of the insurance pools covered by the US taxpayer.

Ever since the GSEs were nationalized in 2008 — an occurrence preceded by decades of official denial of the implicit guarantee given by the US Government — the GSEs underwrote loans during the crash of the Great Housing Bubble. The government enticed buyers to overpay for real estate with tax incentives. The Federal Reserve agreed to overpay for the bad government paper to lower mortgage interest rates and make affordability possible at very high debt-to-income ratios. As a result, many knife-wielding borrowers caught the market in 2008 and 2009 and prices have at least temporarily stabilized.

Most of the crash buyers will fall underwater over the next several years as the slow decline in prices continues. Rising interest rates and the overhang of distressed properties will pressure market prices. Many of the loans securitized and insured by the GSEs in 2008 and 2009 will go bad. When they do, the GSEs will have to repurchase these loans and eat the losses. Since the US taxpayer is now responsible for the GSEs, the US taxpayer will absorb all GSE losses. These losses will be very significant.

Fannie Mae mortgage holdings up after loan buyouts

By Lynn Adler

NEW YORK, May 7 (Reuters) – Fannie Mae (FNM.N), the largest buyer of residential home loans, said on Friday its March mortgage portfolio was inflated by buyouts of seriously delinquent loans repurchased from securities pools.

The company's total book of business, gross mortgage portfolio, commitments to buy loans and net and new business acquisitions included about $40 billion of loans it bought back from the pools.

Forty billion in seriously delinquent loans, meaning those over 120 days late. That is a lot of bad loans.

Excluding those repurchases, which will not be reflected as liquidations from the mortgage-backed securities that Fannie Mae holds until April data, the total book of business would have declined 2.3 percent in March. Including them, there was a 2.8 percent increase to a total book of business of $3.263 trillion.

The company, like its counterpart Freddie Mac (FRE.N), is in the process of buying back tens of billions of dollars in troubled home loans that now collateralize its securities. The loans being repurchased are at least 120 days late and are a capital drain.

The serious delinquency rate on Fannie Mae single-family loans rose 7 basis points in February, the latest month for which data is available, to 5.59 percent. The rate rose 4 basis points on multifamily loans to 0.73 percent.

If 5.59% of their portfolio is seriously delinquent. That is a lot of bad loans.

A year earlier, the single-family rate stood at 2.96 percent and the multifamily rate at 0.32 percent.

Fannie Mae also said in its March portfolio summary that the unpaid principal balance of its gross mortgage portfolio spiked by 87.1 percent to $764.8 billion due to the repurchases that were not reflected as liquidated from the MBS trusts yet.

As of March 31, the gross portfolio end balance, taking into account $25.5 billion in net commitments to sell mortgage assets, stood at $739.3 billion, Fannie Mae said.

Retained holdings were $725.9 billion in February and $783.9 billion in March 2009.

Fannie Mae's total debt outstanding grew to $800 billion in March from $767 billion the prior month. A year ago, the company had $869.3 billion outstanding.


Fannie Mae has yet to report first quarter earnings.

But Freddie Mac on May 5 reported an $8 billion first-quarter loss, which included a dividend payment on senior preferred stock owned by the Treasury Department, and asked the government for an added $10.6 billion in aid.

That draw would bring federal aid for Fannie Mae and Freddie Mac to more than $136 billion.

The Treasury has provided an open credit spigot for the two companies through 2012.

Your potential losses are unlimited. During the Christmas holidays last year when nobody would notice, the $400 billion cap on assistance was removed. No matter how large the bill gets, the US taxpayer will take on the losses. That is a lot of bad loans.

Fannie and Freddie were taken under government control in September 2008, in the midst of the deepest housing crisis since the Great Depression, as loan defaults and record foreclosures slashed their capital.

Fannie Mae is spreading its larger amount of loan buyouts over several months whereas Freddie conducted the lion's share in a single month.

In the aftermath, Freddie reported on April 30 the first decline in the single-family delinquency rate in three years. Still, the 4.13 percent rate in March was well above 2.41 percent a year earlier.

Freddie Mac reports a statistical blip after three years of constant, significant, and unprecedented rises in its delinquency rate. Happy days are here again, right?

The takeover the GSEs was engineered as a stealth bailout of the banks. If bank loans can be redone and repacked with government backed insurance, the losses are transferred from the banks to taxpayers. The losses from the GSEs and the FHA will mount. Some of these losses will be hidden on the Federal Reserve's balance sheet, but most will be covered by the general obligations of the US Treasury. That's you and me.

Now that we are all absorbing these losses, perhaps we should go along with whatever the banks want? Or worse yet, perhaps underwater homeowners should keep paying their oversized mortgages and "take one for the team?" Our leaders made poor decisions. We should not be liable for the bailout of banks either directly through TARP or indirectly through the GSEs. The poor decisions of our leaders does not mean we have some collective obligation to make the bad decisions of lenders go away. Besides, no matter how bad the losses are, twenty years from now the government will produce an accounting report showing that we made money on the deal.

This whole situation sucks. The banks give large amounts of money to irresponsible people who blow it. When the Ponzi scheme collapses and both the Ponzis and the lenders are suffering, the government is called in to take money from the prudent to bail out the reckless. I don't feel good about it.

More equity-stripping HELOC-abusing Ponzis

It was suggested in the comments recently that Irvine house prices have held up because fewer borrowers here are in distress. We do have fewer underwater homeowners because the banks haven't caught up with their foreclosures, but we still have many borrowers who stripped the equity from the walls and spent themselves into oblivion. I profile these every day, and I don't need to hunt and cherry pick to find these people.

  • Today's featured property as purchased on 12/8/2003 for $600,000. The owners used a $400,000 first mortgage, a $170,000 second mortgage, and a $30,000 down payment.
  • On 7/26/2004 they opened a $196,000 HELOC and got back most of their small down payment.
  • On 1/26/2005 they refinanced with a $585,000 first mortgage and a $99,900 second mortgage.
  • On 3/31/2005 they refinanced the first mortgage with a $585,000 Option ARM with a 1% teaser rate.
  • On 12/14/2006 they refinanced the first mortgage for $710,000.
  • On 5/7/2007 they obtained a $131,000 HELOC, and with their previous pattern of borrowing, we can assume they took it out and spent it.
  • Total property debt is $841,000.
  • Total mortgage equity withdrawal is $271,000.
  • The stopped paying the mortgage early this year or late last year.

Foreclosure Record

Recording Date: 04/28/2010

Document Type: Notice of Default

Irvine Home Address … 28 BELMONTE Irvine, CA 92620

Resale Home Price … $675,000

Home Purchase Price … $600,000

Home Purchase Date …. 12/8/2003

Net Gain (Loss) ………. $34,500

Percent Change ………. 12.5%

Annual Appreciation … 1.8%

Cost of Ownership


$675,000 ………. Asking Price

$135,000 ………. 20% Down Conventional

5.01% …………… Mortgage Interest Rate

$540,000 ………. 30-Year Mortgage

$139,925 ………. Income Requirement

$2,902 ………. Monthly Mortgage Payment

$585 ………. Property Tax

$0 ………. Special Taxes and Levies (Mello Roos)

$56 ………. Homeowners Insurance

$0 ………. Homeowners Association Fees


$3,543 ………. Monthly Cash Outlays

-$710 ………. Tax Savings (% of Interest and Property Tax)

-$648 ………. Equity Hidden in Payment

$263 ………. Lost Income to Down Payment (net of taxes)

$84 ………. Maintenance and Replacement Reserves


$2,534 ………. Monthly Cost of Ownership

Cash Acquisition Demands


$6,750 ………. Furnishing and Move In @1%

$6,750 ………. Closing Costs @1%

$5,400 ………… Interest Points @1% of Loan

$135,000 ………. Down Payment


$153,900 ………. Total Cash Costs

$38,800 ………… Emergency Cash Reserves


$192,700 ………. Total Savings Needed

Property Details for 28 BELMONTE Irvine, CA 92620


Beds: 4

Baths: 2 full 1 part baths

Home size: 2,144 sq ft

($315 / sq ft)

Lot Size: 5,000 sq ft

Year Built: 1979

Days on Market: 3

Listing Updated: 40309

MLS Number: S616799

Property Type: Single Family, Residential

Tract: Ol


According to the listing agent, this listing may be a pre-foreclosure or short sale.

Spacious home on a quiet cul-de-sac location. Living room with fireplace. Dining room with wet bar. Kitchen overlooks family room. Oversized master bedroom. Large private backyard. Three car attached garage.

I hope you have enjoyed this week, and thank you for reading the Irvine Housing Blog: astutely observing the Irvine home market and combating California Kool-Aid since 2006.

Have a great weekend,

Irvine Renter

31 thoughts on “The Mechanism For Diverting Bank Losses to the US Taxpayer

  1. IrvineResident

    “Or worse yet, perhaps underwater homeowners should keep paying their oversized mortgages and ‘take one for the team?”

    I don’t understand this comment. It sounds like continuing to pay a mortgage even if the home is underwater is a bad thing. Why would this be bad? Assuming the homeowner has the means to continue paying, doesn’t the homeowner have a contractual obligation to continue paying?

    Am open to reasons as to why the homeowner shouldn’t pay but can think of any at the moment.

    If there’s something obvious I’m missing, please excuse my ignorance. New reader of IHB and the coffee hasn’t quite kicked in yet.

    1. IrvineRenter

      As Walter noted below, we have been beating this issue to death lately.

      The crux of the argument is that owners who are far underwater and who could rent a comparable property for much less than their current cost of ownership are hurting their families.

      Many owners are sending an onerous percentage of their monthly income on housing when they have no realistic chance of seeing any financial benefit from the expenditure. Most of these people only bought the property because prices were going up, and now that prices are not going up and in many areas prices will not go up for a very long time, these people are in a losing investment. This long term cash drain does not benefit the family, particularly since they can replace the house with something similar for far less. The only party that benefits is the bank. In such circumstances, strategic default is what is best for the borrower’s family, not staying in the underwater mortgage.

      1. lowrydr310

        It all depends on what bubbly area you bought in. I have relatives who are underwater in a suburb of Atlanta, however relative to their income they’re doing just fine and will continue to pay. The hassle, headache, hit to their credit score, and realtor/mortgage fees just aren’t worth a strategic default to rent or buy another cheaper home.

        I believe they bought for around $180K and homes in the development (which BTW has ~2000 square foot homes on 1 or more acres) are currently selling for around $100-120K. In their case it’s not hurting them to continue to pay, jobs are stable, and they plan on staying put for a long time. In this case they may be 40% underwater, but the actual dollar amount isn’t so bad of a loss. Even if they were forced to move, they could easily put up the difference if they had to sell, and they’d be able to quickly move on.

        For most of CA however, forget it. Run to the hills, run for your life!

        PS – I’m not trying to say “you can get a better deal outside of CA” (GA weather sucks, and this particular area doesn’t suit my family’s needs). My point is that being underwater isn’t always a hopeless situation.

        1. Walter

          I agree with your balanced view here. While IR has won me over in the morality department, I feel he might short change the costs, tangible and intangible, with bailing out.

          If you are sitting $300,000 underwater in Cali, the decision becomes much easier.

          1. IrvineResident

            So a completely undisguised selfish question:

            How does the owner defaulting help me (or anyone else not in an underwater situation)? Since, I’m not planning on buying in the near future and it seems like the banks will find some way or another to pass their losses on to tax payers, wouldn’t I be better off if the person continues paying? Or would I benefit more from the owners increased disposable income from defaulting and renting somewhere cheaper (and hopefully using it in a way that improves economy) than feeling the negative effects of housing losses passed on to me?

            Read the other thread about this question but I’m not so concerned about the morality. I have my own sense of what is morally right but considerate it irrelevant, since its my view and not necessarily anyone else’s view.

          2. Walter

            Impossible to answer because things change depending on your situation and the effects borrower’s behavior brings to the economy.

            As far as I am concerned, the best overall is to keep the FDIC solvent so depositors get their money and we do not have a complete collapse of the banking system.

            Beyond that, take the pain and clean up the system as fast as possible. The longer the government is involved, the more special interests twist the situation to their advantage.


    2. wheresthebeef

      “It sounds like continuing to pay a mortgage even if the home is underwater is a bad thing. Why would this be bad? Assuming the homeowner has the means to continue paying, doesn’t the homeowner have a contractual obligation to continue paying?”

      If the house is underwater in a big way (25% plus), it probably makes sense to quit paying. It comes down to simple math, that’s it. Nowhere in the loan paperwork does it specifically state you have a contractual obligation to continue paying if you have the means. In a nutshell, it says if you fail to pay your mortgage for any reason, the lender will take back their collateral (house). Indirectly, you will suffer the financial consequences…ruined credit, lower FICO, etc.

  2. newbie2008

    My HO and understanding of CA loan contract essential has out causes for the borrower and conquences for non-payment and for payment. It states either paying or not paying, not the motive, reason, etc.

    Non-payment, either deed of trust sale or judical foreclosure. CA law has one action rule. So the lender also has a menu of actions. No arm breaking, kidnapping, etc. It’s a contact and laws, not the law of the jungle.

    I have no signed contract to support squatter, bailouts, etc. I didn’t sign any document to that effect, but I’m forced to pay.
    Free-rent for years, 2 trillion dollars for banksters’ bailout and bonus.

    Was this all banksters incompetence or where the scenaris run through a risk-benefit, payoff analyses? Or is this so old hat that it was SOP?

    I don’t think the banksters are stupid.

  3. Planet Reality

    The house is impressive. It masterfully combines the feelings of sterile and filthy.

    It’s a shame that the multiple families who make offers on this house don’t see the light and buy their Hole 16 gaudy Riverside McMansion.

    1. tacoshark

      $675k for this house!

      The Irvine schools are good, but c’mon! Buy a better/newer house for half the price 30 min away and use the extra $ to put your kid in the best private school money can buy.

      I’m not to sure about building codes in the 70’s with the brick, but one would assume that 90-00’s construction will be able to withstand the “Big One” much better when it comes in the next 10 years. Now that’s looking out for your kids.

      1. Planet Reality

        The Irvine substitutes ( 2000 sq ft , 5000 sq ft lots ) are selling quickly for around 700K, so you get a discount here for that clever sterile filthy feeling.

      2. irvine_home_owner


        Do you have kids? It’s not as easy as you make it sound.

        Sometimes it’s nice to have kids who live in your neighborhood to also go to the same schools.

        And if the “Big One” hits… it’s not going to matter what year your house was built… just where it’s located. Nevada Beach!

        1. JK

          If you worry about the big one hitting you probably shouldn’t buy a house anyway. You’ll be glad you’re renting then.

  4. winstongator

    Absence of Fear From June 2007. Excerpt:
    Our worst fears were recently confirmed in a study by First American Financial entitled, “First American Real Estate Solutions Report, Alt-A Credit—The Other Shoe Drops?” This report shows the following changes in underwriting standards between 1998 and 2006, with the major changes occurring in the last two or three years:

    * ARM % of originations rose from 0.7% to 69.5%
    * Negative Amortization rose from 0% to 42.2%
    * Interest Only rose from 0.1% to 35.6%
    * Silent Seconds rose from 0.1% to 38.7%
    * Low Documentation rose from 57% to 79.8%
    * FICO scores were essentially unchanged at an average of 706.

    What is interesting is that the origination volumes for the last two years, when the most egregious deterioration in underwriting standards occurred, total more than the previous seven years of originations combined.

    We were on the March 22 call with Fitch regarding the sub-prime securitization market’s difficulties. In their talk, they were highly confident regarding their models and their ratings. My associate asked several questions. “What are the key drivers of your rating model?” They responded, FICO scores and home price appreciation (HPA) of low single digit (LSD) or mid single digit (MSD), as HPA has been for the past 50 years. My associate then asked, “What if HPA was flat for an extended period of time?” They responded that their model would start to break down. He then asked, “What if HPA were to decline 1% to 2% for an extended period of time?” They responded that their models would break down completely. He then asked, “With 2% depreciation, how far up the rating’s scale would it harm?” They responded that it might go as high as the AA or AAA tranches.


    Absence of Fear, by Robert L. Rodriguez, CFA

    Underwriting standards and the assumption of home price appreciation were rampant and few, this guy being one, were considering their implications.

  5. avobserver

    Have you ever wondered about the peculiar nature of these “quasi-gov’t entities” (GSE’s)? When the time is good and market’s booming, GSE’s move to the “private” side and behave like typical profit-making financial institutions and facilitate the market expansion and gains for financial firms. As soon as the market turns south with mounting losses, these same GSE’s all of a sudden switch the side and morph into public entities to help socialize the losses. Only the most perverse form of capitalism (or socialism) could come up with such an insane design – while under the disguise of “helping” home buyers and expanding RE market, really aims at screwing prudent middle class American families. And I have to say that so far they have been right on target.

    1. Planet Reality

      Are you trying to call the past 200 years of American existance “insane”?

  6. avobserver

    Can anybody give me the name of ONE industry or sector in Irvine (or OC in general) that will be bullet-proof for the next 10-15 years, that is, immune from the increasing pressure of competition, industry self-implosion, and employment degradation as a result of outsourcing and gov’t budget cut? IT? Telecom? Financial Services? RE? Retail? Defense Industry? Education? Health Care? Health Care might be a toss up. Education – even UCI is facing funding cut from the state.

    If most of the existing economic drivers for higher wages and employment are either stagnant or in decline, what might be the new industries that will provide the boon necessary for future growth in the area? And what does Irvine (or OC or California) has to offer that will be conducive to attract large employers to the area? High taxes? High cost of living? Prohibitive housing price? Good weather?

    We all know the temporary forces that have supported Irvine and better parts of the OC RE market – gov’t subsidy, idiotic policies to fight foreclosures, FCB’s, low rates, supply restriction … But these are temporary props that will go away sooner or later. No serious buyers or investors would base their long term decision on these unsustainable factors.

    I have seen increasing number of bullish comments on this blog and elsewhere about the invincible future of Irvine/OC RE market. I am scratching my head trying to figure out what I might be missing here. Is this wide spread optimism based on some secrete knowledge that I am not privy to or just blind faith that Irvine market will do well in 5 or 10 years just because it is doing well now?

    1. Planet Reality

      Nothing is bullet proof. The beauty is that it’s diverse and close to LA which is also diverse in high paying jobs. Many areas are dominated by one industry or a handful of large companies. Not true of LA / Irvine.

      It takes 25 minutes to commute from Irvine to Corona.

      It takes 1.5 hours to commute from Corona to Irvine.

      The future of Irvine is bright.

      1. avobserver

        Saying diversity is the key to a bright future for Irvine is like saying buying S&P 500 index will always guarantee stellar return. Look how that strategy paid off in the past 10 years. Actually in a macro environment where economy is declining on a broad base due to several structural problems, betting on diversity is meaningless – even you have a couple of good sectors left they are not going to provide high income and stable employment at a level to sustain the entire OC/Irvine housing market.

      2. Jon

        Sure but not high-paying enough to maintain current house price levels. 🙂 Especially with tax levels at an all time high.

    2. newbie2008

      Police, Fireman, and Executive Services are essentially bullet-proof with the politics, unions, fear mongering and contacts in place. Health care and education with take a hit, but not a very heavy one.

  7. Hu Flung Pu

    I think the Fannie/Freddie (F&F) losses will get recouped by the taxpayers, but over a pretty long time horizon. Spread lenders, almost no matter how bad off they are, can always fill a hole, the only issue being how long it takes. And it’s going to take F&F a long time. To use an example, lets say that F&F charge off 10% of their portfolio (which would be a big number). Further, let’s say the average yield on the remaining 90% of their book is 5.5% and their funding costs (now borrowing at govt rates) are 2.5%. Add in 100 bps of operating expenses and you have a 200 bp spread. Here, it takes F&F 5.5 years to fill its hole (from losses) with spread income from the performing portfolio. If you assume that F&F’s losses are going to be 20% of its book, it takes them 11 years to fill the hole, and so on. So, while we’re hearing about the big “losses” coming out of F&F – which are real losses – we will get that money back… eventually… but it could be many years. We the taxpayers will lose in real (that is, inflation-adjusted) terms for sure, but we’ll get back the nominal dollars.

    1. Henry

      Exactly. That is what Ben explain to us. We could break it even, but we lose the op. to invest in other fields.

  8. theyenguy

    One can use the link to access the John Clapp report in the February 3, 2010, article FHFA Acting Director Provides GSE Update where the financial facts about the Fannie Mae and Freddie Mac operations under US Treasury conservatorship are provided. Mr Clapp relates that the Obama administration surprised the mortgage industry with its 2011 federal budget, which included only a single sentence pertaining to the GSEs. Beginning last year, administration officials repeatedly stated that the timing of the budget’s release would coincide with a proposed framework for Fannie Mae and Freddie Mac going forward. The budget’s lone mention of the GSEs, however, stated that the administration would continue to monitor the situation closely and provide updates on considerations for longer-term reform. Separately, Department of Housing and Urban Development Secretary Shaun Donovan told reporters Monday that a plan will be unveiled “shortly.”

    When the GSEs were taken under US Government control, mortgage finance was formally nationalized, a bloodless coup d’etat was effected; and state-corporate rule commenced; this is otherwise known as state corporatism. Profits were privatized to the banks and investors; losses and risks socialized to the public.

    I “hope” that Freddie Mac and Fannie Mae do not have toxic assets that they keep off balance sheet in special investment vehicles, SIVs.

    Yes, it is as you relate my potential losses are unlimited.

    Furthermore, it makes an inquiring mind wonder just how far and how agressively, the Treasury and the owners of the debt, will pursue their rights for satisfaction of payment of the debt.

  9. Stock Investor

    “In such circumstances, strategic default is what is best for the borrower’s family …”

    Good tactics can not fix bad strategy.

    I have seen a lot of strategic defaulters in the past. The default was temporary relief. Most of defaulters were doomed to fail again and agian.

    Bad strategy is ticking bomb set to explode. Just give it some time. Another day will bring another miscalculation.

    The best for the borrower’s family is to learn from thier mistakes, but they want immediate money instead of knowledge.

    1. Geotpf

      The key is to live within your means. If one can’t or won’t do that, yeah, one will redefault.

  10. pay if you can

    I think people who can continue to pay their mortgage should continue to do so. No one really knows how real estate WILL play out in the long term. If someone allows foreclosure now, he/she/she might not be able to buy a property for at least few years. I went throught the downturn of the 1990’s and considered turning the key to my condo over to the bank but decided against it because I could still afford the payment even though I was about 25% upside down. A friend of mine let his condo go to the bank but he missed the appreciation and recoup of losses of the late 90’s and early 2000’s; this is not to mention the housing bubble that later ensued.

  11. theyenguy

    Gretchen Morgensen of the New York Times writes an insightful article Ignoring The Elephant In The Bailout with helpful facts on Fannie Mae and Freddie Mac.

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