The GSEs were government entities for years, then the government attempted to take them private and deny taxpayers were on the hook for a collapse. Now that we know that illusion was a fantasy, are we going to try to spin the same yarn?
Irvine Home Address … 8 CALICO Irvine, CA 92614
Resale Home Price …… $699,000
Give me time to reason,
give me time to think it through
Passing through the season,
where I cheated you
Aqua — Turn Back Time
We are giving Congress plenty of time to think through the GSE problem. Unfortunately, as we pass through this season, the GSEs continue to cheat taxpayers out of billions of dollars.
As bailouts go, nothing quite matches the torrent of taxpayer money still pouring into Fannie Mae and Freddie Mac, the housing giants that now guarantee nearly half of the nation's $11.7 trillion in mortgages.
To cover loans that go sour, the federal government has already doled out almost $145 billion, and the non-partisan Congressional Budget Office estimates the final tab will be about $381 billion. That's about half the size of the 2008 bank bailout but, unlike that bailout, most of this money won't get paid back. And even now, there's little talk in Washington about how to fix the problem.
Make careful note of the difference between the GSE bailouts and other bank bailouts. The original TARP bailout was a loan, and most of that is being paid back or through a series of accounting tricks will look like it is being paid back. The GSE bailout is fundamentally different; the GSE bailout is where the losses are finally tallied and paid. The GSEs along with AIG will be the repository of losses for the Great Housing Bubble and the associated finacial system meltdown.
Fannie and Freddie can't be allowed to collapse. The fragile housing market would collapse along with them.
This is unfortunately true. Of course, those who want to see the status quo maintained will make this argument long past the time while it is true.
Nor can they go forever as wards of the state, soaking up taxpayer cash.
Actually they can. The GSEs could become a permanent market prop and absorbing all future losses caused by speculation in the residential real estate market. The only thing stopping that outcome will be political pressure on Congress to change it. If the GSEs or the FHA lose enough money, perhaps something will be done, but for now, these entities are being used as the vacuum cleaner sucking up all the toxic mortgage dirt from the housing bubble.
They also should not be allowed to go back to their unusual former status as publicly traded companies that are also "government-sponsored enterprises." That's why they got in trouble in the first place, paying outsized compensation and backing risky mortgages because politicians of both parties prodded them to do so.
I also believe they should not go back to what they were, but not for the reasons stated above. I don't think they can go back to being private. Would anyone believe the government will not step in again? Isn't that a license to gamble with public money?
Fannie and Freddie need to be rethought entirely, if not eliminated outright. And the time to start planning for that is now.
If the companies are eliminated, the process would have to be gradual. Fannie and Freddie are pretty much alone in propping up the housing market, backing three-quarters of the new loans being made this year.
For that reason, a less radical approach may be in order — one that would make mortgage money available at affordable interest rates while limiting taxpayer exposure to bad loans.
That is exactly what must happen. How to do it is the challenging part.
One intriguing possibility is to gradually replace Fannie and Freddie with non-profit cooperatives owned by banks. That is how MasterCard and Visa used to be structured, and how the 12 regional Federal Home Loan Banks are structured today. Those regional institutions — which lend money to banks, which then lend to home buyers — weathered the financial storm in part because of an ownership structure that keeps banks liable for loans they make.
The Obama administration has opted to largely ignore the dilemma for the time being. Failing to deal with the fate of Fannie and Freddie is the most glaring omission in the financial reform bill President Obama hopes to sign by July 4.
Delay could be problematic because, as time passes, a necessary sense of urgency will undoubtedly fade. At that point, expect the companies — and their powerful allies in Congress and the housing industry — to start lobbying for a return to the way things were.
Once people get used to the government backstop for their gambling activities, it will be very difficult to remove. The political pressure will only come from mounting losses, and $400,000,000,000 is a lot of money to lose.
Despite what their critics assert, Fannie and Freddie were not primarily responsible for the financial crisis.
The Right likes to bring this up periodically. The GSEs were not responsible for inflating the housing bubble. The housing bubble was inflated by private-label securities backed by credit default swaps and blessed by ratings agencies. The GSEs were losing significant market share and entered risky borrowing late. The GSEs were reacting to the market not establishing it.
They were late to the game in subprime mortgages and always focused mostly on backing standard, fixed-rate mortgages. But these institutions were founded on faulty premises.
Their "American dream" mission of profitably making risk disappear, so that banks would lend and people could buy their own homes, was always a fantasy. They merely took risks from banks and piled it on the taxpayers. Now everyone is paying the price.
The shifting of risk onto the taxpayer is exactly what everyone in real estate wants to see continue. If mortgage risk were properly priced, interest rates would certainly move higher. However, with GSE debt being a defacto government security, the distinction between a 10-year Treasury Note and a GSE mortgage-backed security pool becomes moot: the government will pay both without limitation.
I usually agree with Dean Baker. He was one of the first in Washington to recognize the housing bubble, and his writing has been accurate and insightful. However, I disagree with him on this one.
The logic here is straightforward. Fannie Mae was created as a public company in the Depression to establish a secondary mortgage market. Before its creation, banks in various regions could often find themselves overloaded with mortgages and lacking the capital to make new loans.
By buying mortgages from banks, Fannie Mae allowed banks to issue more mortgages while limiting their exposure to risks from the housing market. Fannie Mae played a central role in supporting the postwar housing boom that hugely expanded homeownership.
That was their original function. But now that the secondary market is firmly established, are the GSEs still necessary? Would the secondary market disappear if the GSEs were eliminated. I think not.
The efficiency of Fannie Mae was lessened when it became a quasi-public company, alongside its newly created competitor Freddie Mac. This meant Wall Street-type salaries in the millions and tens of millions, instead of the six-figure paychecks that top-level government bureaucrats draw. It also created an incentive to take excessive risk, since the government would bear the downside from losing bets.
That is certainly a large problem, and the only way I see to eliminate it is to get rid of the GSEs entirely.
Fannie and Freddie got themselves into trouble in the housing bubble by first failing to recognize the bubble and second by jumping into junk mortgages near the end of the bubble. Contrary to claims of political conservatives, the decision to get into the subprime mortgages had little to do with helping moderate-income families buy homes. It was a desperate effort to recover market share from the investment banks.
That is an accurate assessment.
Fannie and Freddie can continue to play an important role in promoting home ownership by going back to the original design. They should be boring publicly owned companies that buy and hold mortgages. Securitization in the context of a government-owned company simply adds unnecessary expense and complication. It is completely unnecessary to supply capital for mortgages, since the companies can raise it directly by selling their own stock and bonds.
The only way I could see keeping the GSEs if they stopped selling mortgage insurance and instead became holders of mortgages as Dean Baker describes. As long as they provide mortgage insurance similar to the FHA and the GSE insured mortgages are securitized, the potential for inflating another housing bubble is greatly increased.
If private issuers can meet the needs of a secondary market better or more efficiently than Fannie and Freddie, then they will have the opportunity to do so. But, the United States does not need a financial industry that cannot compete successfully with government bureaucrats.
My View: The GSEs cannot go back to the old design
I can remember watching Ben Bernanke testifying before Congress prior to the nationalization of the GSEs. In his testimony, he was incredulous that investors would act as if the GSEs had the implied backing of the US government when they explicitly did not. Perhaps he was the only man in Washington who was surprised when it turned out that the GSEs did have the backing of the US government because when their collapse was imminent, the government stepped in and took them over, and as a consequence, assumed all their liabilities.
How could we plausibly maintain the illusion that we would not do it again? If the GSEs are ever turned back over to the private sector, it will be a laughable facade just as it always was. For the last several decades, the government tried to maintain the illusion that they were not liable for the GSEs, but when a crisis hit, the government immediately stepped in. There simply is no way to establish with any credibility that the government will not do this again, particularly now that there is precedence for it.
If would not surprise me that politicians will want to spin these entities off at some future date. The stock might have value, and the sale might recoup a tiny fraction of the losses. Removing these liabilities from the federal balance sheet will also be appealing, but it will be an illusion — and a rather obvious one at that.
A conservative borrower
The owners of this property owe $550,000 as they extracted a relatively prudent $138,000 in mortgage equity withdrawal. That is conservative by Irvine standards — horrible by any rational standard, but conservative by Irvine standards.
Irvine Home Address … 8 CALICO Irvine, CA 92614
Resale Home Price … $699,000
Home Purchase Price … $515,000
Home Purchase Date …. 5/15/2003
Net Gain (Loss) ………. $142,060
Percent Change ………. 35.7%
Annual Appreciation … 3.9%
Cost of Ownership
$699,000 ………. Asking Price
$139,800 ………. 20% Down Conventional
4.91% …………… Mortgage Interest Rate
$559,200 ………. 30-Year Mortgage
$143,255 ………. Income Requirement
$2,971 ………. Monthly Mortgage Payment
$606 ………. Property Tax
$0 ………. Special Taxes and Levies (Mello Roos)
$58 ………. Homeowners Insurance
$380 ………. Homeowners Association Fees
$4,015 ………. Monthly Cash Outlays
-$723 ………. Tax Savings (% of Interest and Property Tax)
-$683 ………. Equity Hidden in Payment
$265 ………. Lost Income to Down Payment (net of taxes)
$87 ………. Maintenance and Replacement Reserves
$2,961 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$6,990 ………. Furnishing and Move In @1%
$6,990 ………. Closing Costs @1%
$5,592 ………… Interest Points @1% of Loan
$139,800 ………. Down Payment
$159,372 ………. Total Cash Costs
$45,300 ………… Emergency Cash Reserves
$204,672 ………. Total Savings Needed
Baths: 1 full 2 part baths
Home size: 2,300 sq ft
($304 / sq ft)
Lot Size: n/a
Year Built: 1984
Days on Market: 5
Listing Updated: 40332
MLS Number: S619220
Property Type: Condominium, Townhouse, Residential
**WOW**FABULOS** 4 BR UPGRADED home, desirable one bedroom downstairs. Cul-de Sac location off the loop across from the park & pool. 3rd story Attic conversion with approx.400 sqft with window,AC, Fan & phone line, great for bonus/office/den. Customize loft/landing features office with built in bookcase and cabinets.Formal Dining Rm, Family Rm & Kitchen overlook lovely hardscaped & landsaped yard. Great size yard for entertaining. Pergo flooring throughout.MA BR with walk in closet and closet organizers.Many windows makes this a lite & brite home. Inside laundry with window & outside door to the yard. Cozy fireplace & built in speakers in family rm, spacious living rm with high ceilings. Custom walk-in pantry.2 car garage with finished garage attic for storage.UPGRADED bathrooms & Kitchen. Walk to all of the wonderful Woodbridge Amenities. Walking distance to all Schools.
You have to admire the realtor who can put a particularly jarring misspelling in ALL CAPS and between asterisks. **WOW**FABULOS**
lite & brite? OMG! Do you think the realtor did that to get my attention? It worked.
I was contacted by a reader recently who asked about the recent trend toward eliminating formal reception rooms. I use that room in my place for an office, but I like the game room approach. Looks like fun.