http://tinyurl.com/9et2q8

“The overall [home-loan bank] system is strong,” James Lockhart, director of the Federal Housing Finance Agency, which regulates the banks, said in an interview.

another Lockhart masterpiece… again, he’s no Falcon.

I suggest you learn how to read and be certain of your facts before making criticisms. The analysis cited above, as clearly stated in the post, is from Jim Hamilton in a paper presented at the Fed’s Jackson Hole conference. So this isn’t “your analysis” as you incorrectly state.

I am aware of Lockhart’s and OFHEO’s existence and role and have mentioned them in previous posts; I have no doubt Hamilton is as well if you bothered checking his blog or papers. Lockhart has held the line on GSE growth in the face of enormous pressure to increase their balance sheets. Note further that Hamilton’s comments clearly imply that GSE balance sheets need to shrink. As desirable as that is, it is a non-starter. The only time I can think of a government official doing something that would be similarly unpopular was Volcker raising rates in the early 1980s. Then, inflation had gotten bad enough that there was a lot of agreement that something had to be done, even though there were a lot of people screaming to reverse course as the program proved to be painful.

If you read the X axis of the chart, the spike up in the Fannie Mae spread over Treasuries conforms very closely with the passage of the stimulus package, which includes a provision to increase the celling on conforming loans from $417,000 to a maximum of $729,750.

Pray, tell me how could negative convexity explain a 30 basis point increase in spreads in a mere week?

As for Lockhart being “Bush’s flunky appointee”, you seem to be alone in that view. Lockhart has fought ongong pressure to raise the GSE’s limits, as John Dizard reported in the Financial Times:

At a time when America, or at least Wall Street, needs a spineless hack as the head of a key agency, it is saddled with a credible man of principle: James Lockhart, OFHEO’s director. Yale graduate, Harvard MBA, lieutenant in the nuclear navy, risk management software entrepreneur, senior insurance executive, and former head of the Pension Benefit Guarantee Corporation. “A real hard-ass” in the words of a mortgage finance executive. It doesn’t seem as though he can be intimidated by the threat of being sent back to Plano, Texas, to work in his uncle’s car dealership.

So it will only be after many more problems surface and under strict conditionality that F&F will pump a bunch of new money into the housing finance pipelines.

Similarly, per Tanta at Calculated Risk:

The bill does not require the GSEs to purchase the new higher-balance loans at the same terms currently in place for $417,000 loans. If they did offer the same loan parameters, that would mean–in theory at least–that the new LFKAJ could be made as high as 95% LTV/CLTV. However, a 95% LTV loan would require mortgage insurance. As a general rule, the MIs mostly limit purchase loans over $650,000** to 90% LTV. So unless the MIs relax their rules–which would surprise me–there wouldn’t be a lot of point in the GSEs setting a maximum LTV that cannot qualify for the required MI. Realistically, the GSEs will have a lot of work to do hashing out what the allowable guidelines are for these loans, which will involve a lot of discussions with the MIs. As OFHEO Director Lockhart has been signalling nothing but disapproval of the whole thing since the idea was first floated, it is surely certain that any proposal the GSEs come up with will involve review and possibly negotiation with OFHEO. Plus, the GSEs have to update their AUS (automated underwriting), their pricing and delivery systems, and their selling and servicing guides to accommodate the new rules. You can confidently expect this to take a while.

While your topic is interesting, the analysis you present is incorrect from the very beginning. Investors in MBS also consider the liklihood that the loans underlying the loans will prepay. MBS are essentially callable by these customers whereas treasurys are not. Therefore comparing nominal spreads makes no sense because as interest rates falls, nominal spreads on MBS need to rise as investors require protection from the free put that the borrowers have. This is called negative convexity. Two much better measures of the GSE’s credit are their credit default swap spreads (CDS) or their debt spreads which more directly correlate to the markets’ view of their credit worthiness.

Let’s look at your final conclusion – that the Bush flunkee apointee Lockhart should be able to control the growth of the GSE’s portfolio and the amount of capital they are required to hold. Guess what – he’s already doing that!!! Both GSE’s have portfolio limits in place as suggested by Lockhart and they are both being required to hold extra capital due to Lockhart’s suggests.

In sum, your analysis and article don’t seem to illustrate that you understand or know what is actually happening in the marketplace or between the GSE’s and OFHEO.

I confess my innocence: In what, or where, would this “adequate net equity cushion” be placed – the Fed? (And I did link back to the original post and found no answer there.)