As time goes on, the various Ministries of Truth just get better and better at their stock in trade. We’ve gone from artful obfuscation like “extraordinary rendition”, and “Public Private Investment Partnerships” to stress free “stress tests” (particularly the Eurozone version) designed to get bank stocks up and credit default swap spreads down, to even grosser debasement of language. What passes for the left has for the most part been dragged so far to the right that the use of once well understood terms like “liberal” and “progressive” virtually call for definition. And the word “reform” has virtually been turned on its head. Financial services reform was so weak as to be the equivalent of a jaywalking ticket; health care reform was a Trojan horse for even large subsidies to Big Pharma and the health care insurers. But GSE reform takes NewSpeak one step further by turning the “reform” concept on its head and using the label to describe an effort to institutionalize even bigger subsidies to the mortgage industrial complex.
While Team Obama appears to have backed down from the trial balloon floated by the Center for American Progress (note that press reports give another rationale) and is expected to offer a menu of choices for “reform” in its overdue white paper on Friday, don’t be fooled. The proposals coming from the lobbyists expected to have real influence on which ideas get the green light are virtually without exception serving up such a narrow menu of choices as to constitute unanimity. We offered our take as of the release of the CAP report; a subsequent proposal by Moody’s Mark Zandi (see details here) is more of the same.
It’s as if a population suffering from a toxic reaction to mustard was now offered options ranging from Dijon to pommery to spicy brown as meaningful improvements. And this is not an exaggeration. The new GSEs (and let us not kid ourselves that that this is where the Powers That Be are driving this effort) would have an explicit government guarantee, be larger in number, and supposedly have higher capital buffers.
The problem is that any government sector guarantee for a private sector entity is a terrible idea absent very tough constraints on operations, which is the still-unlearned lesson of the financial crisis. And the idea that any higher capital standards will hold over time is dubious. Fannie and Freddie were enormously powerful lobbying forces, a de facto mainly Democrat slush fund; any new GSEs will have similar collective clout and will press for their agenda on a unified basis, which is certain to include waivers that will amount to lower equity requirements. Increasing leverage is one of the easiest ways to improve performance in a financial firm.
Now the Administration is also allegedly presenting some elements of securitization reform on Friday. We’d be glad to be proven wrong, but we anticipate any proposals will be cosmetic and/or insufficient in scope. The real problem is that the coming staged fight over GSE reform will serve as a useful distraction for what is really needed, which is much broader mortgage market reform. Pursing the GSE question largely in isolation is sure to produce bad outcomes.
For instance, one of the excuses for continuing to have a large role for the GSEs 2.0 is that the private securitization market is dead. But that is because the banks have been blocking reform and investors have gone on strike. But the lack of private market demand is then used as an excuse as to why we still need something GSE like to play a big role. That’s tantamount to killing your parents and asking for charity because you are now an orphan.
But the biggest failing is the continued massive subsidies to the banks, particularly in the housing arena, with a lack of accountability not only for past messes but ongoing train wrecks. Financial firms continue to benefit from heroic efforts to prop up asset prices as a way to preserve the banks from realizing additional losses. For instance, the Fed continues to present quantitative easing as beneficial, when it has in fact done more for the banks than the real economy. And other subsidies are not as widely recognized. From banking expert Chris Whalen:
Much of this increase in the size of Fannie’s balance sheet is repurchased defaulted loans from securitization trusts, grim evidence of the generosity of Secretary Geithner in letting Bank of America (“BAC”/Q3 2010 Stress Rating: “C”) off the hook for mere single digit billions in terms of loan repurchase liabilities. The taxpayer will have to pay the cost of this gift to BAC shareholders, with interest. But excluding this inflow of financial detrius, the balance sheets of the zombie GSEs would be shrinking on ebbing industry new loan origination volume.
Another urban legend the banks are eagerly promoting is that we wouldn’t have a 30 year mortgage market ex the GSEs. Nonsense, we did before the crisis, in jumbo mortgages. And ironically those effectively had better disclosure than other private label mortgages. There were so many fewer mortgages in a jumbo than a normal securitization that the investors could eyeball them a tad. But the industry has resisted calls for better loan level disclosure, both pre crisis and now.
The old rule in Wall Street is everything can be solved by price. So the issue is not that there would not be a 30 year mortgage market; the implicit claim is that the price would be so high as to kill housing. The problem (to the extent there is a problem) is NOT the uninsured 30 year mortgage, but the further intervention in the mortgage market thanks to the Fed targeting mortgage spreads directly in the first QE and continuing to influence them indirectly by targeting intermediate-maturity Treasury bond yields in QE2 (note that the degree to which the Fed is actually affecting yields is hotly debated; one study of QE one found it only had 17 basis points of impact so this may be less of an issue that many believe).
The premium for the unsubsidized jumbo product was a mere 25 basis points pre-crisis; even now its 75 basis point. This is far from a huge premium. Indeed, since the CAP proposal estimated that its plan would result in mortgage spread being 50 basis points higher than now, it suggests there is no reason for the government to be in the business of guaranteeing mortgages on anything approaching a Fannie/Freddie scale. There are much simpler, less bankster-enriching ways to provide subsides to particular groups or underserved areas, such as providing credit directly or using tax breaks.
Getting the government out of the mortgage finance business could lead to banks providing more alternatives particularly ones where he takes more interest rate risk in return for a lower interest rate. The US 30 year fixed rate mortgage is borrower favorable to an exceptional degree and is a holdover from the protracted post war period of stable interest rates. Lenders might offer floating rate mortgages with floors and ceilings (this was the only product available in the co-op market in New York City in the early 1980s and consumers had a favorable experience with it), or mortgages with tougher prepayment penalties, or restrictions on refis (corporate bonds often have those provisions, they aren’t unusual).
We’ve managed to skip over the real elephant in the room, the ongoing fraud in courtrooms all over the US to deal with the breakdown of procedures and documentation. How can we talk about monster subsidies to a sector rife with consumer abuse and probable criminal activity without having a real investigation and cleanup first? That’s putting the cart before the horse in a very serious way. And that’s by design,