Let’s be clear: I’m not a fan of Fannie and Freddie. Subsidizing housing finance is a lousy way to subsidize housing (and that’s before you get to the question of whether housing should be subsidized at all, save for low-income people). It’s indirect, inefficient, and very hard to measure what the effects are.
But reality is path-dependent and we need to remember where we are now. As much as the Republicans have good reason to go obsess over Fannie and Freddie (they were Democratic party pork machines) and the conservatorship mandates their wind-down, both parties have been utterly unwilling to take any serious steps needed to have either a functioning private mortgage securities market or see about migrating more mortgage lending back onto bank balance sheets (the latter tends to be reflexively rejected as “too costly” since banks have to put up equity and pay for FDIC insurance, and the need to cover those expenses typically leads to higher consumer mortgage rates. Can’t make houses less affordable, as in cheaper, now can we?).
We now have a mortgage market that has gone before the crisis from having Federally-guaranteed loans as a large component of the market to being virtually the only game in town, with the GSEs as the biggest providers. You’d think a critical first step would be at least to get a decent private label market back in running. But for the most part, investors are still correctly leery, since the sell-side has successfully beaten back meaningful investor protections (such as a proposal floated by the FDIC in early 2010).
Reuters gives a brief overview:
Under the bill, which is being led by Tennessee Republican Bob Corker and Virginia Democrat Mark Warner, the two companies would be liquidated within five years. The legislation would provide for government reinsurance that would kick in only once private creditors had shouldered large losses.
“It lessens the footprint of the federal government in housing and winds down Fannie and Freddie,” Corker said at a news conference. “But at the same time it keeps the housing finance industry in a liquid state.”
So this proposal is basically a reworked version of some plans floated by the Treasury in 2011, which we shredded then in The 7 Things Really Wrong with the Treasury’s GSE Reform Plan. Every problem on that list is still operative here. This is not a plan to get rid of GSEs, it’s to create new, supposedly better/safer GSEs 2.0, which it calls the Federal Mortgage Insurance Corporation (FMIC).
But the problem is the “better/safer” feature is a great big fantasy, a bipartisan private market version of Obama magic sparkle ponies. The scheme hinges on having private insurers take the first 10% of losses, not the government. Reader MBS Guy explains why there is less here than meets the eye:
The idea of private capital taking a first loss position isn’t bad. However, in reality, this isn’t that much of a change. Currently, privately owned mortgage insurers take a first loss on all Fannie/Freddie loans with LTVs over 80, which is a large portion of the overall portfolio. Then Fannie and Freddie guarantee the securities.
Mortgage insurance is essentially a failed business model – several went bankrupt and all would be insolvent if not for waivers of capital requirements from Fannie and Freddie due to higher than expected losses. The insurers had carve outs from their coverage which turned out to be larger than they had marketed them as.
This proposal would effectively replace have mortgage insurers provide some of the first loss capital with having some other private entities provide all of the first loss capital. In all likelihood, the same flaws, qualifications and massive lobbying would crop up over time with this structure.
I can’t really see what the difference would be between Fan/Fred MBS guarantees and FMIC reinsurance or why this distinction carries some meaning in DC. Would a reinsurer not have interest rate risk, investment risk, corruption risk, etc.? Consultants, lobbyists and lawyers will make gobs of money replacing one failed system with a new system that is not dramatically different.
As MBS Guy points out, for insurance to work, you really need for risk to be transferred to the insurer. That does not happen under the current private mortgage insurer system. If Corker-Warner relies on insurers, it’s hard to see that the risk transfer is anything other than a chimera, since PMI insurers have never been well enough capitalized to be credible counterparties. It’s not hard to predict that if this insurance were to be put in place, the new PMI insurers would be rescued if they were to get in trouble, since the mortgage market would come to depend on them.
The other route might be to use bonds to transfer the first-loss risk. That sounds great, since risk would be transferred to well-diversified deep pockets. But in reality, this idea will founder for a different reason: sophisticated investors are unlikely to want this paper, except on a very selective basis.
Remember, this is exactly how subprime worked. Subprime bonds were tranched by credit risk, with the riskiest tranches bearing the greatest risk of loss and therefore getting lower ratings (this was achieved by having they higher-rated tranches get priority in payment, and only when the money borrowers sent in every month met the amount due for the AAA tranches did any funds go to the AA tranche(s), and so down the ladder. The effect was that the lowest tranches bore the first losses. Now the very very bottom tranche (net income margin bonds, or NIM bonds) got extra goodies (extra interest margin in the deal, a loss buffer) so they were popular, since on a risk adjusted basis, if the deal worked out at all, they paid out fast and paid a premium return. So the real turkey was the lowest rated tranche, usually a BBB or BBB- tranche.
Here’s the dirty secret: there was never enough of a market for that stuff. Both times the US had a meaningful subprime market (a small one in the 1990s and the bigger one we know all too well), it depended critically on CDOs. The CDOs would buy the drecky stuff no investors wanted, plus some better stuff to make them more palatable. They were then tranched. But really no one wanted the bad parts of the CDO either (sometimes stuffees bought them, sometimes correllation traders would go long one tranche and short the one immediately above it) and so they were mainly rolled into OTHER CDOs. So the subprime market was ultimately a Ponzi scheme, and both times (late 1990s and the 2000s) both the CDO market and the subprime market imploded.
MBS Guy explains:
The financial crisis showed that the market is pretty horrible at pricing and understanding first loss mortgage risk. It seems odd to think that the market will get it right this time. First loss bonds are, by their nature, illiquid, hard to price, volatile and extremely sensitive to small market changes. I’m fairly skeptical that we can replace Fannie and Freddie with a stable housing infrastructure that depends on liquidity in a market for first-loss mortgage risk that has repeatedly shown itself to be illiquid and volatile.
It’s unlikely this proposal will go anywhere. It lowers the maximum eligible loan size from $625,000 to $412,000 (broker and homebuilder howls to raise the ceiling to old GSE limits guaranteed) and claims to make lending standards more stringent (right now, lenders are being bloody-minded, but that’s not guaranteed to continue). With the Fed’s tough taper talk having scared the mortgage market, the last thing anyone is going to want to do is make credit less available when the central bank might have halted the housing “recovery” (we won’t know for sure what the impact is until July data is in, which will be in September).
The sad bit here is the resistance to ending the 30-year fixed rate freely refinanceable mortgage. That’s the real impediment to fixing housing credit. An adjustable mortgage with interest rate floors and ceilings (which would mean borrowers would not have to refi to benefit from falling rates and would be protected from big rate jumps) or restrictions on refis (say for the first five years) would make it possible to move a lot of mortgage lending back on bank balance sheets, since it would greatly reduce interest rate risk. Having the lender have real skin in the game is a better way to provide the right incentives than trying to make failed markets work. But all we are likely to get is more discussions of how to rearrange deck chairs on the mortgage Titanic.
What a bunch of smoke. Corker-Warner deliver the balderdash: “it lessens the footprint of the federal government”. Oh we see, that’s the biggest problem. Funny how it wasn’t a some years ago when “constituents” needed rescue.
“I’m not a fan of Fannie and Freddie. Subsidizing housing finance is a lousy way to subsidize housing.”
It seems to be a great way to subsidize banks and investors, at the cost of people whow otherwise may or may not be housed.
Does JP Morgan’s top Senator have a bad idea? Who could have imagined?
John Lennon-“I wouldn’t wrestle the wrestling dog…..would you?” (CDO’s)
Warner, Corker and other republican and democrat members of the Bankster party, were instrumental in preventing cramdown for the expendable losers. Were the stars aligned, since this will never happen at the voting booth, both would be out of their jobs.
great headline, great article.
This is the fundamental danger when liberals abandon market-based economics and limited governance and rule of law and so forth in favor of regressive bailouts that misallocate resources.
No one is in a position to offer real alternatives.
I have a radical idea: let local banks fund mortgages (with no Federal interference) and hold the note in-house.
are you a communist (snark).
yes. Local banks for local real estate.
it has a wonderful side benefit of reducing the size of the TBTF banks.
Wow, seriously. What happens when the bank cant lend more money because they have exhausted their capital. Oh, can see it now, Hi Mr. X, sorry we are out of money but our next loan will be available in the year 2045 when our 30 year notes have been paid in full. F&F are necessary to provide liquidity to banks that provide home loans. Banks were the ones writting bad loans out of greed, F&F were just there to free up $$$ so the mortgage market could lend out this money again again and again. Hence why the money does not run dry. 10 Trillion dollars in the Mtg Market, do you really think the banks can handle that on their own.
People will be able to buy homes cash, once the price is right. This latest debacle was not about anyone being able to own their own home.
Going in to a Bank for a loan is still a very dangerous thing today. Fannie has been protecting Banks and receiving criticism from authors, bloggers, mocking birds since this is also their role. Funny, the bankstas I knew at Fannie Mayhem, were the same bankstas in an earlier or later career move.
before F&F were created, there were no 30 mortgages, because banks didnt want to deal with such a long term trade. they still dont. and this change wont fix that. nor does it do more than just change the name on F&F
“People will be able to buy homes cash…”
Only if they get paid substantially more than they do now, and/or spend years living in their parents’ basements. Very few people now can save much while paying rent.
“do you really think the banks can handle that on their own.”
Not wif’out the Federal Reserve and the taxpayin’ slobs, and Fannie and Freddie kickin’ em out, and a perverted legal system that is written to favor larceny over human rights.
And so on.
More lying, timid mortality.
The phases of capitalism are not natural anyway you go about them. They are anti-western and anti-nature.
capitalism by its nature, is misallocation of resources.
Voice your disapproval, Call Warner:
475 Russell Senate Office Building
Washington, DC 20510
Voice disapproval, mention “liberal abandonment” or whatever, but also stress his unfortunate legislating on behalf of banks, everything from debit card fees to cramdown.
Call Bob too:
U.S. Senator Bob Corker
185 Dirksen Senate Office Building
Washington, D.C., 20510
Start off slow, perhaps with a Southern drawl – ‘Thanks fer protecting our guns but darn them banks. Do somethin’ right
about them liberals and the FIRE sector, this legislatin’ is a fraud!’
Warner doesn’t like to acknowledge how he is JP Morgan’s top money recipient.
housing is so overpriced that a person has to toil 30 years to get (plywood-and-cardboard) one,
there is NO SOLUTION to morgage crisis.
There are always mad ‘Einstein was wrong’ tracts on the Internet, based on anything from Antisemitism to abandon all physics ye who enter here. Sometimes we do need to shed conceptual baggage, but lots of provocation to do so is frankly barking. I’ve looked through many apparently coherent and lengthy arguments against relativity looking for general rules to spot where the dog is howling at the Moon – I have this thing about straight and crooked argument (sad).
Often it isn’t what is in the argument that is faulty – it’s what is left out to create a compelling but false logic. There have to be questions on why something as basic as mortgage finance needs private sector magic-pixie-dust in the first place and how the trust in this comes about. Do we have any real evaluation of the faith we place in private sector solutions and markets? I don’t mean this in the sense that big government bureaucracy is the better default, but more to question whether we are locked-in to belief that Sooty’s magic wand is in play as a real force.
If you or I put a spare million into high return Cyprus we’d have taken a hair cut with a blow torch. We’d be too smart to do such – but how do we explain how smart money gets in, takes the high return and gets out? I know we sort of know.
What in mortgage lending processes is left out of the ‘equations’ we are looking at? The obvious change to me is the supply of well paid jobs and lack of wage inflation compared with when I took my first mortgage 35 years ago. Another is the transfer of liquid assets from the bottom 50% on a massive scale to the rich. One could go on, but those likely to be sub-prime have less and less to pay with and more and more to pay because of asset bubble.
Anyone who suggested CDO or private sector pixie dust to me as a solution to this would have got the bums’ rush. I get the impression that all talk of private sector solutions to what we need insured is as bad as the drivel peddled at us on personal pensions and the truth may well be that the cutting edge, thrusting private sector is no such animal. It is a parasite telling us it can do the government job cheaper.
My pay rose from £1150 a year to £5K in my first 5 years of work. Much later in 1989 I was on top of the senior lecturer scale at £18,400 – this is now £45K (though I now do different work) – all this made buying a house easier. Mortgage insurance wasn’t needed because my government provided it (until 10 years ago). It was too expensive 35 years back and now is scary. How do we get focused in on pass the toxic parcel financing no one understands (like they really understand these CDO and real derivatives – surely this would be the mens rea of their crimes given the outcomes) when there are so many clear structural changes we need to account? If this was physics it would be a physics without energy.
I saw Dee Dee Ramone lamenting about drugs, drinking and womanizing in Detroit City. One of the best live shows I have ever seen, music that was pure energy.
Grace Lee Boggs:
“We have to probe more deeply, to understand the link between our passion for economic growth and slavery. We talk about enslaving people as if it were only a matter of racism. It was not just racism. In the 17th and 18th centuries, this country’s rapid economic growth depended on having many more people doing the work. That’s why we enslaved Blacks. And it depended on getting more land. That’s why we exterminated so many Native Americans. That fundamental contradiction – of dehumanizing ourselves while degrading others, for the sake of rapid economic growth – was built into the founding of this country.”
I don’t pretend to understand the arcana of mortgage finance, or health care finance either, but IMHO the obvious solution to both is direct financial support from our federal Go’mint, which could afford it by getting out of the corporate welfare and imperialism businesses and reimposing taxes on the plutocracy. I will leave the details to others.
Private medical insurance is just a system of looting. Mortgage finance is now a matter of passing the bad penny to overeducated lemmings who have managed to get themselves in charge of handling other people’s money, and who don’t care what kind of dreck they buy so long as their peers are ingesting the same thing.
“…………rearranging deck chairs on the mortgage Titanic.”
I like it.
Another tenant of the American Dream, home ownership, soon to bite the dust.
Despite many aberrations, the American Dream was ultimately about empowering ordinary people and putting an end to unearned privilege. No aristocracy and (if you follow out the logic) no inherited fortunes either. That’s why the wealthy never liked it, and want it dead. Why some on the left want it dead is harder to understand.
Yup. Skin in the game should be an essential part of a mortgage lending program – especially the subprime stuff. Would slow things down, but in a good way.
I take the talk of killing Fannie and Freddie with a grain of salt. History tells me that the people employed will simply be transferred to a successor company. With Fannie & Fredddie having a larger share of the mortgage market than ever, simply ending a government role as desirable as it might be to some, is simply not an option. And then you have Wall Street now very dependent on having Fannie & Freddie purchasing mortgages from them for packaging into pools as a huge money maker. So interests be as they may, I see some form of Fannie & Freddie continuing. History would suggest this will be the case. Just take the OTS for example. The OTS was killed off not to long ago, but most of the bad actors woun up getting employed by other regulators, which by the way also happened in earlier decades(anyone recall the FSLIC?)
Oh but who then will give lobbying “donations” to Congress????
Although the word dates back to at least 2008, it was popularized by the Sparkle Pony Corral, a theme camp present in Black Rock City [at Burning Man festival] from 2009-2010. Frustrated participants could drop off their camp’s sparkle ponies at the corral where they would be fed, watered, and have their egos stroked by “certifiable experts.” Sparkle ponies received much-needed attention while campmates received a much-needed break.
A house is a home and not an investment. Were the home’s occupants likely participating in an economy functioning to increase the productive power of labor–this being effectively assured by credit and tax policy promoting greater command over abundant natural resources, beginning most emphatically with those whose provision increase the density of energy available to the labor force–then subsidized housing finance is an excellent way to facilitate conditions conducive to increasing the tangible, physical wealth of the nation. A roof over one’s head being a basic condition raising the likelihood one’s labor will be fruitful, subsided housing is excellent policy, no matter how very hard to measure what the effects are. So long as being efficiently sustained through effective policy is progress increasing the relative population density with access to ever denser sources of energy serving to increase the productive power of labor, then petty concerns like subsidies to mortgage finance are best left to those regulatory agencies of government seeing to it that, these subsidies are being lawfully applied.
As for this bill, well, everyone is pushing deflation these days, as this is a policy evidently thought the best course toward keeping today’s imperial imperatives in place serving to promote increasing concentration of wealth and power through scarcity. As far as I am concerned, anything this Congress promotes short of nationalizing the Federal Reserve for the sake of its providing credit financing the build out of a physical economy worthy the 21st century and altering tax policy for the sake of encouraging this build out will invariably exacerbate conditions that are generally becoming evermore intolerable over time and highlighting evermore graphically Congress’ failure to honor it sworn duty to uphold principles eloquently stated in the Constitution’s preamble. Unless these dunces relearn practical distinctions separating the U.S. from its English-speaking cousins, the trend toward abject failure leading to increasing misery more or less is certain to continue.
Big banks know there is much money to be made in secondary mortgage markets. Why should the Federal government subsidize Fan/Fred when other players can take a share. Investors are licking their lips at the billions.
Presently the federal government owns all F/F mortgtages (& FHA mortgages too), but does not want to give back ownership of those as though nothing wrong had ever happened and we are all good now. There does need to be a plan in place.
The new federal agency is expected to act only as a backstop, as it does through the FHA. It would serve as support in the event of a financial crisis (as we just had), and possibly for lower fico loans that private markets reject.