On Freddie and Fannie.

[randomness]

What's lost in all the handwringing over Freddie Mac and Fannie Mae was that from the start they were entities created for the express political purpose of manipulating the housing market. They exist in order to promote what later became called "the ownership society", as a way to fight socialism. Putting more people into houses as owners means more people who have a stake in the defense of private property and of capitalism. Arguably, this was quite effective.

However, it cost money. Now, the bill is coming due. Who pays the bill--and how they pay it--those are the real issues, not why and how the money was spent. They spent the money fighting socialism.

It's therefore rather ironic that rather than see Freddie and Fannie fail, a self-described conservative government has decided ideology be damned. The government must take these outfits over lest they collapse and take down the housing market and the credit market with them, rather than let the market sort everything out, as their ideology would have it.

Of course they're trying very hard to obfuscate all this, rather than have people ask the awkward question of why the fight against socialism, and those who gained from it, should be bailed out by socialism.

Do I think we should prevent a collapse? Yes. Spending some money to engineer a graceful outcome and avoid a chaotic crash is worthwhile. Do I think the taxpayer should be the one to pay for that graceful outcome? No.

We'll see who ends up paying the bill.

Comments

[cerebralpaladin.livejournal.com]

So, here is my understanding of what's going on. Fannie and Freddie have exposure on huge amounts of loans-- mind-bogglingly huge amounts, actually. Freddie alone has a total loan portfolio of $2.2 trillion. Now, those loans are assets, not liabilities-- they are entitled to get paid as the homeowners pay off their mortgages. But there are countervailing liabilities-- they pay for the loans they buy by selling bonds ("Agency bonds", because they are GSEs), and they have an obligation to pay back those bonds. Also, much of their portfolio is not directly retained, but sold subject to a guarantee. They sell the future income from a mortgage as a Mortgage Backed Security, but they promise that even if the homeowner defaults, they will pay the purchaser, in exchange for a fee for that guarantee (essentially, this is like selling a financial asset and simultaneously selling insurance on its value-- as long as its value stays there, you get the insurance premia, but if it doesn't, you have to pay out).

So, as loans become delinquent, Fannie and Freddie lose money-- they have to keep paying on their bonds, and they have to pay out on their guarantees on loans that they have sold. The current state of the housing market is very bad, so they've taken big losses, and there are more on the way. In particular, drops in property value are what really hits them. ARM resets contribute to that, but if your payment goes up and you can't afford to pay the mortgage anymore, but you still have net equity in your house, you don't get foreclosed on-- instead, you sell, pay off the mortgage, pocket the difference, and still probably curse the evil bank that sold you the mortgage in the first place. The real problem is when people have gone negative, because of small or nonexistant downpayments (or negative amortization loans) combined with large drops in property values. Then, people actually default, and the bank can't make its money back through a foreclosure sale.

All that said, one of their major expenses is the amount of money they need to spend on interest on the bonds that they issue. Their interest rate has traditionally been only a smidgen above the US government's interest rate on its Treasury bonds. Recently, that spread has increased dramatically. Now, it should drop to 0 or essentially 0-- Agency debt is as good as Treasuries. That means that Fannie and Freddie will have to spend much less money to get their capital, which should mean that they will lose less/make more money. It should also help unclog the mortgage market, which should help make the declines in house values lower (not make them stop altogether, but make the bleeding less bad). So the best case scenario is that, taken as a whole and bearing in mind the fact that both GSEs still had net positive balance sheets before the bail-out, they can now make money again by borrowing at a very low rate, lending at a higher rate, and having enough cushion there to absorb the losses on foreclosed mortgages as part of the cost of doing business (which is what happens in normal times). If they lose money next year and the year after, then return to profitability without an infusion of new capital and make all their payments to the government on its preferred, then at the end of the day the government ends up ahead, even though it lost money in the meantime. So while they may (likely will) lose more money, it may not be as bad as all that, especially now that their costs are so much lower.

In the worst case scenario, the government has to keep pouring money in as they lose money, but then I think the common and preferred shareholders will never see another dime, so that's something. At least it holds down on the moral hazard.

[cerebralpaladin.livejournal.com]

I was curious, so I looked up what Fannie Mae's total mortgage portfolio (retained plus guaranteed) is. Turns out that it's just north of $3 trillion. The $5 trillion or so that they are both involved in is really just unbelievably huge.

This is also why it's really important that the GSE's not default. They have trillions of dollars of outstanding debt and obligations that could totally send many other banks that own their debt or rely on their guarantees into insolvency, as well as really, really pissing off the central banks and such that own lots of the remainder of their debt.