Friday, July 11, 2008

GSE's collapsing; is anyone surprised?

A quick recap, in case you're not familiar with the recent financial news. We're in a housing asset price correction, driven by a lack of easy risky credit and an unwillingness of big banks to continue to sponsor deficit consumer spending at their own loss. Fannie Mae and Freddie Mac, two enormous companies who have reaped massive profits for their executives and shareholders during the bubble, are now being forced to acknowledge their losses, and rely on their implicit government bailout, which looks likely to eventually cost US taxpayers trillions. I ask: is anyone surprised?

This entire economic cycle has been about privatizing gains and socializing losses. Everybody has been operating under the assumption of bailouts, from the large investment banks, to the GSE's, to the individual consumers. The GSE regulators have either been completely asleep at the wheel, or letting the GSE's do whatever they want with a "wink-wink" for an eventual bailout.

How dense are the people who didn't see this coming? I mean, let's consider for a moment the proposal to have the FHA insure another $300 billion on home loans with 97%+ LTV. Raise your hand if you think less than 90% of those will default leaving taxpayers on the hook. Anyone with their hand up fails, goodbye, do not pass go and please do not hold public office.

Ok, next: raise your hand if you think that loans which nobody will buy except the GSE's are likely to be just as safe as those made by normal banks pricing in risk because they don't count on a bailout when they are insolvent. Anyone? Hm, I guess all those people already flunked out of the class on the first question; good for you if you're left. Oh, I see you Mr. GSE regulator, hiding in the back, you're supposed to be making sure the GSE's don't incur excessively more risk than normal banks... you're very fired also, and hopefully the administration will vote to hold you personally liable for the GSE losses. It won't cover much of their trillions of bad loans, but it'll be something.

Here's a news flash for all the geniuses in Congress: companies and individuals who expect a bailout when things go wrong will take excessive risk to make as much as possible while things are going right. In bailing them out, you encourage this behavior. In not ensuring they operate for long-term viability, you allow this behavior. In creating, regulating, overseeing, and guiding these companies, YOU (Congress) are responsible for their failure, and the trillions it's going to cost taxpayers. Good thing America already thinks you're doing a horrible job, and your approval rating is already down to partisan supporters only, cause this is a f-up of historical proportions.


  1. I mean, let's consider for a moment the proposal to have the FHA insure another $300 billion on home loans with 97%+ LTV. Raise your hand if you think less than 90% of those will default leaving taxpayers on the hook.
    Yes. If those were good deals, investors would come in an voluntarily buy bonds to fund the loans.

    They're not good deals. The houses are overvalued compared to historical norms. Investors won't fund the deals. The only choice is to use taxpayer funds to force people to invest in the loans that they wouldn't fund by choice. I sure hope they work out okay.

    Fortunately for taxpayers, I question how many loans they'll actually insure. My understanding is the lender and the borrower have to agree to take the guarantee. The lender writes down part of the loan, and the buyer agrees to pay some of the write down if their house price goes up before they sell it. Moreover, I wonder if second and third lienholders will be able to stop this deal even if the primary lender and borrow want to do it. I suspect this plan is a bandaid that won't present as much moral hazard as you might think.

  2. As written originally (not sure how it has changed during the negotiations and payoff which constitute our legislative process), the provision was that if the lender wrote off 15% of the principle, the loan could then be insured by the FHA. Since most of the bad loans are already 15% underwater or greater, this is no loss for the lenders, so it's expected that many would try to use the new facility (which is the point). Lower principle is good for the buyer, reduces their payments, etc.

    However, the market is falling way more than 15%; this is pretty common knowledge at this point. Losses in excess of 15% will cause those borrowers to default anyway, which causes the FHA (ie: the taxpayers) to pay the banks for the difference when they foreclose/sell. So most people who would have defaulted before will still default, except instead of the banks eating the entire losses for the bad loans they made, they get to share the losses with the taxpayers, ie: us.

    You could begin to wonder how this is of any benefit to Americans at all, until you realize that Dodd's home state has several of the big banks which would be on the receiving end of the payout, and then it makes more sense.

    For new loans, the FHA is only limited in insuring by the amount granted by Congress to lose funding ridiculously risky auto-default loans. Fortunately for them, that's currently low enough to seem small compared to the GSE bailout amounts. Unfortunately for us, we lose in both cases.