The Fannie-Freddie panic began on Wednesday — that is, this Fannie-Freddie panic, as opposed to the prior ones. The firms had already lost 90 percent of their stock value, and can continue to lose half of their remaining value every day forever with no trouble. It’s losing the other half that’s a problem.
The immediate market response is perverse: Mortgage rates have fallen a hair this week (near 6.375 percent), but Treasury bond yields have risen overnight (the 10-year from 3.81 percent to 3.92 percent), opposite the normal response to panic. The market logic: If Fannie and Freddie will be government-guaranteed, then all their mortgages and securities have suddenly improved in credit quality. Treasurys are hurt by the prospective cost of guarantee — if it costs money, it means more borrowing and more Treasurys.
Meanwhile, lending operations are normal today, closings proceeding, although we are still desperately short of credit (jumbos, ARMs, non-owner, flexible underwriting…).
The Fannie-Freddie story will be widely misreported, especially in those journals hostile to housing or to any intervention by government into markets.
The real story is a tale of public policy mangled by everybody connected to the two agencies in the last 15 years — both parties, two administrations, eight Congresses, and real estate- and mortgage-industry lobbying.
Fannie and Freddie were created as last-resort buyers of mortgages in bad times, and in good times facilitators of mortgage securitization by guarantee. Guarantors face little risk, if underwriting is tough, and it is a good, self-sustaining fee business. Owning mortgages is high-risk. Beginning in the early ’90s, Fannie and Freddie jumped their charters, buying huge masses of loans in good times, roughly $3 trillion worth. This bloat on slim capital was a great benefit to their stockholders, whose interests were perfectly opposite the original charter: self-sacrifice in hard times, buying loans that nobody else wants in a moment of falling home prices. Right now!
From here, the real story is very good news. Fannie and Freddie have high-quality portfolios, the only trash the "affordables" forced on them by Congress. A government takeover would wipe out stockholders, but might not cost a dime. Then the original charters will be restored: upon return of good times, both outfits will gradually sell their portfolios.
Here’s the bad news, and the reason for panic spreading to stocks and Treasurys. It is rather bad news.
Since the financial markets seized last August, the authorities have done well with emergency extensions of credit to the system, and especially the Fed’s finest hour in the liquidation of Bear Stearns. However, during that time, the Fed and Treasury have insisted that institutions — many large banks and dealers — can and should raise new capital in open markets.
The risk during this wait for market capital: Credit starvation would kill the economy. Until institutions raise capital, their capacity to provide credit has been very limited, even running in reverse as the whole system has tried to shrink, selling existing loans, and choking on the unsalable trillions of bad loans and securities.
This Fannie-Freddie end-game has exposed that capital-raising plan as hopeless. If these guys with good assets cannot recapitalize, neither can the big banks and the Street. It was worth a try at market-sourcing, but I have believed since August that a nouveau Resolution Trust Corp would be required to extract the worst of the assets, take stock in the institutions, and work out the trash over a long time. That extraction will work (we’ve done it many times), but I’m a tad nervous that we waited too long — damage from credit starvation now may be hard to stop, especially in housing.
Some good news: The same Congresspersons who insisted all fall and winter — "No bailouts! Punish the lenders!" — by this weekend began a different chorus. "Necessary evil … Regrettable but unavoidable." About time, guys; and I hope in time.
Lou Barnes is a mortgage broker and nationally syndicated columnist based in Boulder, Colo. He can be reached at firstname.lastname@example.org.
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