gonegolfin
Member
This is something I recently wrote and thought it might be of interest to some ...
The Housing Bill
In an attempt to "save" the economy and reverse or mitigate a housing crisis that financial leaders claimed was non-existent less than a year ago, the House, Senate, and President recently signed off on one of the worst pieces of legislation this country has ever seen. And it will be years until the full cost to the US taxpayer is determined. This bill is a 690 page document with plenty of "goodies" buried inside. It is an affront to free market capitalism. But we should not be surprised. We have been heading in that direction for several decades, with the Federal Reserve underpinning this movement. Perhaps we should first address the bill's safeguarding of the nation's two mortgage finance giants, Fannie Mae and Freddie Mac.
Fannie Mae (FNMA) was a New Deal invention with the purpose of making housing more affordable via making credit cheaper and expanding the number of loans that could be made by serving as liquidity provider. But it was founded as a government agency, not a private corporation. Fannie Mae was privatized in 1968 in an attempt to balance the budget (move losses off of the federal balance sheet). Freddie Mac (FHLMC) came along in 1970 to expand and provide competition in the secondary mortgage market. But even as "private" corporations, their goal is and always has been to subsidize housing. These agencies subsidize housing in this country because they allow for borrowers to obtain loans at below market rates as well as provide instant and substantive liquidity to the market. Spreads between long term treasuries (essentially no risk lending - in terms of default) and agency MBSs (Mortgage Backed Securities - purchased by investors) have traditionally been about 50 basis points (very small). Such a low spread means a much cheaper mortgage for the borrower. Cheaper than what could be had in a free market without Fannie and Freddie. You can look at the difference in cost between conventional and non-conventional loans (Jumbo loans are not purchased by Freddie and Fannie) for starters. But the real cost would be even higher since the competition for capital would be even more competitive without Fannie and Freddie. The above mentioned spread is so low because these agency MBSs have the implied backing of the federal government. And it has just been proven that this implied backing is actually real backing. Without this federal backing (taxpayer backing), mortgage rates would be much higher because investors would demand more risk premium in their investments. So, we have two "private" quasi-governmental agencies that privatize the profits, but socialize the losses.
As I stated in my last writing, this subsidization is costing the taxpayer because investors of these agency MBSs (and agency bonds/debt) are getting free risk premium (amounts to about $50 billion/year at present). Borrowers are not getting the full benefit of the subsidization as the risk premium is being paid to investors (many foreign) without them bearing any risk. That is, the borrower does not receive a loan discount (discount to what a loan in the free market would cost) in the full amount of the subsidization (paid for by taxpayers). This should make people angry. This is why I think that the investors of agency debt and agency MBSs should take a haircut. We are giving them a free lunch.
Simplified Example:
* Let's say that the 30-year T-Bond is yielding 5.0%
* Fannie Mae purchases a 30-year mortgage loan yielding 6.25% (principal plus a fee for the services of the mortgage originator)
* Fannie Mae sells and guarantees the mortgage at a yield of 5.5% (in reality, a pool of securitized mortgages would be sold). Thus investors (Ex. Chinese or Russian Central Bank) receive a guaranteed yield of 5.5% for their investment.
* Fannie Mae pockets the 0.75% yield (75 basis points) minus the nominal flat fee paid to make the original purchase
In the above example, the difference between the 30-year T-Bond yield (5.0%) and the yield paid by the security sold by Fannie Mae (5.5%) is the risk premium. Except, when the Federal Government is actually backing the securities, there is no risk, just premium. Hence, taxpayers and mortgage holders are being milked of that 0.5%. A decision must be made. Fannie Mae and Freddie Mac are either fully nationalized institutions (preferably not) or they are private institutions that can fail and will not be made solvent by taxpayers (preferable).
If that is not enough, the bill that just passed also bails out shareholders of these "private" corporations as it maintains the agencies in their current form. Additionally, there is no cap on the size of the bailout (other than the limits of the national debt ceiling), despite Treasury Secretary Paulson's insistence that the agencies are well capitalized. Where have we heard this before? Ah yes ... "The fallout in subprime mortgages is going to be painful to some lenders, but it is largely contained." Paulson on 3/13/2007. "I don't think it [the subprime mess] poses any threat to the overall economy." Pauson on 7/26/2007. "I also said I thought in an economy as diverse and healthy as this that losses may occur in a number of institutions, but that overall it is contained and we have a healthy economy." Paulson on 8/2/2007 just days before the hedge fund explosion. "The troubles in the subprime sector seem unlikely to seriously spill over to the broader economy or the financial system." Federal Reserve Chairman Bernanke on 6/5/2007.
So, what we have here is a bill that bails out shareholders of the agencies, investors in the agency debt and guaranteed MBSs (many of which are foreign), and provides unlimited backstop to $12 trillion in mortgage lending and agency debt (and growing dramatically since these agencies now are the secondary market in the current credit environment). All of this wreaks of moral hazard.
I will close this section of the Housing Bill by saying that the measures taken by our government in the form of housing and credit subsidization, the backstopping of these organizations by taxpayers, and cheap money provided by the Federal Reserve serves only to put an artificial floor under housing prices. It is an indirect form of price controls and is not healthy to a free market economy. The only way to correct this mis-allocation of capital (housing bubble) is to allow a proper cleansing to take place (this is the purpose of recession). To continue to punt this problem down the road will only make the situation much worse in years to come.
Let's take a look at a few other facets of the bill (this is not exhaustive, but addresses what I see as the most important items).
The bill allows for the Federal Housing Administration (FHA) to insure up to $300 billion of refinanced mortgages in an attempt to stem the rising tide of foreclosures. Here, the lender must agree to reduce the principal to 85% of the newly appraised value (how this will be done is another question) of the home. The borrower must also be able to qualify for a new 30-year mortgage using the new principal amount. So, we might have a home with a $300,000 loan that is now actually worth $240,000. Once we apply the 85% reduction of the principal, the lender would receive $204,000 for the loan, should the lender choose to exercise this option. Now, the lender is only going to choose this route if the cost of foreclosure is higher. So, what we have here is a bailout in some amount for the lenders (on selective sales to the FHA) in conjunction with the bailout of irresponsible borrowers that bit off more than they could chew (this is a loan that the free market would not bear). How will this type of government response discourage inappropriate borrowing/lending in the future? It will not. This is moral hazard. The situation gets much worse when we have borrowers that refinanced their homes using inflated appraisals and used the extra cash to fund their lifestyles. This is more legislation that attempts to reflate the housing market. The longer we prevent the free market from determining prices (by providing artificial support), the longer the problem will continue (as it will be exacerbated).
Finally, a lesser known effect of this bad legislation is that it ends penalties for Federal Reserve loans extending beyond a certain time limit to failed banks. That is, the Fed will be able to more easily lend to institutions under Federal control (ex. FDIC). Thes penalties were put into place by Federal Reserve Act 10b and were intended to keep our Central Bank from keeping financial institutions open that should otherwise fail. Upon further thought and examination, this may be a way to backstop an FDIC that is woefully underfunded. This may mean yet more use of the Fed's dwindling balance sheet to prop up US financial institutions. This has the net effect that the Fed is now subject to more pressure from lawmakers to serve as a backstop (remember that the Federal Reserve is chartered as an independent body) instead of coming clean to the taxpayer w/respect to funding required to keep the financial system solvent. Does this sound scary? It should.
Now for the icing on the cake ... the bill also raises the national debt ceiling to $10.6 trillion, from $9.8 trillion. That is an addition $800 billion for a problem that is not a problem according to the Treasury Secretary. Of course, who believes it will be difficult to pass additional legislation to raise the debt ceiling once again should Fannie and Freddie prove to be more costly that the politicians are estimating.
Being that this is an election year, it is appropriate to ask who was in favor of (instrumental in) getting this legislation passed? The Fannie Mae/Freddie Mac legislation was crafted by the Treasury Secretary (and advisors) and enthusiastically supported by the President as well as the majority of Democrats in the House and Senate. The President originally threatened a veto as he opposed certain measures in the bill. But he felt that the Fannie/Freddie backstopping took precedence and thus signed the bill into law. As for the votes in the House and Senate ...
House: (272 For, 152 Against)
Democrats (227 For, 3 Against)
Republicans (45 For, 149 Against)
Senate: (72 For, 13 Against)
Democrats (43 For, 0 Against)
Republicans (27 For, 13 Against)
All Texas Democratic representatives to the House voted in favor of the bill, while all Texas Republican representatives voted against it (with one abstention). All Louisiana Democratic representatives to the House voted in favor of the bill, while two Louisiana Republican representatives to the House voted in favor and two voted against it. Both Republican Texas Senators voted against the measure while in Louisiana, Landrieu (D) voted in favor and Vitter (R) voted against. How did our two big party candidates for President vote in this significant legislation? They did not vote. This is typical in the politics of today. Less ammunition for the opposition and one less thing to raise the ire of voters (on something so controversial). Obama came out and said he supports the bill, but we will never know for sure because he did not cast a vote. McCain has publicly stated that he thought that Fannie and Freddie were too big too fail. But recently he stated that he was against the Housing Bill. Maybe that was a statement designed to take a position different than his opponent. Or maybe he really felt that the bill was bad. But we will never truly know because he did not vote.
In any event, the system of today is not setup to address problems looming in the future (and created by policies of the present). It is only setup to address problems in the near-term and punt the problems of today further down the road until they are too colossal to ignore. Politicians are only looking to the next election. Any long term problems introduced by short term fixes are simply problems for future politicians. In the case of Presidents, they are usually too concerned with their "legacy" and will certainly not take the requisite medicine now to forestall a bigger crisis in the future. The incentives simply are not in the right place. This legislation drives home that point.
Brian
The Housing Bill
In an attempt to "save" the economy and reverse or mitigate a housing crisis that financial leaders claimed was non-existent less than a year ago, the House, Senate, and President recently signed off on one of the worst pieces of legislation this country has ever seen. And it will be years until the full cost to the US taxpayer is determined. This bill is a 690 page document with plenty of "goodies" buried inside. It is an affront to free market capitalism. But we should not be surprised. We have been heading in that direction for several decades, with the Federal Reserve underpinning this movement. Perhaps we should first address the bill's safeguarding of the nation's two mortgage finance giants, Fannie Mae and Freddie Mac.
Fannie Mae (FNMA) was a New Deal invention with the purpose of making housing more affordable via making credit cheaper and expanding the number of loans that could be made by serving as liquidity provider. But it was founded as a government agency, not a private corporation. Fannie Mae was privatized in 1968 in an attempt to balance the budget (move losses off of the federal balance sheet). Freddie Mac (FHLMC) came along in 1970 to expand and provide competition in the secondary mortgage market. But even as "private" corporations, their goal is and always has been to subsidize housing. These agencies subsidize housing in this country because they allow for borrowers to obtain loans at below market rates as well as provide instant and substantive liquidity to the market. Spreads between long term treasuries (essentially no risk lending - in terms of default) and agency MBSs (Mortgage Backed Securities - purchased by investors) have traditionally been about 50 basis points (very small). Such a low spread means a much cheaper mortgage for the borrower. Cheaper than what could be had in a free market without Fannie and Freddie. You can look at the difference in cost between conventional and non-conventional loans (Jumbo loans are not purchased by Freddie and Fannie) for starters. But the real cost would be even higher since the competition for capital would be even more competitive without Fannie and Freddie. The above mentioned spread is so low because these agency MBSs have the implied backing of the federal government. And it has just been proven that this implied backing is actually real backing. Without this federal backing (taxpayer backing), mortgage rates would be much higher because investors would demand more risk premium in their investments. So, we have two "private" quasi-governmental agencies that privatize the profits, but socialize the losses.
As I stated in my last writing, this subsidization is costing the taxpayer because investors of these agency MBSs (and agency bonds/debt) are getting free risk premium (amounts to about $50 billion/year at present). Borrowers are not getting the full benefit of the subsidization as the risk premium is being paid to investors (many foreign) without them bearing any risk. That is, the borrower does not receive a loan discount (discount to what a loan in the free market would cost) in the full amount of the subsidization (paid for by taxpayers). This should make people angry. This is why I think that the investors of agency debt and agency MBSs should take a haircut. We are giving them a free lunch.
Simplified Example:
* Let's say that the 30-year T-Bond is yielding 5.0%
* Fannie Mae purchases a 30-year mortgage loan yielding 6.25% (principal plus a fee for the services of the mortgage originator)
* Fannie Mae sells and guarantees the mortgage at a yield of 5.5% (in reality, a pool of securitized mortgages would be sold). Thus investors (Ex. Chinese or Russian Central Bank) receive a guaranteed yield of 5.5% for their investment.
* Fannie Mae pockets the 0.75% yield (75 basis points) minus the nominal flat fee paid to make the original purchase
In the above example, the difference between the 30-year T-Bond yield (5.0%) and the yield paid by the security sold by Fannie Mae (5.5%) is the risk premium. Except, when the Federal Government is actually backing the securities, there is no risk, just premium. Hence, taxpayers and mortgage holders are being milked of that 0.5%. A decision must be made. Fannie Mae and Freddie Mac are either fully nationalized institutions (preferably not) or they are private institutions that can fail and will not be made solvent by taxpayers (preferable).
If that is not enough, the bill that just passed also bails out shareholders of these "private" corporations as it maintains the agencies in their current form. Additionally, there is no cap on the size of the bailout (other than the limits of the national debt ceiling), despite Treasury Secretary Paulson's insistence that the agencies are well capitalized. Where have we heard this before? Ah yes ... "The fallout in subprime mortgages is going to be painful to some lenders, but it is largely contained." Paulson on 3/13/2007. "I don't think it [the subprime mess] poses any threat to the overall economy." Pauson on 7/26/2007. "I also said I thought in an economy as diverse and healthy as this that losses may occur in a number of institutions, but that overall it is contained and we have a healthy economy." Paulson on 8/2/2007 just days before the hedge fund explosion. "The troubles in the subprime sector seem unlikely to seriously spill over to the broader economy or the financial system." Federal Reserve Chairman Bernanke on 6/5/2007.
So, what we have here is a bill that bails out shareholders of the agencies, investors in the agency debt and guaranteed MBSs (many of which are foreign), and provides unlimited backstop to $12 trillion in mortgage lending and agency debt (and growing dramatically since these agencies now are the secondary market in the current credit environment). All of this wreaks of moral hazard.
I will close this section of the Housing Bill by saying that the measures taken by our government in the form of housing and credit subsidization, the backstopping of these organizations by taxpayers, and cheap money provided by the Federal Reserve serves only to put an artificial floor under housing prices. It is an indirect form of price controls and is not healthy to a free market economy. The only way to correct this mis-allocation of capital (housing bubble) is to allow a proper cleansing to take place (this is the purpose of recession). To continue to punt this problem down the road will only make the situation much worse in years to come.
Let's take a look at a few other facets of the bill (this is not exhaustive, but addresses what I see as the most important items).
The bill allows for the Federal Housing Administration (FHA) to insure up to $300 billion of refinanced mortgages in an attempt to stem the rising tide of foreclosures. Here, the lender must agree to reduce the principal to 85% of the newly appraised value (how this will be done is another question) of the home. The borrower must also be able to qualify for a new 30-year mortgage using the new principal amount. So, we might have a home with a $300,000 loan that is now actually worth $240,000. Once we apply the 85% reduction of the principal, the lender would receive $204,000 for the loan, should the lender choose to exercise this option. Now, the lender is only going to choose this route if the cost of foreclosure is higher. So, what we have here is a bailout in some amount for the lenders (on selective sales to the FHA) in conjunction with the bailout of irresponsible borrowers that bit off more than they could chew (this is a loan that the free market would not bear). How will this type of government response discourage inappropriate borrowing/lending in the future? It will not. This is moral hazard. The situation gets much worse when we have borrowers that refinanced their homes using inflated appraisals and used the extra cash to fund their lifestyles. This is more legislation that attempts to reflate the housing market. The longer we prevent the free market from determining prices (by providing artificial support), the longer the problem will continue (as it will be exacerbated).
Finally, a lesser known effect of this bad legislation is that it ends penalties for Federal Reserve loans extending beyond a certain time limit to failed banks. That is, the Fed will be able to more easily lend to institutions under Federal control (ex. FDIC). Thes penalties were put into place by Federal Reserve Act 10b and were intended to keep our Central Bank from keeping financial institutions open that should otherwise fail. Upon further thought and examination, this may be a way to backstop an FDIC that is woefully underfunded. This may mean yet more use of the Fed's dwindling balance sheet to prop up US financial institutions. This has the net effect that the Fed is now subject to more pressure from lawmakers to serve as a backstop (remember that the Federal Reserve is chartered as an independent body) instead of coming clean to the taxpayer w/respect to funding required to keep the financial system solvent. Does this sound scary? It should.
Now for the icing on the cake ... the bill also raises the national debt ceiling to $10.6 trillion, from $9.8 trillion. That is an addition $800 billion for a problem that is not a problem according to the Treasury Secretary. Of course, who believes it will be difficult to pass additional legislation to raise the debt ceiling once again should Fannie and Freddie prove to be more costly that the politicians are estimating.
Being that this is an election year, it is appropriate to ask who was in favor of (instrumental in) getting this legislation passed? The Fannie Mae/Freddie Mac legislation was crafted by the Treasury Secretary (and advisors) and enthusiastically supported by the President as well as the majority of Democrats in the House and Senate. The President originally threatened a veto as he opposed certain measures in the bill. But he felt that the Fannie/Freddie backstopping took precedence and thus signed the bill into law. As for the votes in the House and Senate ...
House: (272 For, 152 Against)
Democrats (227 For, 3 Against)
Republicans (45 For, 149 Against)
Senate: (72 For, 13 Against)
Democrats (43 For, 0 Against)
Republicans (27 For, 13 Against)
All Texas Democratic representatives to the House voted in favor of the bill, while all Texas Republican representatives voted against it (with one abstention). All Louisiana Democratic representatives to the House voted in favor of the bill, while two Louisiana Republican representatives to the House voted in favor and two voted against it. Both Republican Texas Senators voted against the measure while in Louisiana, Landrieu (D) voted in favor and Vitter (R) voted against. How did our two big party candidates for President vote in this significant legislation? They did not vote. This is typical in the politics of today. Less ammunition for the opposition and one less thing to raise the ire of voters (on something so controversial). Obama came out and said he supports the bill, but we will never know for sure because he did not cast a vote. McCain has publicly stated that he thought that Fannie and Freddie were too big too fail. But recently he stated that he was against the Housing Bill. Maybe that was a statement designed to take a position different than his opponent. Or maybe he really felt that the bill was bad. But we will never truly know because he did not vote.
In any event, the system of today is not setup to address problems looming in the future (and created by policies of the present). It is only setup to address problems in the near-term and punt the problems of today further down the road until they are too colossal to ignore. Politicians are only looking to the next election. Any long term problems introduced by short term fixes are simply problems for future politicians. In the case of Presidents, they are usually too concerned with their "legacy" and will certainly not take the requisite medicine now to forestall a bigger crisis in the future. The incentives simply are not in the right place. This legislation drives home that point.
Brian
Well done! 
