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Home sweet loan.

February 6, 2010

“The home-ownership policy/mandate will go down as one of the biggest failed social engineering experiments in modern times.  The costs are staggering and the returns are negative to date.  I have to ask myself why would this even be pursued?  There is evidence that home ownership fosters community growth, lower crime, etc, but there are also big downsides like debt burdens and lack of mobility – as in moving to where the jobs are.

Lest I be accused of only being able to point out what’s wrong, I’ll offer a much better goal for a nation to aspire to: a top-ranked educational system.” -GMT

Fannie Mae / Freddie Mac etc. buy loans from approved mortgage lenders and create mortgage-backed securities that comprise those loans and, for a fee, carry Fannie Mae’s guarantee of timely payment of interest and principal. Long story short, the GSE’s goal is to use a implicit govt guarantee to secure cheap financing for Americans to buy homes.

Freddie/Fannie (FF) set guidelines for the loans that they will insure, i.e. they understandably did not loan to sub- prime borrowers. Well, that all changed around 2005.

Following their mission to meet HUD government goals and to improve home ownership of low and middle income families, GSE relaxed these loan guidelines. They also started to not only guarantee these securities for a fee, they started to buy and hold mortgage debt to increase profits.

“Although Fannie’s and Freddie’s core business is their role guaranteeing payments to mortgage investors, for years they earned additional profits and generated controversy by maintaining a large investment portfolio filled with mortgages and related securities. ” -WSJ

Side note: late 2004, Fannie Mae was under investigation for its accounting practices. The Office of Federal Housing Enterprise Oversight released a report[39] on September 20, 2004, alleging widespread accounting errors, i.e. they were cooking their books for profit. 

When the Treasury Department took over Fannie and Freddie last year, one of the requirements they set for the companies was to begin shrinking their portfolios to limit the taxpayer exposure to the toxic garbage on their balance sheet.  Makes sense. The idea was to rein in the companies’ size and growth as they were bleeding cash. But last Thursday the Treasury reversed direction and decided the companies won’t be forced to sell mortgages and could even buy mortgages on the market.

The Treasury also wiped away the $400 billion cap on the losses.

Hmmmm. Wonder why they did that…

The agencies now have greater flexibility to pursue more expensive loan modifications including writing down loan balances, further transferring losses to tax payers. Yippie!

“Credit Suisse says the firms could use their increased capacity to even purchase delinquent loans from pools of mortgage-backed securities that they guarantee. Fannie and Freddie already purchase defaulted loans as they modify them under the administration’s loan-modification program, but the additional breathing room means it is now a ‘slam-dunk for them to speed up’ purchases of delinquent loans, Mr. Swaminathan said. New accounting rules that take effect next year also could make it more cost-effective for the companies to buy out bad loans and keep them in their investment portfolios.

‘It’s created a government-purchasing facility other than the Fed.'”

A Freddie spokesman said the company will continue to use its investment portfolio as “an important tool” to “keep order in the housing and housing-finance markets.” These entities own almost every mortgage out there. “The administration is responsible for backing nearly nine in 10 mortgages.” This means they are on the hook if almost every mortgage out there defaults.. FF have essentially been nationalized. But why are they not reported on the Treasuries balance sheet. Why not?

The Govt has a budget deficit and debt level that could make the pope blush. Therefore they have conveniently left FF and their $4 Trillion in obligations off the balance sheet. The Govt criticizes the bank for off balance sheet shenanigans and currently have the biggest off balance sheet exposure on the planet. Hypocrites. FUCK ME.

RIght now the Govt determines which Americans can and cannot get mortgages, the rate of interest on those mortgages and the overall home values.

That scares the fucking shit out of me.

Not necessarily to do with the housing market but the guys at Beacon Hedge fund get it:

“Any healthy system needs a way to correct error and remove waste. Nature has extinction, the economy has loss, bankruptcy, liquidation. Interfering in this process lengthens feedback loops. Error and waste are allowed to accumulate, and you ultimately get a massive collapse.  Capitalism is primarily attacked by two groups: utopians who wish to impose a more “compassionate” system, and political capitalists who want to enjoy the fruits of success without bearing the pain of failure. They use the coercion of the state to gain privileges, at the expense of everyone else.  As a country we’ve become less tolerant of economic failure. The result has been a series of interventions, such as meddling in the credit markets, promoting homeownership and creating a variety of safety nets for investors. Each crisis leads to an even greater crisis. The solution is always greater doses of intervention. So the system becomes increasingly unstable. The interventionists never see the bust coming, then blame it on ‘capitalism.’ But Capitalism would have allowed those who essentially bet wrongly to fail, instead of bailing out people with friends in high places.

The little guy actually has been crushed. Money has essentially flowed into the political economy at the expense of the real economy. The little guy is always going to be the last one in the soup line. So he will get a bone tossed to him, like cash for clunkers. But if you are Goldman Sachs or if you have got essentially the red bat-phone to Washington, D.C., you are first in line.  The central planners have already spent $3.15 trillion on various bailouts, credit backstops, guarantees, etc., and given approximately $17.5 trillion of government commitments, etc., while allowing many of these institutions to remain in place, with the same people running them.

We don’t believe in a central bank. The idea that banks can speculate with essentially free money from the [Federal Reserve], which ultimately is the taxpayer, and that when they lose money the Fed bails them out and then passes that invoice to the taxpayer — that whole model is broken and needs to go away.

We need to address fractional-reserve banking, which is causing the instability. We have essentially socialized deposit insurance and prevented the bank run, which used to impose discipline on this unstable system. At least it had some check on those who were acting most recklessly. Until we address the root of the problem, we are going to have a series of crises, greater responses and intervention, and more bubbles — and the system will keep perpetuating itself.”

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12 Comments leave one →
  1. la mama permalink
    February 6, 2010 10:47 pm

    I could really use a primer, or a list of terms with definitions (and even that would have limited use for my pea brain’s comprehension), to follow all that’s going on in the world of finance, esp. as it seems to have blown things to sh-t. Reading this reminds me of trying to figure out what the chemistry text in high school was trying to tell me. I would read it over and over, and someone smart would explain it to me, then I’d GET it … but only for a little while, after which the concept I thought I had grasped would just slip out of my comprehension.
    I (and millions of other finance-challenged Americans) need help figuring out what is happening to us.
    Could someone explain it to me as if I were, say, 10 years old? Seriously. Anybody.

    • debaseface permalink
      February 6, 2010 11:05 pm

      Hey Mom 😉
      I agree that most people in this country are “finance-challenged” I’ll try to provide a better explanation.

      The US Govt has always promoted home ownership and the best way to get more people into homes is providing cheap financing i.e low interest rates.. But the problem is banks are smart enough than to charge low interest to chumps who have no business borrowing a few hundred thousand clams. So the guberment created Freddie and Fannie who told banks to just make them damn loans and we will take the mortgages from you and sell them to the public with an explicit performance guarantee. i.e. if the homeowner defaulted the govt would step in and continue to pay int. on the debt.

      This is the crux of the problem.. why is the govt subsidizing home ownership? It is a giant shit show. You and I will discuss over a cold domestic beer next time i’m upstate. Hopefully soon.

  2. la mama permalink
    February 7, 2010 11:14 pm

    Wow. I did not know that. I really did get the impression that greedy “predatory lenders” were out there acting like con artists, signing people up for mortgages they could afford in order to … what? make commissions?
    That is a very good, simple explanation. And I agree: there is no reason the govmt should be subsidizing home ownership (I mean, even more than offering an income tax break on mortgage interest, which is a helpful feature).
    Thanks for the clarification. Definitely looking forward to our next tutorial, esp. with the brewskis!

  3. Mutterskopf permalink
    February 8, 2010 4:39 pm

    The boom and bust cycle seems to be inherent to capitalism. There were certainly plenty of booms and busts prior to the New Deal. Trying to pin everything on this one policy seems a little thin to me. I don’t claim to understand the “crisis” but I think it is a wee bit more complicated than that.

    Also, this argument that you are making seems more moral than factual to me (the gov’t “should not” subsidize home ownership)(why not?). the good old “Free market as religion” line of thinking.

  4. debaseface permalink
    February 8, 2010 9:26 pm

    Hey Mutterskopf.
    Yes, booms and busts were around before the Fed but Instead of implementing and enforcing prudent regulation we created a bail out mechanism which resulted in Moral hazard and larger booms and busts. The FED. (phew. long sentence)

    My argument is far more factual than moral IMHO – But I will admit, on principal alone, I feel the govt should stay the fuck out of intervening in the economy and markets. If you feel the govt belongs bumbling with the economy then there is no greater poster child than the housing market as proof that the govt belongs nowhere near the markets.

    The Govt. created the housing bubble.

    Supply and demand (free market) should decide asset prices and not a govt mandate. A declining number of eligible borrowers and bank capital to lend and ballooning consumer debt (which should have resulted in higher int. rates) should have been major headwinds on home prices in the early 2000’s.

    Enter the govt

    Govt. initiatives that helped spur demand resulting in the bubble:

    1-Artificially low nterest rates

    2-Banks being allowed to increase leverage / use derivatives for capital relief and create a shadow banking system to securitize mortgages and spread risk.

    3- Govt agencies – such as HUD and FHA – pushed banks to lend to low income home buyers and generally lower loan standards.

    All 3 resulted in unintended consequences

    The govt’s goal was “affordable housing” and I’m wicked sure they didnt intend on house prices doubling in 5 years. Low int. rates, Govt programs and subsidies didnt so much sponsor home ownership but promoted speculation and real estate investment (flip this house – NO MONEY DOWN etc..)

    I had a buddy who had a shit job but owned 3 expensive homes on LI and it seemed like he was buying and selling a NEW house every other week. Thats called gaming the system.
    house prices kept going up and the govt just started doing the pee pee dance and muttering “just gotta keep this going.. just as long as we keep keep this going at any cost..”
    But that didnt happen.

    The Govt felt the bails outs were necessary to deal with a problem they created.

    The should now raise rates, reduce the reliance on the shadow banking system, reduce private and public debt and allow the housing market find a “natural” bottom.

    They are doing non of the above. Sorry.. this was tooo long I think.

  5. Mutterskopf permalink
    February 9, 2010 11:56 am

    What would it look like if the gov’t just let things fall to their “natural” bottom? Probably really bad, don’t you think? Like really, really bad. Like the amount of losses would wreak havoc and unemployment would get a LOT worse than it already is, right? I can’t really vouch for these policies, I don’t know enough to say “yes this is the right thing to do” BUT i do think that sometimes you have to just protect the short-term (even if it risks more long-term problems) when the situation is that you are facing immediate disaster. which i think maybe we are/were/are.

    on the subject of “moral hazard”- i was thinking about this some last night. it’s a tough issue. if we are to be truly “free” in a full sense, then we have to have the freedom to succeed and to fail economically. but, having lots of folks “fail” economically is kind of a disaster for society. so, we really can’t have that. question then is what do we do about it:

    (a) option 1: do not let people take extreme risks.

    if folks were required to keep their economic behavior within certain “reasonable” bounds, then for the most part they wouldn’t “fail.” of course, this is totally unpalatable in terms of loss of freedom.

    (b) option 2: provide some kind of safety net that allows people to take risks and not be destroyed if they lose.

    This sounds better, right? But, it has the “moral hazard” problem. But is “moral hazard” all bad? For many years folks have argued that moral hazard is a good thing in the context of the “corporation,” which of course is a great example of moral hazard. corporations shield their owners from liability for the corporate acts, so the owners are able to take risks without fear that they themselves will be screwed if their corporate entity screws up too much. (if the corporation has enough money to pay its liabilities, there’s no problem; but if it doesn’t, then risk of loss is on the tort & contract counterparties!) this seems to be a good example of regulation (laws allowing folks to make these crazy “corporation” things with limited liability) that creates a “moral hazard.” and yet this regulation is lauded by academics/etc. because it allows folks to take risks, which grow the economy!

    so anyhow in terms of absolutes, i think we have to accept that there is a role for moral hazard. of course the issue of HOW MUCH moral hazard is a totally different question…

    (sorry this is so long)

  6. A. Strung permalink*
    February 9, 2010 1:17 pm

    I question the degree to which these entities bank (pardon the pun) on getting a bailout. First of all there’s no guarantee they will, however likely it may be. Second and probably more importantly, I don’t think being bailed out is a positive thing except for the fact you don’t go under. Everything else seems to be problematic about it.

    Beyond that I can’t subscribe to this idea that the banks would be stand-up, responsible organizations were it not for the promise of bailouts and other federally provided enticements.

    Not that the government doesn’t sometimes play a huge role. But saying the housing bubble was “created” by the federal government is like saying a baby is “created” by sperm. It takes two (or three or four) to tango …

    Also I wonder for all the trouble the federal government causes in this arena with their “meddling”, what good have they done? It’s not an exact science and I imagine some of these failures are part of the process of effective governance and regulation. Or at least an attempt at it.

    Anyway I think we should just do the one thing that will make all these conversations purely academic: Limit the size of these things so they’re not “too big to fail”. Then you CAN just let em go belly up – even when they’ve been so deviously taken advantage of by the feds ; )

    (On the subject of freedom, I mean – you have the right to free speech but you do not have the right to yell “fire” in a crowded movie theater. There are limits to all our cherished freedoms and plenty of room for discussion on where those limits are)

  7. debaseface permalink
    February 9, 2010 7:57 pm

    Mutterskopf-
    Your view is logical and pretty widely accepted. Allow me to retort.

    What would it look like if the gov’t just let things fall to their “natural” bottom?

    I argue that house prices would not have risen to “unatural” levels had the govt not decided to sponsor home ownership. Now we have to decide between the lesser of 2 evils. – Allow the govt to run up ungodly deficits to prop up the market or allow people to default on their mortgages and banks to deal with foreclosed properties. I choose whats behind door # 2. Everybody else in this country (and bleeding hearts) would rather pony up their hard earned money to help chumps stay in their overpriced homes and banks rack up billions in bonus pools.. I dont get it.

    Losses would wreak havoc and unemployment would get a LOT worse than it already is. You have to just protect the short-term (even if it risks more long-term problems) when the situation is that you are facing immediate disaster.

    Banks and thr Govt rely (prey) on people having these fears in order to rationalize their irresponsible actions: Every time I watch Tim Geitner defend his actions (govt fraud and back door bail outs) he says the same fucking line of bull “we needed to do to avoid disaster. Sorry, each time the govt screams fire I a not giving them my ATM and pin # . Unfortunately, the govt doesnt need to ask for money, they just print it.

    Is “moral hazard” all bad?

    Unequivocally yes (with the exception of small children and retards) In terms of your corporate moral hazard theory – If a corporation was to fail and they had debts they file for bankruptcy and the loss is “on the tort & contract counterparties” Agreed. However, at the end of the day the losses are realized by their counterparties (banks) that made a risky loan to the company – Similar to banks taking losses on risky loans to homeowners… Moral hazard would exist only if the lenders were bailed out or if the corporation was not required to file bankruptcy – had their debt forgiven instead.

    How much moral hazard is okay? None.

  8. debaseface permalink
    February 9, 2010 8:02 pm

    “Anyway I think we should just do the one thing that will make all these conversations purely academic: Limit the size of these things so they’re not “too big to fail”. Then you CAN just let em go belly up”

    Hear hear

  9. Mutterskopf permalink
    February 12, 2010 10:33 am

    So debaseface I don’t think you’ve really responded to the conundrum of the corporation issue for your “any moral hazard is bad” theory. because it counts for tort as well, not just contract. a tort “counterparty” (aka plaintiff) did not choose to suffer the injury. it’s not like when a bank negotiates a deal and has the opportunity to assess the risks and then things go bad and it gets fucked. a tort is like let’s say all the 2010 toyotas spontaneously combusted, and the folks driving fords next to them got hit with the shrapnel. that’s a tort. the ford driver bears no responsibility, but has suffered a loss. but if toyota goes bankrupt, guess what? no recovery for the ford driver, even if the shareholders of toyota (its owners) have the money in their personal accounts to pay for what their company did. in this situation, the “fair” thing to do would be to take the money from Mr. X-Toyota shareholder’s pocket and put it into Mr. Y- Ford driver/victim’s pocket. Yet that’s not what happens. The corporation limits liability to itself. The owners are shielded (besides their ownership stake). This law seems totally unfair, right? and certainly creates moral hazard (owners can let their companies take more risks than they otherwise would because they won’t have to suffer the full consequences if things go terribly wrong).

    so- maybe this is just bad, and we should do away with corporations and anything else that creates moral hazard.

    or- maybe (as most commentators would argue) it’s a good thing because businesses need to be able to engage in some degree of risk in order to grow.

    but anyhow so you can’t really discount this issue just by reference to contract-type scenarios where the counterparty has the opportunity to assess the risk and make a choice…

    on the “disaster” issue- so you are saying that you don’t think that the economy would have been significantly worse off today if more firms had been allowed to fail? doesn’t it set off a chain reaction of defaults once a big entity defaults on its stuff? isn’t that the concern that’s going on with greece right now?

  10. debaseface permalink
    February 13, 2010 7:52 pm

    Moral hazard does not stipulate the amount of loss, just as long as there is actually a loss…

    Toyota makes a car that explodes. Not good for business. Equity/ bond holders lose 100% of their investment.
    Next time: toyota makes a car that their investors ensure will not explode (so they dont lose their money again)

    Citibank makes shit loans and dodgy investments which implode. Their equity / bond holders dont lose a dime because of a bail out.
    Next time: Citibank makes shit loans and dodgy investments. Nothing changes

    Spare the shareholders fine, but not their investment – and you avoid moral hazard.

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