Fannie Mae and Freddie Mac Go Junk

This headline from FHFA yesterday. The full report is here.

This is incredibly flawed policy. The Government mortgage Agencies have created a window whereby borrowers can automatically get upside down on a loan. This is reckless lending and should not be permitted. This is much worse than any lending standard that existed in the go-go sub prime era. There is a mountain of evidence from academia, the government Agencies themselves and the mortgage insurance industry [MICA] that default rates explode when LTVs exceed 100%. Even good borrowers lose the incentive to pay back a loan.

In his statement FHFA Director Lockhart said, “The higher LTV refinancing will allow more homeowners to strengthen their finances.” That simply is not true. Borrowing more than your assets are worth is a death trap. Have the events of the past 24 months not proven that sufficiently?

It was galling to see Treasury Secretary Geithner together with Mr. Lockhart as this announcement was made. How many times has Mr. Geithner gone to Congress and spoken on the need for an end to reckless lending. He has been finger pointing at the banks for six months. He has turned half the country against Wall Street by repeatedly accusing them of predatory and unsafe lending. How he can stand there now with a plan to make bad loans with the people's money is beyond my understanding.

Where are the other voices on this? Where are Summers, Volker and Goolsbee? How can Ben Bernake permit this? FHFA is the regulator of the Agencies that is supposed to be protecting the taxpayers from further risks from these behemoths. The Regulator should not permit them to make unsafe loans. In this absurd theater the Regulator is encouraging the lenders to make bad loans.

This plan covers only existing mortgagees of the Agencies. If you have your mortgage with the local S&L you are out of luck. The Agencies own 56% of all the mortgages outstanding. This means that 20 million borrowers will not have the opportunity to get themselves hopelessly in debt. In the long run that will be a blessing. In the short run it is patently unfair. The private mortgage lenders will certainly not offer these silly mortgages. If they did the Controller of the Currency would shut them down.

I would not be surprised if news of this development does not impact the currency markets. We are already viewed as a society that is hopelessly over leveraged. That the largest single provider of mortgages in the world is committing itself to a program of reckless lending is unlikely to instill much confidence. It will be very hard to convince the Chinese that their investments are ‘safe’ when we are doing such stupid things with their money. American taxpayers have their feet to the fire of the Agencies. We are going to get burned and there is nothing we can do about it. Those that can, should and will vote with their feet.

I have followed most of the players in this story for some time. I am certain that if asked privately they would acknowledge that this is a dangerous step that exposes the People to significant losses. They know that over leveraging consumers will haunt them. They know that they run the risk of undermining the entire financial market. Each of them is turning their back on what is the ‘right thing to do’. They are doing it because it is expedient. They want to provide an additional hidden stimulus to the economy. This will achieve that. It is what every Administration has done for the past 16 years. Abuse Fannie and Freddie to achieve a domestic objective. Pay the price later.

This time the market may have something to say about this bad plan.

Comments

[nobby73:]

The bottleneck in the US economy is the excessive leverage of individuals, as a consequence of bridging the wealth gap (i.e. the difference between the lifestyle people could afford and the one they felt, or were told, they were entitled to) first through credit cards then through the housing ATM which helped fan the flames of the housing bubble.

All the bank bailouts in the world won't help address this issue and property prices are falling to reflect what people can afford, but this leaves those who bought in the last few years of the housing bubble in a debt trap.

Perhaps a better solution is to allow people to grandfather a portion of their debt, representing the negative equity, which will be converted into a government loan at a rate discounted to Fed Funds, subject to a floor at zero, with a bonus whereby early prepayment of principal will have a multiplier effect, i.e. for every $1 paid down, the amount will fall by say $1.15 (need the level to be somewhere sensible so that people don't try and use credit cards to pay down, but need to pay down this part before the legacy mortgage.)

As the economy improves, and Fed Funds rates rise, then they will begin paying interest on the loan, but this will give the Fed greater control over money supply and inflation. After all, the current almost zero rates only benefit the banks as the increased lending margins.

Simply raising LTVs to 125% fails to address the issue, but hopes if they close their eyes, the problems will go away. You can't have a secured loan on an amount greater than the security. But if we continue in the current direction, with bailouts galore for corporations, with no discernible benefit for households, things are going to get a great deal worse.

Jul 02 03:29 AM

[Loan Survivor:]

You both have valid concerns, but can you tell me how the government is worsening their position with this move?

As pointed out, the new guideline applies ONLY to EXISTING FNMA/FHLMC mortgages. The government already OWNS FNMA/FHLMC and has basically guaranteed the debt.

Is it sound business strategy to let your debtors default, or is it a better strategy to renegotiate with them to pay something?

Right now, many companies are filing for bankruptcy and renegotiating their debts with their creditors. Why shouldn't upside down homeowners be allowed to do the same?

That's basically what this program is doing. It's NOT creating new debt as Bruce implies. The debt ALREADY exists!

If, by lowering housing payments, fewer people default, than it's a smart move.

Why would homeowners choose to keep paying on something they're upside down on? Well, not all will, but many will be emotionally tied to their homes. Don't ever underestimate that emotional factor.

A logical reason homeowners will continue to pay is because they HAVE TO LIVE SOMEWHERE! If the cost of remaining in their current home can be brought down within X% of the local rental market, then they cannot live somewhere else cheaper. So, they will stay & pay, hoping that housing prices will recover and they won't be upside down forever.

The government actually just needs to do away with appraisals on restricted refinances altogether. This has already been the case with FHA Streamline refinances since 1984 and I've never heard any "financial experts" complain about that program.

Jul 02 08:24 AM

[Edward Harr...:]

Bruce, I am with you on this one. Mortgage debtors are going from a non-recourse loan to a recourse refinancing at a significant premium of up to 25% more than the value of their house.

In effect, one becomes shackled to the house in a way that one was not previously. This is being touted as a way to help people stay in their houses. In reality, it is a way to help banks keep from writing down assets while they earn enough money to increase their capital base.

If we really wanted people to stay in their hoses, we would allow them to go into foreclosure and help them find alternative housing. Moving them into a 125% LTV recourse loan is setting them up for disaster and setting taxpayers up to take on more losses.

And, of course, this is predatory because most people will not know that they are going from non-recourse to recourse.

Jul 02 08:44 AM

[Bruce Krasting:]

loan survivor:

1) Yes the gvmt has gteed the debts of the Agencies (at least functionally). That means you and I pay the price for what happens. They are making substandard loans with your money!

2) It is always better to renegotiate with troubled borrowers. That is our system of law.

3) Look at those corporate deals you talk about. The end result of the GM,Chrysler,Six Flags etal. restructurings is that the borrowers end up with less debt. Their debt is reduced based on the size of their assets. In the case of GM bondholders got 29 cents on the dollar. What the Agencies are doing is piling on debt to troubled borrowers. They are doing the exact opposite of what are courts would do by way of a resolution.

4) This will result in more new debt by the agencies. That means YOU have to pay this off. Why should you get stuck with this? This is not going to help anyone.

5) I understand this emotional factor you refer to. This has nothing to do with emotions. It is an over leveraging of the borrower. It is creating more bad borrowers in the future. We need programs that end the cycle of default. It is a dangerous precedent. The Agencies could not do this on new loans as it would be a violation of their Charter and the rules governing the Receivership. The are breaking their own rules.

6) What the gvmt needs to do is pass a law that it is illegal for a lender to extend a mortgage in excess of fair value. That would stop this insanity. We would all be better off.

Thanks for the comments. I need to vent on this one.
b

Jul 02 09:42 AM

[David McSwain:]

Great post! I agree wholeheartedly. As many have said "if bad loans got us into this mess how can we expect more bad loans to get us out?"

Last September when the wheels fell off I had concerns about actions that would prop up the economy only to have it fall further. I had hoped the powers that be would have had the testicular fortitude to do the right thing and just wait out the storm. It appears they do not.

My bet is that actions like this will give a false sense of recovery for a time only to have us fall further in the future, much like the stimulus money is currently doing.

To me these actions are sheer panic. It's like hitting black ice at 80 mph and slamming on the brakes- your panic reaction only makes things worse.

Jul 02 10:54 AM

[Perry B:]

Good article good comments. Lets not forget that good lending officers became great mottgage lenders. Later as thier power grew became even greater Hedgefund managers. Now these individuals have the golden rule in thier hands. They will ultimately decide who emerges as the Nation with the most profitable sound buisness plan. Our congress and legislators are not helping our position in this new future buisness model. The good news is that there is a plan. The bad news is we as Americans will suffer greatly for the banking industries greed in the late 70's

Jul 02 11:46 AM

[John Lounsbury:]

Bruce - - -

Good article. I wrote an Instablog earlier today on this. After looking at a couple of case studies, I came to the conclusion that this revised plan would not have much impact, at least with respect to variable mortgages originated in 2005 and 2006 and due for resets in 2010 and 2011. Since only agency mortgages are eligible, the impact on the variable rate resets may not only be small, but possibly negligible. Were any of these variable mortgages underwritten by Fannie and Freddie?

Bruce, I hadn't read your article at the time I wrote the Instablog. I have gone back and added a hyperlink. If picked up by SA editors, it will be an article tomorrow.

Edward Harrison - - -

I have missed the point that these refi's will make the mortgages recourse loans. I guess I should dig deeper.

Jul 02 06:14 PM

[Bruce Krasting:]

E. Harrison and Yves Smith did us a favor on the issue of recourse. Hopefully that fact will get some traction and derail this effort.

I doubt it. They are going to push this out the door. There are mortgage brokers working this 24/7. By Monday there will be ads on TV. It is not a hard sell to borrowers. Most have already done a cash our refi so the recourse issue is not relevant there.

Wild stab at numbers:

FNM/FRE have 30 mm borrowers. The average is $200k/ borrower. Say 10mm are current and want to take advantage of this deal. The up their mortgage by an average 0f 20%.

Well that comes to $400 bil. A very large stimulus to the economy.

That number too high? Ok cut it in half to $200 b. Still a big deal.

What is your guess on this number? Anyone else?

Jul 04 08:33 AM

[a fat panda:]

Loan -

"Right now, many companies are filing for bankruptcy and renegotiating their debts with their creditors. Why shouldn't upside down homeowners be allowed to do the same?"

What renegotiation? The government told the bond holders that contract law doesn't really mean anything. Senior debt holders were simply moved aside. That is a precedent that I really don't want to see repeated.

On Jul 02 08:24 AM Loan Survivor wrote:

> You both have valid concerns, but can you tell me how the government
> is worsening their position with this move?
>
> As pointed out, the new guideline applies ONLY to EXISTING FNMA/FHLMC
> mortgages. The government already OWNS FNMA/FHLMC and has basically
> guaranteed the debt.
>
> Is it sound business strategy to let your debtors default, or is
> it a better strategy to renegotiate with them to pay something?<br/>
>
> Right now, many companies are filing for bankruptcy and renegotiating
> their debts with their creditors. Why shouldn't upside down homeowners
> be allowed to do the same?
>
> That's basically what this program is doing. It's NOT creating new
> debt as Bruce implies. The debt ALREADY exists!
>
> If, by lowering housing payments, fewer people default, than it's
> a smart move.
>
> Why would homeowners choose to keep paying on something they're upside
> down on? Well, not all will, but many will be emotionally tied to
> their homes. Don't ever underestimate that emotional factor.
>
> A logical reason homeowners will continue to pay is because they
> HAVE TO LIVE SOMEWHERE! If the cost of remaining in their current
> home can be brought down within X% of the local rental market, then
> they cannot live somewhere else cheaper. So, they will stay &amp;
> pay, hoping that housing prices will recover and they won't be upside
> down forever.
>
> The government actually just needs to do away with appraisals on
> restricted refinances altogether. This has already been the case
> with FHA Streamline refinances since 1984 and I've never heard any
> "financial experts" complain about that program.

Jul 07 11:11 PM

[Moon Kil Woong:]

It is doubtful even the stupid people who bought houses with insufficient credit and income with little or no down will be interested in digging themselves deeper by borrowing even more at this point, which will probably make them even more incapable of paying back their even larger loan. That is, unless they have no assets and no expected income and plan on spending it all and not repaying that as well.

Either way, Fannie Mae and Freddie Mac will be losers once again, not that they care. For after all, it's the taxpayers who are the losers. According to the government we should pay them on the back and say well done. Without them, according to the government, there would be no housing market. The way they are going, they will be exactly right. They have already monopolized one of the most important sectors of the economy offering loans no others can offer at rates that can't possibly hope to be profitable.

The problem is they way they are running it, no houses will have any net worth by the time they finish. But once again, why should they care if we are all wards of the state. It just means more marketshare for them.

Jul 13 04:53 AM