FHFA Five Year Plan: Where's the Exit Strategy for American Taxpayers?

The FHFA released its five-year plan yesterday. There are no surprises in this report. There are no innovative plans to change the troubled mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE). The five-year plan by FHFA calls for them to do what they have been doing for the past year as FHFA and for the past decade as OFHEO. Not much in the way of supervision or control. Just business as usual.

The primary goal set forth by FHFA is as follows:


How are they doing in their Primary Goal? Not so good. On page 29 of the report is the following:

The GSEs have not met and may continue to be unable to meet many regulatory standards

A critical component of the report is missing. Where is the exit strategy for American taxpayers? There is none in the five-year plan. This topic is glossed over with a reference to the requirement by the Conservatorship Agreement that a) limits the maximum balance sheet of the GSEs and b) a requirement that those aggregate limits be reduced in a significant manner over a number of years. This sounds like a way out. But it is not. It is misleading to leave the reader with that impression.

Any balance sheet caps by the Agencies are worthless. The other wing under the FHFA is the Federal Home Loan Banks. They are ramping up their balance sheets to adjust for the limits at the Agencies. There are no effective limitations on assets under the FHFA umbrella.

In addition, there are no restrictions on the amount of MBS that either FNM or FRE can guarantee. So the amount of mortgages they can have at risk is unlimited. This open-ended guaranty is a backdoor way to maintain and expand the Agencies position in the mortgage market. So far this year their balance sheets have been stable. But they sold nearly $1 billion of newly issued guaranteed MBS to the Federal Reserve. This is just moving the deck chairs. The end result is the same. The taxpayers are at greater risk to the mortgage market today than ever. The systemic risk is continuing to be concentrated exactly where it should not be. In the hands of the government.

A five-year plan should have at least addressed this problem. Even I understand that there are no quick fixes to the mortgage mess. Our feet are stuck in this cement. It would have been refreshing if Mr. Lockhart had included as one of his goals that FHFA would create a Blue Ribbon type panel to take on this very serious topic. The panel should include academia, existing and former Fed and Treasury folks, the private sector financial side and some people who do not have an axe to grind. There should be a bulldog running this.

If we let the FHFA set the five-year plan for the FHFA then in five years we will have accomplished nothing. The government’s role will be bigger than ever. One FHFA goal should be (click to enlarge):


FHFA puts the following sentences at the bottom of its correspondence. They are very proud of this big number. The folks at FHFA want this number to grow every week and month forever. If we are not careful that number will grow to $10 Trillion in five years.


I did like the cover and all the other pictures of the happy home owners.

Comments

[Adam855:]

The goal should be to break Fannie Mae and Freddie Mac into multiple smaller pieces (5-10 at least?) and privatized with no implicit or implicit government guarantee on any of the pieces. They have way too much of the mortgage market, and their government/political element is market distorting to say the least. Let the pieces survive or fail on their own through market competition. I don't know if that can/should happen within 5 years, but it's best to start with the right goal. Unfortunately it looks like the current plan is to continue on the same course that created the massive real estate bubble we're still attempting to deal with.

Jul 10 07:50 AM

[Old Rick:]

Good article!! I wonder if Franklin Raines and his "outstanding leadership" will be returning as part of the 5-year plan?

Jul 10 10:50 AM

[Jake Blues:]

Adam855-

And what of the shareholders in such a scenario?

Jul 10 11:15 AM

[Bruce Krasting:]

Jake: There are no shareholders. This stuff is trading at 50cent because there are so many shorts that can't cover at these prices. That will work itself out. The stock is worthless. There is no upside to it.

However, The Preff is interesting. I think the Preff got screwed in the receivership structure. That stuff is worth a buck or so today. I think there has to a settlement on this one day. Maybe worth 10$????

I did a joke piece recently. Except I was not really kidding. It sort of covered the pref question.

I don't think anyone got the humor of this.......

brucekrasting.blogspot...

Jul 10 12:35 PM

[long roh:]

The fundamental question is whether we, as a nation, want to encourage home ownership. In today's world, this question is largely left out of any debate in favor of haggling over the details of government intervention. So I applaud the author for provoking that question.

That being said, I think there are sound policy reasons to encourage an "ownership" society. Chief among them is that owners of assets (even leveraged assets) are more likely to be better caretakers of assets than renters. Second, relegating huge swaths of the population to near-permanent renter status would lead to higher rates of poverty and less socioeconomic stability. Finally, the ownership phenomenon allows for the expansion of credit supply and more economic growth than would be possible without it. (Hence, the real estate bubble and dislocation caused a massive contraction of credit and economic strife.)

It is tempting to throw out the whole damn scheme (as Adam855 would) in light of what has happened as a result of an ironic combination of misguided government intervention and a lack of effective regulation, but ultimately I think we need government policies that encourage home ownership. Don't throw out the baby with the bath water.

I agree with the author's suggestion that the solution to the current quandry should be actively considered. At the same time, there is so much economic uncertainty right now that any "exit" strategy is probably premature.

Jul 10 02:10 PM

[Jake Blues:]

On Jul 10 12:35 PM Bruce Krasting wrote:

> Jake: There are no shareholders. This stuff is trading at 50cent
> because there are so many shorts that can't cover at these prices.
> That will work itself out. The stock is worthless. There is no upside
> to it.
>

I ask because I'm a shareholder. I've been holding since $1.15 and was too stubborn to take my losses when it crossed back over $1 several months ago. I bought this with a long term perspective, but I'm starting to come around to the fact that there may not be a long term. Within a month, FNM will either reverse split or be de-listed and I don't want to be a holder when it happens. I will spend the weekend trying to determine if there is anyway it can make a run to .60-.70 so my loss isn't so devastating. If not, I'll take my punishment on Monday.

Thanks for the reply.

Jul 10 04:25 PM

[Between The...:]

On Jul 10 02:10 PM long roh wrote:
> The fundamental question is whether we, as a nation, want to encourage
> home ownership
The current policies do not encourage home *ownership*, only over-leveraged home *borrowing*. Zero down used to be ok, and FHA still allows 3% down, but anything less than 20% is way too aggressive from an investment standpoint (still 4:1 leverage). Inflating the price of homes makes it harder for regular people to actually ever own the house, and the boom-bust cycle destroys the balance sheets of so many people when they end up underwater.

> That being said, I think there are sound policy reasons to encourage
> an "ownership" society. Chief among them is that owners of assets
> (even leveraged assets) are more likely to be better caretakers of
> assets than renters.
Again, home borrowers that have little to no equity DON'T do a good job of caretaking their houses as shown by the terrible rate of recovery on foreclosures. Once underwater, home maintenance pummets and the condition of REOs is notoriously pitiful.

Second, relegating huge swaths of the population
> to near-permanent renter status would lead to higher rates of poverty
> and less socioeconomic stability.
Many, if not most, industrialized nations have lower home ownership rates, higher rent rates, and lower poverty. A middle class home buyer in 2005 is now impoverished (with six-figure negative equity) because of the ease of getting a risky home investment.

Finally, the ownership phenomenon
> allows for the expansion of credit supply and more economic growth
> than would be possible without it. (Hence, the real estate bubble
> and dislocation caused a massive contraction of credit and economic strife.)
Expansion of credit supply that cannot reasonable be paid back does not cause economic growth. Requiring unsustainable growth of asset collateral (home values) to support more growth will eventually collapse as the loans cannot be serviced. This causes a deflationary cycle (See Japan 1987-now) as asset prices plunge, defaults occur, pushing prices down more, causing more defaults, etc. Credit alone does not build wealth, and enough bad loans now will cause recessions in the future.

> It is tempting to throw out the whole damn scheme (as Adam855 would)
> in light of what has happened as a result of an ironic combination
> of misguided government intervention and a lack of effective regulation,
> but ultimately I think we need government policies that encourage
> home ownership. Don't throw out the baby with the bath water.<br/>

Throw it out because market distortion always has unintended consequences, because regulation that is the last line of defense against corruption always fails, because home ownership based on bad credit is not "good" in the long term.

> I agree with the author's suggestion that the solution to the current
> quandry should be actively considered. At the same time, there is
> so much economic uncertainty right now that any "exit" strategy is
> probably premature.
The GSEs got too big, took too many risks, and abused their implicit gov't debt backing to the tune of $5 trillion. It's not too early to talk about exit strategy, it is too *late*.

Jul 10 05:31 PM

[Poor Texan:]

On Jul 10 02:10 PM long roh wrote:

>The fundamental question is whether we, as a nation, want to encourage home ownership.

No! Home ownership restricts mobility for those who need to follow their work. It also requires an investment of time and money to maintain the property and those who are not rich enough to hire help or skilled enough to do their own maintenance or are very busy in their careers should rent. The deductions for real estate taxes and mortgage interest have been way oversold.

>Second, relegating huge swaths of the population to near-permanent renter status would lead to higher rates of poverty and less socioeconomic stability.

Where is there an empirical study on this? Back in the sixties (in Chicago!) we had a program that made the downpayment so poor people could own homes and then paid part of their mortgage payment. When the maintenance became a problem, the people, totally clueless in home ownership, walked away and whole neighborhoods were reduced to empty lots.

If you need a place to live you can rent an apartment or house and let the owner handle the maintenance problems and concentrate on building up your savings account or investments.

Home ownership is NOT for everyone!

Jul 10 06:10 PM

[Duude:]

Exit strategy? What? Are you kidding me? There isn't a strategy now, nor will their ever be. This isn't about fixing their balance sheet and spinning them off to private investors. The GSEs are in government hands and will remain that way forever more. The fact is politicians have always considered the GSEs as government agencies for government planning. The whole business about their debt having an 'implied' backing of the government was a ruse orchestrated so as to fool the bubbas into thinking the government didn't have their hand tinkering in one of the largest parts of the US economy. The GSE's have always been a governmental instrument for social engineering. Now that the emperor has shed its clothes for good, its expected that all free marketeers will adapt to the truth. If the government was to turn it into a true private company, who would buy it? They are way overextended and the quality of their book is rubbish, on average. They would require a major infusion of fresh cash to cover future foreclosures amounting to trillions. it would only put politicians behind the eight ball for all the social engineering they've done. They'd much rather keep this dog and keep it on an intravenous feed of taxpayer dollars forever thus insuring they could continue subsidizing bad risk homeowners to their heart's content.

Jul 10 06:38 PM

[marathonman:]

The love the Performance Goal 1.1 "Starting today and over the next five years FHA will develop a viable plan to minimize the governments role in the mortgage market."...yeah, good luck with that.
scott atl.

Jul 11 07:57 PM

[long roh:]

For those who mistook my comment as defense of what happened in the past, allow me to clarify: I believe mass home ownership is in the public interest. Obviously unsustainable borrowing practices are not the right course. On the flip side, the suggestion that the government has no role in regulating or encouraging home ownership going forward puts far too much faith in "private markets." There is no easy answer to the present quandry, but I'm quite certain that simply extricating the taxpayer from the equation will be destablizing.

Jul 11 11:01 PM

[Radardoc:]

I can't believe this question is even being asked! You can't operate in a free market with this socialist ideal.

Let me clarify:

It's not the job of the damn "nation" to encourage OR discourage home ownership. If the market is such that ownership is a good deal for you, you buy, if not you don't.

The government "encouaging" everyone to own a home was the first step in the mess we now find ourselves in.

On Jul 10 02:10 PM long roh wrote:

"The fundamental question is whether we, as a nation, want to encourage home ownership."

Jul 13 11:39 AM