John Hussman: Can the Emergency Housing Bill Be Fixed?

Excerpt from the Hussman Funds' Weekly Market Comment (7/28/08)

 

Congress passed an emergency housing bill over the weekend, raising the government debt ceiling by $800 billion to $10.6 trillion. The FHA was authorized to refinance up to $300 billion in mortgages. In order to qualify for the FHA loans, lenders would take a write-down on the existing mortgages, and homeowners would have to share future home price increases with the government. Generally speaking, my impression is these FHA refinancing provisions of the bill are reasonable. Unfortunate, but reasonable.

One shortfall of the bill is that it doesn't appear to impose sufficient costs on Fannie Mae and Freddie Mac, given that those institutions bought so many bad loans originated by careless lenders. Over the past decade, Fannie and Freddie have dramatically increased the size of their retained mortgage portfolios in an attempt to boost earnings. In dollar terms, the increase has been more than 10-fold. As a percentage of total home mortgages, the portion held directly by Freddie and Fannie for their own portfolios has grown from about 5% of total mortgages in 1990 to more than 20% today. This was not required to enhance housing affordability or availability. It was pure profit-seeking, with the risk borne by U.S. taxpayers.

...

Stanford economist Ronald McKinnon has long argued that public policy obligating taxpayers to act as the lender of the last resort should be constructed in accordance with Bagehot's Rule. British economist Walter Bagehot's early and influential work on the management of financial crisis has a particularly important prescription as it applies to mounting credit failures in the U.S. financial system: very large loans at very high rates are the best remedy for the worst malady of the money market when a foreign drain is added to a domestic drain.

Bagehot's name has surfaced in a few editorials in recent weeks, but they have invariably focused on the "lend freely" portion of his advice, while overlooking Bagehot's admonition to impose costs, capital requirements, and other safeguards where public funds are concerned. In short, liquidity should be available to Fannie Mae and Freddie Mac, but the interest rates charged should be very high. This would create natural disincentive against further bad lending practices. Though it is too late to save the current housing bill, subsequent legislation should explicitly include provisions to charge high interest rates on the government-provided liquidity. It is in the public interest for Fannie and Freddie to continue to operate, but they shouldn't stand to earn a private profit at taxpayer expense. High interest rates on government provided liquidity would also encourage these institutions to rely on private capital rather than taxpayer support wherever possible.

Comments

[Real Estate...:]

Here we go again....The Fed Bailing people out. What a joke....

So here's what the future holds:

-The Fed/Bush Administration ok's FHA to refinance overinflated homes at today's 2004 pricing.

-x amount of homes are refi'd at max value (today's percieved value).

-The RE market continues to adjust downward, slowly but surely ebbing its way to 1998 levels (market equilibrium/Where it's supposed to be).

-Vwallaaa! The "$700k home" that they refinanced has predicatably adjusted downward and is now worth $650k.

-So to start: $50k drop per home (not substantial or remotely unrealistic) multiplied by the 400,000 homeowner's the plan "will benefit" = larger deficit/another failed government plan.

But, my friends it like a hard night out on the town after a good payday; it's fun in the beginning but the morning hangover reveals the truth.

Mr. Bernanke I have two questions:

1) Where do we get that giant bottle of Motrin for the bigger economic hangover to come?

2) Where do I get and send the government paperwork that ensures my business has not downside risk and i'll be bailed out?

2008 Jul 31 12:41 PM

[ASG:]

The author makes the claim:

"One shortfall of the bill is that it doesn't appear to impose sufficient costs on Fannie Mae and Freddie Mac, <b>given that those institutions bought so many bad loans originated by careless lenders"</b>

We hear this claim repeatedly made about Fannie Mae but curiously there is NEVER any factual support offered to prove it ....

The reality and reason is that there is not factual support for this claim ... a review of Fannie Maes loan portfolio shows a tiny fraction of their portfolio in subprime loans - a fraction of 1% - and likewise their ALT-A exposure is similarly limited at appx 10% of their total portfolio

A similar review of default and more importantly actual foreclosure rates shows that Fannies portfolio is performing very well - with both default and foreclosure rates far below industry standards

Additionally, a legitimate honest review would show that they have stopped entirely buying subprime, and almost eliminated ALT-A purchases as well

Again - a simple review of Fannie Maes real numbers would show a strong portfolio performing well above industry standards - it would show very good avg credit scores - 721 FICO - and 90+% fixed rate (not ARM) loans

It would also show, despite its low default and foreclsoure rates, support for a decreasing direction in both

And as such that Fannie Mae, rather than the albatross it is claimed to be is actually an excellent steward of the trust placed in it

An honest review would show, absent the ridiculous "mark to market "fair value" write downs (which really mean "mark your perfectly good fully performing assets down to fire sale liquidation prices"), Fannie Mae is making very good money ... $3.4 billion in interest and guarantee income in Q1 2008 alone ....

Fannie Mae is not in any way, other than if you use accounting rule forced "paper" losses not supported by real world performance, insolvent or in trouble - at least not in their assets - their loan portfolio ....

That does not seem to prevent ignorant investors - who apparently aren't smart enough to do their own research, from riding the wave of media hype right into the ground ...

2008 Jul 31 02:52 PM

[adan:]

a blank check priviledge to anyone in govt is irresponsible no matter to whom it's to no matter for what it's for

relinquishing our fiscal responsibilities via our elected representatives who elect not to do their job is a waste of our democracy and constitution

2008 Aug 01 08:28 AM

[rm:]

[a legitimate honest review would show that they have stopped entirely buying subprime, and almost eliminated ALT-A purchases as well ]

It was my understanding that the main reason they ventured off into subprime was because they were under governmental pressure to do so.

[That does not seem to prevent ignorant investors - who apparently aren't smart enough to do their own research, from riding the wave of media hype right into the ground ... ]

That ignorance isn't the exclusive province of investors. Have you seen some of Maxine Waters' statements?

2008 Aug 01 08:43 AM

[TommyG:]

ASG, I believe you are correct, bought both Fanny and Freddie. I don't believe they'll need to borrow. Not that they were the most well managed company around, the lobbying they do is disturbing. They need to reduce assets, shore up capital a bit. New mortgage bond program may ease some of the pressure they have to lend.

2008 Aug 01 09:51 AM