The Irony of the GSE Bailout

Includes: FMCC, FNMA, IYR
by: Bo Peng

While the Congress has chosen to ignore the pink elephant in the room called GSEs in their half-hearted jab at financial reform, the topic certainly has not been lost to some in the blogosphere. And it's seeping into the mainstream financial media. Bloomberg has this good piece on the subject. (By the way, when can we get a US version of FT Aphaville from any mainstream financial media?)

But what the Bloomberg report calls a "worst case scenario" of housing prices going down another 20% and GSEs needing $1T more bailout, I call a very realistic scenario. The key is the outlook of US economy and how it manifests into jobs and expansion of credit. I hate to sound like a broken record. So I'll just let Bloomberg speak for me: Europe and EUR. I read extensively on the economic outlook, and that includes arguments for recovery. Yes, at the philosophical level everything is possible, but none of the arguments for recovery appear plausible to me.

The bailout of GSEs is the biggest, yet stealthiest, bailout to banks and "lenders", whose only goal was to collect fees. And Bruce Krasting just added FHA to the worry list. Where's the outrage?

Here's my explanation. GSEs own or guarantee 80% of all US residential mortgages. A tax-payer funded bailout of GSEs is ultimately a bailout of tax-payer themselves. Banks and GSE employees/shareholders/bondholders are merely fringe beneficiaries riding the coat-tail.

But the key to realize is that it's a Ponzi forced upon our future generations. If housing recovers strongly, the GSE problem may resolve itself in a few decades; but our children would pay more for housing. If it doesn't, then they'd be stuck with the debt.

Don't feel too guilty, though. There's a good chance that the current generations will have to pay, in or before retirement. It'll come as a "surprise" in budget deficits but no biggie, it'll only double it.

Disclosure: None