Posted on 03/15/2006 12:37:13 PM PST by ex-Texan
The key to holding up the entire speculative U.S. financial system with its current excessive levels of debt - federal (current account and trade), state, municipal, corporate and household - is maintaining the U.S. housing bubble. Anything less would result in America’s worst nightmare and, in short order, the entire world.
The housing market is dominated by Fannie Mae and Freddie Mac who hold 75% of all outstanding home mortgages (and the Federal Home Loan Bank Board to a much lesser extent). One too many additional increases in the Fed rate may well turn out to be the U.S. economy's Achilles' heel and lead to a major crisis at these two institutions generating an out-of-control systemic breakdown situation and disastrous financial implosion. AbsolBanners Image
Here's why. Fannie’s and Freddie's (FF) original functions were to provide liquidity to the housing market. After a mortgage lending institution (MLI) originated a mortgage – say, $100,000 – FF would purchase that mortgage from the MLI for a fee and hold the mortgage to maturity.
The MLI now had $100,000 to make yet another mortgage loan and earn yet another fee. By the repeating of this process FF injected liquidity into the housing market making it possible for MLIs to increase the number of mortgage loans they could make each year and earn considerably more fees in the process.
Where did the money come from for FF to raise money to purchase these mortgages from MLIs?
It was easy. FF simply issued bonds (which, as you know, are a form of debt) at a somewhat higher interest rate, which was their spread or profit.
The more mortgages they bought from the MLIs covered by the issuance of their bonds the more money they made. And it was all totally secured by the assets of the houses themselves. A risk free arrangement. Not bad. The MLIs made money, FF made money and the consumers owned houses on which they could afford to make their monthly mortgage payments.
Beginning in the 1980's FF got greedy! They began to encourage the MLIs to sell mortgages to purchasers who would have to spend more than the U.S. Department of Housing’s recommended 28% of gross income to service the housing (mortgage payments, home insurance payments and home property tax due) costs involved.
As FF expected the demand for houses went up, the price of houses went up, the number of mortgages went up, the size of mortgages went up, the profits of the MLIs went up and the profits of FF went up.
But the degree of financial risk for FF increased dramatically.
Many mortgagees had to pay out 50%-60% of their household income in housing costs and were extremely vulnerable to any economic setback they might encounter - loss of job; increased cost of living; health problems; death, incarceration or illness of breadwinner. As a result, the rate of delinquencies and foreclosures went up.
In many cases the down payments made by these new mortgagees were so small that the only way FF could recoup its outstanding mortgages was if the resale prices of the homes appreciated considerably from the date of the initial purchase. The greater the appreciation of such homes the less the risk to FF.
Next, in the unending search for increased profits, FF undertook some financial innovation. They began bundling groups of mortgages together as mortgage-backed securities (MBS) on which they guaranteed, in case of default, to pay interest and principal “fully and in a timely fashion.”
They sold these MBSs for a fee, to mutual and pension funds and to insurance companies around the world. This gave the funds a claim to the underlying principal and interest stream of the mortgage.
In doing so the risks entailed in the owning of mortgage debt were broadened beyond FF. If FF were unable to fulfil their guarantee (and the monies provided by the government are totally inadequate) these funds, too, would be adversely affected and depending on the extend of the default, gravely so. FF's profits went up but its reward/risk ratio dropped like a stone!
And finally, to squeeze out even more profits, FF began taking 50% of their MBS holdings and pooling them once again into derivative instruments called Real Estate Mortgage Investment Conduits, i.e."restructured MBS" or into what are called Collateralized Mortgage Obligations for which they are paid a fee.
These instruments are highly specialized derivatives, i.e. bets on the direction of future rates of interest. FF's profits went up even more but the risks associated with these actions became excessive!!
Thus, what started out as a simple home mortgage, has been transmogrified in to something one would expect to find at a Las Vegas gambling casino. Yet the housing bubble now depends on precisely these instruments as sources of funds.
If too great a portion of FF mortgages were to go into default and cease to pay interest or principal, FF would not have sufficient cash to pay the holders of its bonds. If the situation were to become too great FF would default on its bonds.
So, whereas before one had one economic catastrophe - the default of some mortgages – because of the way the housing market is structured, this produces a second catastrophe – the default of FF’s bonds, which are at least 10 times greater than that of any corporation in the U.S. Such a default would put an end to the U.S. financial system, right then and there.
Yet a second obligation compounds the problem - its guarantees on the MBS. In a crisis in the housing mortgage market, FF would not be able to meet the terms of their guarantees and would go bankrupt from this source, if it had not already defaulted on their bonds. The pension and mutual funds, which had bought the MBS on it guarantees, would suffer tens of billions of dollars in losses.
Finally, FF's derivative obligations in hedges, allegedly to protect it from risks, could themselves go in to default against the banks and other counter parties.
The above-mentioned obligations of FF total over $5 trillion. Another $1 trillion in obligations are held by the Federal Home Loan Bank Board and private issuers of MBS. These $6 trillion in risky obligations are distinct from, and in addition to, the more than $6 trillion in mortgages themselves.
As such, a total in excess of $12 trillion is laden on to the homes and attached to to the incomes of America's homeowners. And then there is credit card debt, car lease debt, cell phone contract debt, bank loan debts, margin debt, etc!
Nothing, absolutely nothing, must stand in the way of consumers fulfilling their financial obligations - and they absolutely must not default on their mortgages. Cheap money must prevail. Not dirt-cheap like before but still very cheap by historical standards.
Cheap money is necessary to keep the real estate bubble in force because consumer spending increases 0.62% for every 10% gain in the housing market (more than twice that of a 10% gain in the stock market).
Regretfully, though, this FF house of cards is on the verge of collapse. Bond prices have fallen and interest rates are approaching 5%. The ramifications are dire.
A wide variety of partners hold large chunks of FF debt: commercial and investment banks, hedge funds, mutual funds, pension funds, insurance companies, private investors. They are all exposed to large losses were either Fannie Mae or Freddie Mac to default on their debt.
In the U.S., for example, 60% of all banks (approx. 5000) own FF debt in excess of 50% of their equity capital. As the Office of Federal Housing Enterprise Oversight has said "such an event as the default of FF debt could lead to contagious illiquidity in the market for those debt securities which would cause or worsen illiquidity problems at other financial institutions…potentially leading to a systemic event.
The Fed is between the proverbial 'rock and a hard place.’ They engineered low interest rates in the first place, both to keep the financial markets going, and in large measure to keep the housing bubble afloat. They are now in the final stages of raising interest rates to prop up the collapsing U.S. dollar and to forestall rampant inflation.
Were they to initiate one quarter percent increase too many it would destroy the interest rate environment that is essential to keeping the housing bubble alive; to keeping consumers spending at a high level thereby keeping the economy growing; to keeping corporate sales and profits high thereby keeping the stock market healthy. Have they gone too far already?
The bubble seems to be loosing air slowly at this point but what will the impact be of the next increase? The impact of one too many rate increases on such a chronically debt-ridden and maladjusted economy must not be over estimated.
It is just a matter of time before further increases in mortgage rates will result in increases in monthly mortgage payments than some borrowers cannot handle. This will be particularly so for borrowers of sub-prime loans who were able to purchase their first homes with almost nothing in the way of a down payment and who, even now, have a delinquency rate at near record levels.
In addition, as mortgage rates rise further, fewer first-time buyers will be able to afford to buy a home which will, in turn, slow down the sale of new and resale homes.
With further increases in mortgage rates there will be dramatically reduced refinancing of mortgages, which have gone a long way to financing the retail boom in retail sales over the past few years. Indeed, more than $500 billion in equity has been withdrawn annually in the U.S. and $29 billion annually in Canada for that purpose.
But rest assured the Fed will do absolutely everything in its power to prevent the puncturing of the housing bubble!
FF assets have expanded so rapidly over the past few years due to the number of mortgages, the escalating value of mortgages (as a result of escalating real estate prices) and the refinancing of mortgages and they have so much debt in the form of mortgages, bonds, MBS’s and derivatives that should they encounter any problems servicing the debt it most likely will have a destabilizing effect on the U.S. economy.
Indeed, the Fed are so concerned about this happening they are flooding the economy with almost limitless liquidity.
There must be a crisis of historic proportions coming, and the Federal Reserve Bank of the United States is making sure that there is enough liquidity in place to protect our nation's fragile financial system. The amazing thing is that the Fed's actions mean they know what is about to happen.
Perhaps the Fed finally recognizes that the housing bubble has experienced a leak that could well escalate into major proportions soon. Perhaps the Fed has learned that one (or more) of the 3 American banks holding 95% of U.S. derivatives are experiencing some difficulties managing their risks. Perhaps the FF is encountering major derivative losses once again. Perhaps the Fed are concerned that the rising budget deficit and/or the ever increasing and already record-high current account (trade) deficits are very near the tipping point. Perhaps it is their fear that the recent and continuing interest rate hikes are going to have a very negative impact on the already overly indebted U.S. consumers (rising mortgage, lease and credit card rates), the stock market (lower corporate profits) and the bond market and lead to a recession.
Perhaps the Fed sees their greatest fear of all - deflation - just around the corner.
So where should we be investing our money? Certainly not in real estate. Definitely not in bonds. Absolutely not in the general stock market. What’s left? Well, there is cash (at least you won't lose your shirt if you hold it in something other than U.S. currency); gold bullion which performs well in such a chaotic environment (and by extension mining company shares and/or their warrants) and also energy stocks because of the political climate being the way it is in the Middle East.
Fannie Mae and Freddie Mac who hold 75% of all outstanding home mortgages (and the Federal Home Loan Bank Board to a much lesser extent). Congress is taking a closer look at FF. Perhaps if our representatives had investigated this operation five years ago we would all have been spared some grief. Oh, well. Not for me to worry, anyway.
Gold's not looking so good over the past month. What does the goldbug newsletter responsible for this article have to say? Is the gold bubble bursting?
People got to have a place to live. I am more worried about jobs outsourced to India.
parsy, whose mobile home is paid for.
Homes becoming more affordable to more people? The horror...
Article is an oldie but goodie.
I think I'm drawing in all bank accounts and investments and heading to Vegas. Vegas is a better investment than the mess the FF ponzi scheme has created.
Very good article. However, the author didn't mention the other two investment opportunities: canned tuna and powder milk. And look at it this way, if the bird flu goes the way everyone thinks, only half of your creditors will be calling you.
Right, and here in Central Texas, NW of San Antonio in our rural county, houses are being built at a record rate and on average, with record large floorplans. My wife has worked in the title/abstract business for over 30 yrs so she's got a darn good perspective of that market.
We can't find folks to do small jobs, they're all working on new houses going up--and that's a good thing even though it might be aggravating. Maybe we ought to hire a "wet", oh excuse me, an UNDOCUMENTED EMMIGRANT, they'll just do the work that Americans won't do, is that the mantra?
ROTFL!
emmigrant=immigrant---sheesh! Use spell check, use spell check.
The H5N1 virus is not a joking matter, but can you imagine what might happen to our national economy? I'm not even 'going there' on this thread.
IT'S HUSH MONEY
By PAUL THARP
March 2, 2006 -- Franklin Raines — the ousted cooked-books chief of mortgage giant Fannie Mae — is being accused of corrupting its directors by giving them $12 million in charity checks to ignore his scandals.
A federal shareholder suit yesterday claims that Raines lavished directors with generous donations to their favorite charities, which were funneled through a Fannie Mae charitable foundation he controlled for serving the needy.
The suit, filed in U.S. District Court in Washington, said Raines improperly used the foundation's dollars to "dominate his fellow board members" and prevent them from challenging his activities in a mounting $10.8 billion accounting scandal at Fannie Mae.
Raines who was chairman of Fannie Mae's board and the its charitable foundation, directed the money to charities on which the directors served as trustees or supporters, giving them more personal stature as philanthropists, the suit said.
In exchange, the directors looked the other way and kept quiet about raising questions in at least 78 board meetings when the issues arose.
The money also influenced directors to let Raines and his financial chief Timothy Howard to simply walk away from the mess with $135 million in golden parachutes, the suit said.
The suit didn't say whether the allegedly rigged donations caused any truly deserving charities to lose out on support because they weren't on the inside track with Raines and his directors.
Among pet groups Raines "directed" cash to were the Brookings Institution, which got $3.9 million, and John F. Kennedy Center, which got $2.9 million. Director Kenneth Duberstein served as a trustee at both organizations, the suit says.
Two other charities where Duberstien served as a director were the National Alliance to End Homelessness Inc., which got $1 million, and Johns Hopkins University, which got $240,000, the suit said.
The suit cited several other grants to charities to involving directors H. Patrick Swygert, Ann Korologos, Donald Marron, Daniel Mudd and Thomas Gerrity.
"Defendants would jeopardize these lucrative donations if they caused the company to bring suit against Raines or their fellow directors," the suit said.
Fannie Mae had no comment, and none of the charities or directors had any comment.
The Fannie Mae Foundation, begun in 1979, characterizes itself "as the largest foundation in the country devoted to affordable housing and the revitalization of communities." It says it provided $47.4 million in 2004 to 600 non-profit groups nationwide.
An internal investigation funded by the board and released last week indicated that Fannie Mae directors acted properly before disclosures of the accounting errors in September 2004. The Senate Finance Committee said early last month it was investigating whether the charitable foundations of Fannie Mae and Freddie Mac violated lobbying and campaign finance laws.
paul.tharp@nypost.com
Hawaii real estate market is dropping fast?
Nope. I was born and raised there and parents still live there. The market is still on overdrive there. Hawaii now has to deal with the baby boomers who are coming over there with fat wallets buying up retirement/second/vacation homes like crazy. Condo's going up everywhere the eye can see.
And a stinky papaya.
By Paul M. Thompson
Whether you're raising children or managing people, it's never a good idea to reward bad behavior.
I'm afraid that's what's happening at Fannie Mae, the government-sponsored enterprise that for years has served as the solid foundation of our nation's secondary mortgage market.
Fannie Mae and its cousin, Freddie Mac, are the reasons that mortgages are so readily available to today's home buyers. Most mortgages are packaged by lenders as securities and sold on Wall Street as investments. The "securitization" of our mortgage finance system freed our industry from the volatility of the capital markets and paved the way to 10-plus years of robust home building.
When the Securities and Exchange Commission discovered that Fannie Mae "cooked the books" and over-stated its earnings by $9 billion from 2001 through 2004, the Office of Federal Housing Enterprise Oversight (Ofheo) pressured Fannie Mae's Board of Directors to oust its Chief Executive Officer, Franklin D. Raines.
Now comes the news that Raines has negotiated a sweetheart settlement package, a golden parachute if you will that will pay him about $1.4 million a year for the rest of his life, not to mention $8.7 million in deferred compensation, payment of his life insurance premiums and possibly a bonus. Ofheo has threatened to challenge the deal.
What's wrong with this picture? It's the kind of story that further tarnishes a negative image of business that has already been sullied by the likes of Arthur Andersen, Enron and Martha Stewart. Unfortunately, it represents the kind of "me first" selfishness that permeates many aspects of society. (NBA star Latrell Sprewell was quoted recently that if he didn't get an increase over his current $13.1 million annual salary from the Minnesota Timberwolves, he wouldn't be able to feed his family.)
Raines would do well to take a lesson from a man who built Fannie Mae into one of America's most respected corporations. When David Maxwell took over Fannie Mae in 1981, the company was losing $1 million every business day, according to Jim Collins's current best-seller, Good to Great. Over the next nine years, Maxwell transformed Fannie Mae into a high-performance culture that rivaled the best Wall Street firms, earning $4 million every business day and beating the general stock market by 3.8 to 1.
When Maxwell retired, his retirement package, based on Fannie Mae's stellar financial performance, was $20 million. Fearing that taking such a sum would jeopardize Fannie Mae's sterling image, Maxwell instructed his successor, Jim Johnson, not to pay him the remaining balance -- $5.5 million -- and asked that the entire amount be contributed to the Fannie Mae Foundation for low-income housing.
I was in the audience several years ago when Franklin Raines accepted membership into the NAHB Housing Hall of Fame. I'll never forget what he said: "When you see a turtle on a fence post, you know it didn't get there by itself." He went on to thank those who helped him achieve success.
Today, he should consider how his most recent actions will impact his legacy at Fannie Mae, and the company itself. We all make mistakes. But it's never too late to do the right thing.
Paul Thompson is the editor of fhba.com
Thank for posting that information, dennisw. Some people may become highly outraged when this FF scandal begins to emerge fully into the light.
Are you joking? I understand about 25 acres broke off and fell into the sea last month on the Big Island...and more of it washed out to sea with that broken dam on Kauai yesterday...
A lot of california investors are investing in apartments in oklahoma. when rates go up and houses are hard to buy, apartments fill up. You can get a nice apt complex for 1.5 million. I don't know how or when, but I Bush did this. :)
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