Posted on 03/26/2008 2:51:17 PM PDT by kiriath_jearim
The US is sending in the cavalry to fight the crisis in the credit and housing markets – unleashing government-sponsored enterprises to buy and hold mortgage-backed securities (MBS) for which there is little private demand.
The move marks a new stage in the policy response to the credit crisis, in which the US government is increasingly deploying all the tools at its disposal – short of an outright public purchase of mortgage securities – to prevent a full-blown credit crunch.
It also marks an expansion of what Michael Feroli, an economist at JPMorgan, calls the “socialisation of housing finance” in the US – ever greater reliance on Fannie Mae, Freddie Mac and the Federal Home Loan Banks to sustain the flow of funds into the crisis-hit housing sector.
These government-sponsored enterprises are housing agencies chartered by act of Congress. They are not legally part of the public sector but the market believes their debt is implicitly guaranteed by the government, allowing them to borrow cheaply.
Regulators this week gave the FHLB – a network of bank co-operatives founded in the Great Depression – permission to double investments in MBS for two years. The Federal Housing Finance Board, which regulates the FHLB, said this “could provide well in excess of $100bn (€63bn, £50bn) in additional liquidity” to the MBS market.
The move followed last week’s decision to reduce the capital surcharge imposed on Fannie Mae and Freddie Mac, allowing these housing finance companies to buy or guarantee more debt. The Office of Federal Housing Oversight, which regulates Fannie and Freddie, said this would “provide up to $200bn of immediate liquidity” to the mortgage markets.
The decisions – while taken seperately by independent regulators – were orchestrated by Hank Paulson, the US treasury secretary, who pressed the GSEs and their regulators to find ways to provide more support to markets that would not require legislation.
Economists said the government is, in effect, encouraging Fannie, Freddie and the FHLB to increase their leverage and exploit the perceived government guarantee to raise funds and buy and hold mortgage securities – offsetting to some degree the deleveraging taking place in the private financial sector. This is a policy change for the Treasury, which before the credit crisis had focused on the risk that GSE borrowing poses to taxpayers. Officials do not believe the GSEs will have any difficulty to raising additional funds.
“The Federal Home Loan Banks are able to raise enormous amounts of money in the capital markets,” says Joseph McKenzie, deputy chief economist at the Federal Housing Finance Board. Their asset level “can expand and contract like an accordion.”
The deployment of the GSEs creates a new source of demand for MBS and mitigates the danger of a downward spiral of forced sales.
“It has proven quite successful” at reducing the risk premium on MBS guaranteed by Fannie and Freddie, says Peter Hooper, chief economist at Deutsche Bank Securities. “This is clearly an effective weapon in policymakers’ arsenal.”
However, the direct impact of GSE buying may not be as great as some believe. The mortgage market is huge, and the GSEs’ incentives are not perfectly aligned with policymakers’ objectives.
Bert Ely, a critic of Fannie and Freddie, said the changes would encourage the firms to hold more securities on the balance sheet – taking on more interest rate risk – rather than take on more credit risk in housing.
Analysts said the bigger public benefit would come if and when Fannie and Freddie deliver on their commitment to raise new capital. “That is an unambiguously good thing,” said Mr Feroli of JPMorgan.
The FHLB, meanwhile, are unlikely to ramp up their investments quickly. John Price, chairman of the FHLB presidents’ council, told the FT that they were “cautious” by nature and close to statutory leverage limits.
“There is not a lot of elbow room for us to bulk up on those securities,” he said.
Some analysts believe the FHLB will increase investments by only about $30bn, compared to the $100bn cited by their regulator.
Yet unleashing the GSEs might prove more significant than the numbers suggest. To many analysts the move indicates that the US is willing to deploy an increasingly broad-based and unorthodox set of policies to fight the credit crisis.
“The government of last resort is working with the lender of last resort to shore up the housing and credit markets to avoid Great Depression 2,” says Ed Yardeni of Yardeni Associates. “I think the federal government and the Federal Reserve will succeed.”
http://www.247wallst.com/2008/03/fannie-mae-fn-1.html
he idea behind the new plan has plenty of benefit for an Administration that wants to being some calm to the markets. but it only addresses half of the problem. Fannie Mae and Freddie Mac are losing billions of dollars because of home foreclosures. While they may be able to put more capital into the market, there is nothing in place to keep them solvent if their red ink keeps piling up. Solving a piece of the trouble does not do much good, at least longer-term. The two companies cannot do help rescue the mortgage markets if their own financial status begins to collapse.
http://globaleconomicanalysis.blogspot.com/2008/03/wamu-alt-pool-revisited.html
Cesspool Bottom Line
22.69% of a pool that was 92.6% rated AAA is 60 days delinquent or worse. 3.56% of that pool is REO. That's an amazing performance for an AAA pool whose issue date was May, 2007. At the current rate of progression it would not be surprising to see 30% of this pool get to REO status.
Here’s “the other thing” —
Say that fannie and freddy buy another $300Bil to the mortgage market. Banks are sitting on cash and cutting down on their lending. The brokerage firm’s are trying to stay in net capital compliance and are not adding inventory subject to haircuts. Institutional buyers are like wise trying to avoid taking losses or investing in stuff that they are not dead CERTAIN they will see a return on. Loans that the agencies buy at this point may end up being in inventory for good long while.
Get used to hearing variations on the word “liquidity” and “liquid” over the next few months. There is next issue, and it was obvious to anyone that noticed the latest round of muni bond auction failures. No one wants to buy debt right now, except at ridiculous discounts, and potential sellers are’nt of a mind to take realized losses on a fire sale. Nice catch 22.
Yeah, I read that. Not something Paulson wants to talk about, huh ?
If the government ends up with a bunch of foreclosed properties on its hand, I have a great way for them to put such properties to good use:
VA HOME LOANS. Put veterans and their families in those houses with very low interest mortgages. Essentially, have veterans by the homes *at value cost*, not at speculation cost.
This means that a home worth $150k, that was originally far overpriced at $750k, be sold to the veteran for just $150k, what it is actually worth.
By doing so, the feds will drive the prices of homes down to realistic levels nationwide, overnight. But, and here is the big “but”, as soon as the empty houses are occupied by veterans and their families, the *price* of housing will go up all over the country.
It will have eliminated the surplus of homes, and restored the market to balance.
I think the only “problem” with your analysis, with which I completely agree, is that banks AREN’T sitting on cash. According to the Fed reserves reports, most all banks are operating on borrowed reserves, ie they are technically insolvent. I don’t think they can lend, because as fast as the Fed infuses cash they take more writedowns.
For my part, I think the liquidity issue follows the insolvency issue. If any other shoe drops, the next most insolvent entity just might topple the whole house of cards.
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