Posted on 02/19/2009 4:11:07 AM PST by managusta
The recent compromise struck between the Treasury and Democrats in Congress on the fate of Fannie Mae and Freddie Mac, the government-sponsored mortgage guarantors, constitutes the worst of all possible worlds.
The Treasury offered a blank cheque to come to the rescue, if necessary, but the managements of both companies were kept in place. They know that their survival depends on not drawing on that blank cheque.
They will therefore do everything in their power to reduce the need for any new equity capital that would be dilutive. In short, as privately owned but undercapitalised financial institutions, the GSEs cannot fulfil their stated mission of providing stability, liquidity and affordability to the nation’s housing finance system.
In presentations to investors, which followed big quarterly losses, the GSEs said they would curtail purchases of mortgages and might shrink their holdings to preserve capital.
They highlighted that fees from their insurance guarantee business had nearly doubled. They also improved the quality of new loans by focusing on borrowers with higher-quality credit, who put down greater down payments. This means that the GSEs have significantly increased the cost of mortgages and tightened lending standards.
The problems in the banking system have left the two GSEs as the only game in town in the mortgage market. Their market share of new mortgages has doubled over the past year and is now close to 80 per cent.
Much of the balance is accounted for by the Federal Housing Administration, a fully guaranteed government agency.
As the two companies fight for survival and try to reduce their need for new capital, the availability and cost of mortgages in the US suffer. Coming at a time when the supply of houses is swollen by a rising tide of foreclosures, this is a recipe for disaster. House prices have already fallen sharply and will continue to fall unless mortgages are made available on more favourable terms to a broader group of people.
This compromise, or stalemate, practically ensures that house prices will overshoot on the downside. That, in turn, renders the policies of the GSEs self-defeating as lower house prices increase their losses and push them further into insolvency. The GSE crisis has merely been postponed, at a cost of making the housing crisis more severe.
Confidence in GSE-backed bonds has been shaken. The stocks remain under pressure. Markets are forcing officials to come up with a better solution.
We need to recognise that the business model of the GSEs is fatally flawed. They are public/private partnerships in which the risks are borne by the public sector while profits accrue to the private sector: management and shareholders.
The companies have been plagued by accounting problems and other irregularities; their managements have spent enormous sums lobbying Capitol Hill. This is not a business model that deserves to be perpetuated.
Fortunately, alternatives are available. Hank Paulson, the Treasury secretary, has suggested the use of covered bonds, a mortgage-financing vehicle popular in Europe.
I would recommend the system of mortgage credit used in Denmark, where loan-to-value ratios and underwriting standards are strictly enforced by a single, strong regulator.
These mortgages are transformed into instantly tradable bonds. Cover for the bonds is provided by both the mortgages and the credit of the financial institutions issuing them. The mortgages remain on the balance sheets of the issuers, eliminating the moral hazard inherent in the US system, which is based on earning fees from selling them on to the market.
The standardisation of mortgages in the Danish system promotes transparency and liquidity. Householders can prepay their mortgages at any time by buying the bonds.
Since house values and bond prices tend to move in unison this arrangement reduces the danger of householders’ equity falling into negative territory.
For the issuing banks, owning these bonds carries lower capital requirements so the bonds sell at a premium to ordinary covered bonds. This system has survived and provided affordable home mortgages since its creation shortly after the great Copenhagen fire of 1795.
I pioneered the introduction of the Danish system in Mexico with the support of Paul O’Neill, when he was Treasury secretary. With modification, it offers a long-term solution to providing affordable mortgages in the US.
The writer, author of The New Paradigm for Financial Markets, is chairman of Soros Fund Management, which has held and continues to hold short positions in GSEs
It’s weird reading it, though. He writes as though Fannie/Freddie were never taken over.
As for mortgages, what he’s describing is simply a free market, where the value of assets and liabilities are set based on what someone’s willing to pay for them. Without government interference, that’s how the market works.
I think we’re now moving toward a system where the value of real estate assets is partially determined by the government, rather than simply by what someone is willing to pay for them. The price has to be “fair”. That’s how the “free” market will be working.
Since house values and bond prices tend to move in unison this arrangement reduces the danger of householders’ equity falling into negative territory.
QUESTION....should the value of a property fall, can the owner buy the bonds at the current market value of the property?... Conversely, should the value of the property rise, will a payoff require the total value of the bonds?
This is confusing...simply because I do not trust Soros.
He obviously didn't get the memo ... ACORN would never put up with this.
Housing prices must fall to the level that they would have been absent the bubble caused by all of the inappropriate borrowing. The inflated prices of two years ago make no sense unless the market is pumped up artificially. This is the painful reality. For once, the GSEs are doing the right thing.
Sounds more like the bond money mortgages that were available before the subprime lending practices kicked in. Municipal financing used to be a big deal; there were several large lawfirms that did nothing but bond work. Soros wants something like that to become the lending norm.
If it's popular in Europe, you know it's gotta be dripping with socialism. And, from what I recall, the bond mortgages were very restrictive as to house size, location, and so on. Naturally, the bond indenture requires record-keeping of borrower info. They pretty much tell you where you're allowed to reside.
The more I think about it, the more it sounds like a community organizer's wet dream.
Old article— August 11 2008
Regarding mortgage bonds, this is going on here in the U.S. already.
Our church in New Mexico financed their construction this way.
Check out http://www.strongtowerfinancial.com/
It's not a community organizer thing. It works better than what we have, but only because Denmark is small enough that the Government is required to be somewhat sane.
But it won't work here as long as we have the CRA, as we have very bad underwriting standards enforced by law, a pernicious form of insanity.
This is only a variation on the collateralized mortgage tricks that Fanny/Freddie were doing. Both require that the underwriting of the individual mortgages are good. In our case, if the underwriting is bad, everybody loses, the CMO holder loses, the householder loses. (Except those who bet on the loss via CDS).
In the Danish case, if the underwriting is bad, and the homeowner doesn't look like they can pay, the price of the bond falls and maybe the homeowner can buy the bond cheap. Thus, only the bond holder gets screwed. And the homeowner can game things by making it look like they are going to default, and then buying the bond after it falls - short of like short selling.
Like our constitution, the Danish system works only for a moral people.
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