Who Would Finance Mortgages If Fannie, Freddie Disbanded?

CNBC ^ | July 02, 2010 | CNBC

[CutePuppy]

Big changes are in store for the banking system should Fannie Mae and Freddie Mac be revamped or eliminated—both of which are being discussed by housing experts and government officials to deal with the distressed real estate market.

As the system works now with the two entities, Fannie and Freddie , banks write the mortgages, but they rarely hold them. The mortgages are sold off into pools, known as mortgage-backed securities (MBS).

Fannie and Freddie guarantee the mortgage payments, so that the MBS buyer, be it the Chinese government or an American pension plan, has the security of the US government behind them. Their only risk is in the interest rate.

“It helps them make deep and liquid, and it expands, dramatically, the pool of capital that’ll come in and will play and support our housing market,” said Peter Fisher, BlackRock’s managing director and co-head of fixed income.

This system worked great for years. In fact, so great that Fannie and Freddie shareholders got rich because the companies borrowed money in the markets with an implied government guarantee.

But without the guarantees, experts say, there would be no securitization, no capital from the rest of the world for long-term fixed rate mortgages and banks would have to hold on to them.

“We’ve been through another crisis, the S&L (Savings and Loan), where banks indeed held long-term mortgages on their books," said Susan Wachter, professor of real estate and finance at the University of Pennsylvania’s Wharton School. "That’s a recipe for disaster.”

.....

To avert problems and allow private firms to re-enter the $10 trillion mortgage market, DeMarco called for a transition phase in which a new infrastructure for the home financing system is put in place.

[Candor7]

CMHC, with which I am quite familiar, manages to do its job quite effectively and is overseen by bank regulators. We need the same thing here uin the USA.And the polituicians need to be kept away from it.

[Oceander]

"But without the guarantees, experts say, there would be no securitization, no capital from the rest of the world for long-term fixed rate mortgages and banks would have to hold on to them."

Bull and sh*t. Certainly the various tranches of risk in an MBS would be priced differently - those tranches that had previously benefitted from the taxpayers' involuntary guarantee would bear a higher price - but that would finally mean that those tranches were getting prices properly, according a meeting of the minds of willing buyers and sellers, without the inefficient misallocation of capital and risk caused by government's distortion of the market. However, those securitizations would go on and, in fact, the higher risk premiums would tend to attract more, not fewer, investors.

How can we be so sure? Do we need a Fannie or a Freddie guarantee for securitizations in credit card receivables to work, or securitizations in auto loans, or in leases, or in ....?

No, we don't. Same goes for residential mortgages. The assertion that we do is nothing more than covert political disinformation designed to fool us into thinking that we need to have government actively interfering in the markets for a capitalist free-market to work properly - the truth of the matter is diametrically opposite to that.

[Rational Thought]

Fewer people would own homes. We’re discovering that isn't such a terrible thing.

I disagree. Fewer buyers than sellers, both willing and unwilling, means prices continue to drop. Much of the growth in our past "healthy" economy came from real estate. While that may not seem like the most sound basis, it was the case. There is a simple answer to the problem of Freddie and Fannie; Break them up into numerous smaller parts. Then, each smaller company could be product specific, offering financing to the lowest risks all the way to high risk. In a scenario like this, there would be competition and no misrepresentation of what the product was when packaged and sold on the secondary. This would also make financing available to higher risk buyers, which isn't in itself a bad thing. Investors in a high risk mortgage would realize a much higher return in their investment.

In a perfect world, only excellent borrowers would be able to qualify for a loan. In the real world, that excludes too many potential borrowers. After this current Obama economy, people with great credit and strong incomes are becoming a small minority of the over all population.

[Wuli]

The problem is that the totality of “monetary policy” is more than “interest rates”.

And while the Fed has obligations that the Canadian central bank authorities do not have - because the U.S. dollar is a (or “the”) “reserve” currency and the price-delimiter in so much foreign trade - the trade imbalance (trade deficit) is, in part, reflective of a monetary imbalance fueled by the printing of too many dollars (no matter what the reasons, excuses were).

The Canadian economy did not have all those extra dollars seeking their homeland to re-invest in.

They were “extra” dollars because Americans were borrowing and spending and consuming more than they were earning, in the aggregate, but the Fed just printed enough dollars to let them do it anyway.

When the foreigners piled up too many of them, selling the imports Americans bought on debt, they sent them (the dollars) back to the U.S. and, in part, bought securitized mortgage instruments (that had Uncle Sam standing behind them- implied) but got higher interest rates than treasury notes.

But yes, another shibboleth that needs to be torn down is the acceptance of the Fed’s easy-money printing presses and the failure to acknowledge the role of it’s policies in the trade deficit and excessive debt.

The Canadian central bankers cannot use the pretense of their currency being a “world reserve currency” to excuse political abuse of their monetary policy, as our Fed has done (probably for my entire lifetime). That’s a good thing for them, with regard to how monetary policy intersects with interest rates and housing; theirs is more stable.

[NonValueAdded]

George Bailey?

[Ethrane]

Gee...you mean that no one would underwrite mortgages unless they were deemed ‘credit-worthy’ risks?

Really? Whoulda think it?

You don’t ‘shape’ a housing finance system...you let the MARKET work.

[CutePuppy]

Well stated. The dollar’s “reserve currency” status is a double-edged sword - it could be a blessing and a curse... but is something that often is not considered, particularly regarding the “inflation”.

It certainly makes the job of the Fed far more difficult, having to consider, gauge and attempt to balance the worldwide demand of officially and unofficially pegged sovereign currencies, in addition to accommodating domestic demand, organically or artificially (politically) created.

[Intolerant in NJ]

“We’ve been through another crisis, the S&L (Savings and Loan), where banks indeed held long-term mortgages on their books," said Susan Wachter, professor of real estate and finance at the University of Pennsylvania’s Wharton School. "That’s a recipe for disaster.”...no, the recipe for disaster was when the government started messing around with the established laws which had determined the conditions under which many people had taken out their loans and budgeted their savings and other investments - among other things it abolished the passive investment credit for real estate which immediately sucked the value out of many of the mortgages the S&L's had on their books, and many of them went under - if government would stop interfering - excuse me, regulating - people could start making investments in the economy including housing which would be longterm and stable, far from disastrous.....

[CutePuppy]

... if government would stop interfering - excuse me, regulating - people could start making investments in the economy ... based on standard financial and economic parameters, not the ones distorted and created by politicians and bureaucrats, for their own political benefits.

[CutePuppy]

...you let the MARKET work.

Now, that's a scary thought for politicians... and it goes against the chronic Democratic "Don't Do Nothing, Do Something!" and "If It's Not Broken, Break It!" diseases.

[haroldeveryman]

“Nobody stopped a Canadian bank from lending in the subprime market, they chose not to,” says CIBC’s Benjamin Tal. “It was not the government, it was not monetary policy; there were no regulations whatsoever regarding how much you can lend in the subprime market. Canadian bankers decided not to do so, because it was too risky.”

In other words, Canadian banks did not lend in the subprime market because the government allowed them to not lend in the subprime market.

[CutePuppy]

In other words, Canadian banks did not lend in the subprime market because the government allowed them to not lend in the subprime market.

Or didn't have the laws, rules, regulations and lawyers forcing them to make financially unsound loans... About sums it up.

[CutePuppy]

Fewer people would own homes. We’re discovering that isn't such a terrible thing.

It's not such a terrible thing but it may not necessarily be the end result, as the Wuli's post #18, on Canadian housing market and ownership rate, shows. In other words, housing prices might have to find the "natural" ownership rate...

Investors in a high risk mortgage would realize a much higher return in their investment.

Reward would become commensurate with risk, and that is how free markets work, i.e., free from distortion of government's influence and direct or indirect (mandated or incentivized) malinvestment.

[wac3rd]

If Fannie or Freddie “disbanded” and the existing loans were paid off/sold/foreclosed by outside investors, the immediate effect would be a huge drop in home prices. The FHA would be innundated, but they already hae a huge default rate and would hopefully only serve Vets.

Oddly enough, if the GOP wins back a majority in one or more houses in November, and Fannie folded, private banks and investors would fill the void...but there would be no subprime, no doc, no job, no savings, no credit-type loans, they would be underwritten like the old days.

Minorities and Liberals would cry and in 3 years, Barney Fwank would be pressing for loosening of standards, again.

[jazminerose]

Yes. We have it now by way of hard money lenders. Borrowers with terrible credit & unverifiable income have always been able to get mortgages—provided they have 30-40% down & a willingness to pay loan shark rates.

Many if not most of those hard money loans will go south, the lenders have priced that into the loan.

No problem for me—again, your hard earned tax money & mine isn’t goint into it. Let borrower & lender figure out what works for them. I don’t care.

[haroldeveryman]

Exactly. Also note that the two people chosen by the Democrat Congressional majority to head up the “investigation” of the banking crisis, Barney Frank and Chris Dodd, were the two legislators most closely associated with Fannie and Freddie (whose securitization of the subprime mortgage loans created the toxic assets that led to bank insolvency).

This illustrates the fact that in this day and age, at least, the implicit purpose of government appointed “regulators” is to protect vested interests.

[CutePuppy]

Also note that the two people chosen by the Democrat Congressional majority to head up the “investigation” of the banking crisis, Barney Frank and Chris Dodd, were the two legislators most closely associated with Fannie and Freddie...

... and writing FinReg legislation that is pure power grab of financial industry, where Fannie and Freddie are not even mentioned...

The exact equivalent of Jamie Gorelick getting a seat on the 9/11 Commission "investigating" the reasons behind the successful al-Qaeda attack and why different legal, investigative and intelligence departments and agencies had "problems" communicating with each other... while ignoring and hushing up her own directive mandating precisely "The Wall" between them.

[haroldeveryman]

I was watching when John Ashcroft testified before the 9//11 Commission to defend the Justice Department’s role in the War Against Terrorism. They were trying,in the interest of “Internatonal Human Rights”, and against every precedent in US history, to disallow Bush’s use of miltary tribunals to try foreign military combatants. They sat Sandy Gorelich right across from him, making eye contact, trying to make him lose his poise. Instead of trying to sound reasonable”, Ashcroft tore this beeotch a knew one, relating how Ms Gorelich’s “wall” prevented CIA information that could have stopped the enemy from acting from getting to the FBI, who had the authority to get these guys before they hurt someone. Sandy just sat there with this scheiss-eating grin trying to look like she was mocking him. Our intelligence agencies and military did get results after 9-11 succeeded, and disrupted the ability of Al Qaeda’s leadership from moving around and communicating.

[CutePuppy]

Phony Financial Reform - B, 2010 July 03, by Thomas G. Donlan

The huge overhaul bill ignores most big problems and dodges the rest.

There is something in the financial-services bill for almost every interest, but the real winners are the cynics who think Congress can't do anything right. The monster that crawled out of the conference committee on June 25 has about 2,300 pages, and one hostile Republican congressman said it probably has three unintended consequences per page.

It will keep the bureaucrats and lobbyists busy, that's for sure: The Chamber of Commerce counted 355 potential new agency rule-makings, 47 studies and 74 reports required by the bill. The infamous Sarbanes-Oxley law of 2002 -- the previous congressional exercise in futile corporate regulation -- demanded only 16 rule-makings and six studies.

The general intent of the financial-reform bill was impossible. Sponsors wanted to reduce the risk in an inherently risky industry, and they wanted to do it without tightly regulating it or subjecting it to the discipline of a free market.

The big issues will remain untouchable.

What is to be done with Fannie Mae and Freddie Mac, the quasi-government agencies that have become the nation's main source of new home mortgages? There's no answer in this bill. Converting Fannie and Freddie to Feddie hasn't stopped them from losing more tens of billions of dollars on bad loans, and it hasn't brought order and good sense to the housing market. .....

If the bill becomes widely known as Dodd-Frank, then maybe Sen. Christopher Dodd, D., Conn., and Rep. Barney Frank, D., Mass., finally will acquire the reputations they so richly deserve. It happened to former Sen. Paul Sarbanes, D., Md., and former Rep. Michael Oxley, R., Ohio. Their Sarbanes-Oxley "reform" of corporate accounting and other issues has turned out to be an expensive failure, blighting their names for the history books. Dodd and Frank deserve the same, only more so.