 Let me start by saying that despite working 3 1/2 years in the mortgage industry, I don't consider myself an expert in the secondary markets. And when you hear me say I know it all about anything, just shoot me.
But today, with one Margarita down, listening to the radio on the way home from Taco Cabana, I had one of those moments were I was literally yelling at the radio, and probably scaring MamaSk8z.
Interestingly, last summer was the last time I had such a moment, also listening to NPR, and also in response to the audio clip of a Republican Senator from Kentucky.
In this case, it was Senator Jim Bunning (R-KY) grilling Treasury Secretary Henry Paulson over expanding the authority of the Treasury to backstop federally chartered mortgage giants Fannie Mae and Freddie Mac:
"Our plan is aimed at supporting the stability of financial markets, not just these two enterprises," said Paulson.
Bunning, a longtime critic of Fannie and Freddie, cited the firms' stock slide since the plan was announced. "Your plan is not being accepted," Bunning said.
Paulson responded that "there's not something any of us can do is stabilize the stock price." He pointed to more positive signs such as the fact the spread between Fannie and Freddie debt and treasury yields has narrowed.
Bunning also questioned whether Paulson's expectation that the authority to loan significantly more money or buy equity will not be used if it is authorized.
"There's a lot of us who would like to believe what you're saying," said Bunning. "But we're skeptical. Anytime we approve something, it gets used."
See, I just don't hardly know where to start in responding to this. Hopefully McBlogger will weigh in with a blog post of his own, but here's my take:
1. Fannie and Freddie are of utmost importance to the American people because of their chartered role in providing a secondary market for mortgages. The end result of their existence is to help Americans own their own homes. Whether or not these GSEs actually purchase your loan, their existence and their willingness to purchase loans like yours made your home loan a better investment for whoever holds it. They are like a lever in that way. With just a little of their capital, they can cause lots of money to be available to prospective homeowners.
2. Because of loose underwriting practices and the housing bubble of the past few years, and the resulting sub-prime and alt-A meltdown, too many of these loans have very little in the way of hard assets backing them up. The default rates are higher than they've been in a long time, and short sales are waaay up. This doesn't necessarily apply to all of the GSEs portfolios, though they have definitely shown they need to be more tightly regulated.
3. So, as my friend McBlogger has said over and over, just as loans were irrationally over-valued during the bubble, they are irrationally undervalued now. Investors are afraid to buy them. Think about it this way: It's July 15th. If you needed to buy a heavy winter coat right now, you could get a good deal. But still, do you want to buy one? OK, that's what I thought. Now what if you were in the coat business and had a huge inventory of heavy coats on the books? What if you HAD to report the market value of them as if you absolutely had to sell them TODAY? What if you needed to borrow money and use those coats as collateral?
4. Therefore, what you have right now is investor reluctance to lend Fannie and Freddie the money they need to do what they need to do. It's not terribly bad, and we're hearing that Fannie and Freddie are solvent. But still, there is value to the taxpayers in not only preventing their failure, but in further enabling their success in putting Americans into homeownership.
5. Since the market has shown itself irrational at times, it is thus inefficient in valuing the assets of the GSEs. Further, the free market doesn't take into account the intangible benefits of keeping the GSEs in business.
6. So, the government has an opportunity to serve as a backstop to these GSEs by participating in the market to lend them money, knowing that the risk is minimal and the return is near-market, but carries a lot of intangibles.
I hope that makes sense. I'm sure a mortgage banker could explain it in much more technical terms.
But here's the thing: From OUR perspective, that of the taxpayers and beneficiaries of the GSEs' chartered purpose, we define success as their solvency and fitness to continue operations as a going concern. You and I want them to keep investing in the mortgages of folks like us, so that we can stay in the middle class, and continue to own homes and stay relatively mobile.
What is NOT our goal, as taxpayers is to insure the shareholders of these GSEs. Business is business, folks. Fannie and Freddie shareholders stood to make all the gains when the industry was doing well, and it's only fair they should bear some risk when things go South. If you want a guaranteed investment, you put your money in an FDIC insured bank account, and you earn squat-and-a-half percent, just like grandma. If you're a big boy or girl, and you can take the good with the bad, you buy stocks. And if you want those stocks to do well, you vote your proxy and elect a board to make sure the company stays on track.
So, with all of this, I guess I could say it's an understatement that I'm "puzzled" at Bunning's nonsensical statement about the stock prices indicating the market's supposed rejection of the backstop.
Let me yell this like I yelled at the radio:
THE STOCK PRICE SLIDE HAS NOTHING TO DO WITH REJECTING THE GOVERNMENT'S PLANS!
Repeat after me: "The market is not a living being. The market for a stock is the sum total of many individual fallible human expectations of risk versus return. I will NOT worship the 'invisible hand of the free market' as a deity. Our money says 'In God We Trust', not 'In Wall Street We Trust'."
What is happening here is that the shareholders are concerned about dilution of return. If for instance, whatever deal the federal government comes up with involves the government taking an equity position (something I think is fully justified) then the current shareholders will own a smaller share of whatever remains. They will thus receive a smaller share of the return.
Say what you will about the possibility that the dramatic slide in these stocks since last Thursday might have been brought on in part by the very news that the government was taking steps to be prepared to prop them up. There is probably some bit of truth in that, but you can also blame that on a combination of the fundamentals and the irrationality of investors. If these GSEs had been in great shape, and the federal government made similar contingency plans known - oh, lets say in February or March of 2007, I don't know if it would have gotten a second look.
We need to take steps not only to get our mortgage market back on track, but to implement regulatory reforms so that this shit doesn't keep happening. Home ownership is a cornerstone of the American Dream. Our macro-economy is just too damn important to leave to the wild fluctuations of a market that inflates and deflates mortgages on little more than a whim or a whisper.
With that in mind, I have a deal for Senator Bunning: How about we go ahead and backstop Freddie and Fannie, and do so in a way that drives a hard bargain for the taxpayers. Whatever the CBO says it will cost per taxpayer, Kentucky residents won't have to pay. In exchange, we'll just keep Fannie and Freddie from doing any more business in Kentucky then. It will be a nice scientific experiment to see what happens to mortgage rates and home values in Bunning's home state. |
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