Weitz Law Firm - 520 Kirkland Way, Ste 103 - Kirkland, WA - (425) 889-9300

Sunday, February 13, 2011

Future of Fannie of Freddie - your governement at work

A recent article in the WSJ regarding White House Proposal on Fannie, Freddie:

AP - The Obama administration outlined on Friday its plans to begin shrinking the government's broad support of the nation's crippled mortgage market, a process that officials said could take several years and would include phasing out Fannie Mae and Freddie Mac.

Officials portrayed a housing-finance system that would include a role for both the public and private sectors, but would be different from the current system in that the government's role would be smaller, underwriting standards would be tighter, and borrowers would be required to hold larger amounts of equity in their homes.

Weitz – allow me to translate – housing financing would be darn near impossible to obtain unless you are able to put down a significant down payment, strong income, and strong credit.

Rep. Randy Neugebauer, R-Texas, chairman of a key House oversight subcommittee, is encouraged by the Obama administration's proposal to restructure Fannie Mae and Freddie Mac. But he's disappointed there's no clear long-term reform plan.

The proposal offered a series of short-term steps that would help attract private capital into the mortgage market, including a reduction in the maximum loan sizes that Fannie and Freddie can purchase and gradual increases in the fees the mortgage companies charge lenders. Both of those steps could make it more attractive for lenders and investors to buy loans without government backing, but they could also raise borrowing costs for millions of Americans and weigh on the nation's home-building industry.

Weitz – How could is possibly encourage private capital if the government pulls its guarantees?! This will KILL financing of Real Estate in America – especially at the high end range (above $625,000) and make all loans more expensive.

"The cost of mortgages is probably going to go up, and home ownership is probably going to go down," said Daniel Mudd, the former chief executive of Fannie Mae who is now CEO of Fortress Investment Group. "Both of those things arguably could be a good thing."

Weitz - What?! costs of mortgages is going to go up, and home ownership is going down and that a GOOD THING?! For who?...That's some delusional rationale.

The administration said it would support allowing maximum loan limits to fall to $625,500 from $729,750 as scheduled on Oct 1. It also said it would push to increase minimum down payments to 10% on loans eligible for purchase by Fannie and Freddie. Insurance premiums charged on new loans backed by the Federal Housing Administration could also go up.

Administration officials said the process of transitioning to a post-Fannie and Freddie world would take at least five to seven years, in part because the housing market remains too fragile. Many analysts say the process, which includes dismantling, moving, or reassembling the firms' infrastructure, could take even longer.

The long-awaited proposal was thin on specifics about what would replace Fannie and Freddie, which the government took over in 2008, and which have racked up $134 billion in taxpayer losses. Instead, it outlined three options that were designed to frame what promises to be a prolonged and heated political debate over how to structure the nation's $10.6 trillion mortgage market.

Option 1:
The first of those would put the vast majority of the mortgage market in the hands of the private sector, where lenders would originate mortgages and securitize them without any government backing. The middleman role currently played by Fannie and Freddie would no longer exist.

The government's role would be limited to the FHA and a few other smaller housing agencies, and their reach would be sharply reduced from current levels. The FHA backed 20% of all new mortgages last year. Some conservatives have called for such a private market.

Weitz – this would hurt; Fannie and Freddie back an overwhelming majority of new real estate loan issuance's right now. For the private sector to get comfortable making loans, interest rates would have to go up dramatically as the risk tolerance for the private sector would be far less and they would expect a premium in return.

Option 2:

The second option, championed by a handful of economists, would also create a mostly private market with a limited government backstop that would primarily become active buying or guaranteeing loans in periods when private lenders retreated during financial shocks.

Weitz - great...but this 'period of financial shock' could last a long time

Option 3:

The third option would create new privately owned companies to buy mortgages from banks and sell them as securities. Those securities would be explicitly guaranteed by the government as long as they meet certain criteria. The government would collect fees for that backing, just as the Federal Deposit Insurance Corp. insures bank deposits and regulates banks.

These new companies would essentially replace some of the functions filled by Fannie and Freddie. An array of academics and industry groups have backed such a proposal, and senior Obama administration officials, such as Treasury Secretary Timothy Geithner, have publicly discussed its merits.

Weitz - the problem with this is that no private company is stupid enough to back these loans as the interest rates Fannie and Freddie are doing it. Quite simply, this would never work.

The housing industry greeted the proposal coolly, and some mortgage industry officials criticized the administration for not providing more detail. "It was a political football that they punted back onto Congress's side of the field," said Joseph J. Murin, the former president of Ginnie Mae, a government-owned corporation that guarantees payments on mortgages backed by federal agencies.

Republicans face their own divisions over what kind of role the government should play in the market, while Democrats have generally said a federal backstop function is needed to ensure broad access to homeownership and the 30-year fixed-rate mortgage, in particular.

Weitz – this is the problem – we need to government to prevent a further collapse of Real Estate, yet the economy won’t be truly corrected until we let it collapse; it’s a catch 22 that no one wants to talk about. Thus, the democrats admittedly want the government involved, and the republicans implicitly know the government needs to be involved (or the crash would occur). The problem is they are both trying to prop up a broken system, but politically feel that is necessary.

Many industrialized nations don't have institutions like Fannie and Freddie, and instead rely more heavily on their banking systems to fund mortgages.
But some economists have noted that the mistakes in the U.S. private sector were far greater than the mistakes made by Fannie and Freddie. For example, private-label mortgage securities, which are not government-backed, have performed more poorly than those backed by the mortgage giants. Nearly 45% of private-label loans originated in 2006 had been 90 days past due at least once, compared with 13% for Fannie and Freddie, according to a report from the firms' federal regulator published in September 2010.

"The part of the market that was the most private was also the worst," said Michael Barr, a former assistant Treasury secretary who left the Obama administration in December. He said the report should help remind lawmakers that the government has long had a role backstopping mortgages. "People seem to think there's a nostalgic world that we never had," he said.

Weitz – this is true, but there is a catch – Wall Street screwed up badly, and we didn’t hold them accountable. In order for true capitalism to work in the future, you have to allow the risk of failure as a self-controlling tool to lessen the risk taking. Without the risk of failure, we are destined for bubbles and subsequent busts.

The Obama administration outlined plans to begin shrinking the government's broad support of the nation's crippled mortgage market.

The proposals are likely to set off a furious effort by the financial-services industry to protect generous subsidies and seek out new revenue sources. Investors haven't been willing to buy mortgages that don't have government backing primarily because there haven't been enough steps taken to overhaul the market for private-label securities, said Joshua Rosner, of investment-research firm Graham Fisher & Co. "Investors are on strike," he said.

Weitz – What Josh is trying to say is that there is no support for mortgages from the private sector because 1) interest rates are not indicative of the risk involved (higher risk loans require higher interests); and 2) housing is still overpriced so the private side would rather trade commodities than invest tons of money for a 5% return in Real Estate.

His clients would buy securities without government backing "hand over fist" if the industry had adopted clear and transparent standards, said Mr. Rosner. "The industry isn't doing that, because it's playing for a guarantee."

Weitz – the real story here is that the real estate market is not even close to a point which would allow the government to not be involved. Some would argue that a further collapse would actually be a good thing so the prices get to a point where the typical consumer can buy a house without spending half his/ her paycheck on interest payments to the bank. That said, politicians see falling real estate as a negative and my guess is they continue to use the government (taxpayers) to prop it up with the FHA, Fannie, Freddie guarantees....the saga continues.

Our Firm:

Weitz Law Firm, PLLC
5400 Carillon Point, Bldg 5000
Kirkland, WA 98033

(425) 889-9300

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