Fannie and Freddie

Robert Reich says Fannie and Freddie are too big to be allowed to fail:

Fannie, Freddie, and the Pending Taxpayer Bailout, by Robert Reich: Fannie Mae and Freddie Mac, the two giant quasi-public housing lenders that together own or guarantee about half the $12 trillion in home loans outstanding, are heading into insolvency. No surprise. As housing prices continue to drop, more and more middle-class homeowners who got their loans from Fannie or Freddie are under water... And as the economy continues to go south, more and more of them can't meet their loan payments.

While it's true that most of their home loans were made before 2006 when lending standards were tighter, that doesn't really matter because the rip-tide of this sinking economy is now hitting a much broader group of home owners.

Fannie and Freddie may not be technically insolvent yet, but I'm betting that if their lending portfolios reflected the true market prices of their loans they would be. That's why their own investors are bailing out.

So who gets stuck with the tab? Investors in Fannie and Freddie have always believed that the loans issued by the two giants were guaranteed by the federal government but technically they aren't. The guarantee has always been assumed but has never been put into law explicitly... Yes, the companies' charters give the Treasury the authority to buy as much as $2.25 billion in each of their securities in the event of possible default, and the two companies have access to the Fed's so-called Fedwire payments system allowing them to access funding if needed. But these won't keep the two afloat for long.

As a practical matter, we're facing a Bear Stearns squared. Fannie and Freddie are way too big to fail -- especially now. There's no question the government will have to take over the companies, which means taxpayers will get stuck with the tab yet again.

Here we have another example of socialized capitalism. The executives of Fannie and Freddie have been among the best paid in all of corporate America. We're talking tens of millions a year in CEO pay alone. Fannie and Freddie are treated like giant investor-driven entities as long as they're healthy and their investors and executives are doing well. But when they start to go down the tubes they become public entities with public responsibilities, and the rest of us have to bail them out.

On the too big to fail issue, my view hasn't changed. If failure of these firms endangers the broader economy, and hence threatens to impose large costs on people who had nothing to do with creating the problems, then policymakers need to step in and do what they can to prevent a downward economic economic spiral. In addition, they need to change the rules and regulations that allowed the problem to emerge in the first place, and add new rules and regulations as needed to lower the moral hazard worries going forward.

What would you do?

Update: Big Picture adds:

Uh-Oh! Bad Sign on Fannie & Freddie, The Big Picture: Marketwatch reports that the government discussed a contingency plan in case the unthinkable happens, and Fannie Mae (FNM) and Freddie Mac (FRE) were to fail. But don't worry -- the Bush administration DOES NOT expect the entities to fail. And, they note no rescue plan is imminent.

Rex Nutting says Uh-Oh! This is a major contrary indicator, and it suggests Freddie and Fannie are toast! Why?

Is there any surer sign of an impending disaster than a reassurance from the White House that it doesn't expect it to happen?

Rex adds this short list of other things that the Bush administration didn't expect:

• Terrorists to fly airplanes into buildings.
• Saddam Hussein to have been telling the truth about not having any weapons of mass destruction.
• Iraqis to object to a long-term occupation by a foreign power.
• Hurricane Katrina.
• People in New Orleans to object to the government's response to Hurricane Katrina.
• The Democrats to take control of Congress.
• The Democrats to cave in so easily on important issues after they took control of Congress.
• Scooter Libby to get caught.
• Jack Abramoff to get caught.
• Abu Ghraib to be discovered.
• Scott McClellan to smell the coffee.
• The housing bubble.
• The credit bubble.
• The housing collapse.
• The credit squeeze.
• Bear Stearns to fail.

Gee, that's a tough list to argue against . . .

Comments

[sootytern]

I have no problem with nationalizing either of the companies. By that I mean that we the taxpayers become the owners and we share in the profits and the losses of the companies concerned. Once they are back on their feet again, we issue publicly traded stock and thereby denationalize them. If this is unacceptable, then we can loan them enough money to reorganize and charge a market rate of interest, say 6%. That, I believe, is the capitalist way.

[Rajesh Raut]

The problem is not with Fannie Mae or Freddie Mac. So long as house prices are falling, mortgage lending will be a risky business. Currently, those risks are being concentrated in the two GSEs.

It may be better to do a general bailout of the housing industry than to try to band-aid the problems one by one as they come up. An Resolution Trust Corporation-type agency that would buy up REO houses and keep them off the market for several years would allow prices to stabilize.

Once mortgage lending becomes less risky capital will flood back into the market. A mortgage origination tax would help fund the new agency and would reduce the chance for a new lending bubble to take hold.

[esb]

C'mon folks.

The only way out of this "mess" (temporarily) is to resume lending to those who have no ability and/or intention to repay in full.

Regulation must be by wink and nod and looking the other way.

It's all the American way of doing things, and it will be back, and soon,

because it has to.

[ddt]

nationalize them if necessary. no bailout loans or 'facilities'

[mdm]

they will de-nationalize, this is ripe for more disaster capitalism

[piglet]

What would happen if they are insolvent and we let market capitalism run its natural course? "That, I believe, is the capitalist way."

What exactly are the costs Mark mentions that this would impose on innocent bystanders, and why would a bailout impose less of a cost? Somehow, I am allergic to the idea of corporate bailouts. I can't help it.

[piglet]

"An Resolution Trust Corporation-type agency that would buy up REO houses and keep them off the market for several years would allow prices to stabilize."

Oh, you mean artificially driving home prices up by suppressing supply? That's exactly what we need, thank you very much!

[GAVIN]

If Fannie Mae and Freddie Mac cannot keep the mortgage market working for conventional mortgages a new corporation should be formed. For many decades a housing market with buyers making a down payment of 20%, using a 30-year fixed rate mortgage and having a reasonable debt to income ratio functioned well. I don't see why a new government organization cannot be set up to lend to such borrowers even with falling house prices.

There is much talk about stockholders in Fannie Mae and Freddie Mac being wiped out while the bondholders are made whole. This is nonsense. There is no reason why the bondholders who got the benefit of a higher return than treasuries shouldn't also experience the risk of losses due to default.

[Lafayette]

Article: Fannie and Freddie are way too big to fail -- especially now. There's no question the government will have to take over the companies, which means taxpayers will get stuck with the tab yet again.

So what?

The mortgage holders are taxpayers too, aren't they? They have therefore every reason to expect protection, meaning a moratorium on payments for the time necessary for the economic situation to recover. Or legislation that declares payment resets as illegal if usurious, the latter being defined as some multiple of the Fed rate.

By the way, such a moratorium would go a long way towards boosting spending and thereby strengthening the economy.

[anne]

"The Democrats to cave in so easily on important issues after they took control of Congress."

Right.

[A little justice?]

No problem on the bail out of the company as long as ALL of the current and past (up to 2004) CEOs, board of directors and executives assets beyond ($500K) are confiscated into the treasury. And they should consider themselves lucky they are not put in jail. May be too radical but it would be poetic justice

[skeptictank]

NO, don't nationalize them. The problem right now is that Fannie & Freddie have distorted the market in such a way as to make mortgage lending appear safer than it really is (was), thus making mortgage rates lower than they probably should have been. In this way F&F played a role in the housing bubble.

No, let'em go down hard & fast. That will in turn allow home prices to fall back down to an affordable level (median home prices under 3X median income).

If the government nationalizes them all of us taxpayers will be on the hook for well over $1Trillion. Interest rates on treasuries will (understandably) do a moonshot under those circumstances thus raising mortgage rates anyway. The government should quit mucking around in the housing market - let prices fall quickly. Otherwise we're just going to prolong the agony.

[Winslow R.]

Just yesterday I talked with a former Indymac broker who explained that Fannie was taking on bank loans at 100% of appraised value. Indymac would take a silent second for the difference between the original loan and the current appraised value with no payments for 3 years.

Banks are currently pushing their bad loans onto Freddie and Fannie. Fannie failure is a round about bank bailout.

Without an increase in wages, a bank bailout is needed.

[Bruce Wilder]

The cynical humorist in me thinks that a good solution might be to sell the whole shebang to the People's Bank of China for €1.

"Nationalization" is only a dirty word to the Republicans when it is our nation; if we sell our Ports or tollroads to foreign countries, well that's alright. Why not Fannie and Freddie?

[Bruce Wilder]

I think Fannie, in particular, has to be allowed to fail. The Federal government would impair its own credit rating, to take on the full measure of Fannie's obligations and guarantees. Let them both fail.

After the dust settles, create a new government agency -- as Fannie, itself was, from 1938 to 1968 -- with new rules and explicit, but limited guarantees.

Alternatively, declare a 5% wealth tax, with a personal exemption of $200,000, to finance the rescue, with any excess proceeds to reduce the national debt.

[Barkley Rosser]

If as I noted on another thread the FASB does not impose the Basel II accounting rules on them, they do not have that big of a problem. The current situation is driven by this insistence by the FASB that they must revalue their position according to current market values. Why should they, especially given their quasi-public stabilization role?

[mdm]

"The Federal government would impair its own credit rating, to take on the full measure of Fannie's obligations and guarantees."

Agreed.

[Bruce Wilder]

Mark Thoma: "If failure of these firms endangers the broader economy, and hence threatens to impose large costs on people who had nothing to do with creating the problems, then policymakers need to step in and do what they can to prevent a downward economic economic spiral and also change the rules and regulations that allowed the problem to emerge in the first place . . ."

I think we all ought to get a bit more cynical.

I think the rules and regulations that allowed the problem to emerge were deliberately manipulated, precisely to hurt people, who had nothing -- or little -- to do with creating the problems. The problems were created, in short, with the object of making money, by fleecing the rubes.

The Right has never had any difficulty finding economists, competent to design disaster. Their wrecking crew has been fully staffed, as they have systematically neutered the SEC and bank supervisors, repealed Glass-Steagall and revised the bankruptcy code, all with the object of creating Casino America and sinking 90% of the population into debt peonage.

What we seem to get on the Left, however, are half-blind hand wringers, twiddling their neo-liberal/libertarian worry beads, and expressing surprise, endless surprise, alongside earnest do-goodism about reform. This isn't a case of good faith failure, to be corrected in learning and a revision of the rules. Someone wanted the rules written this way, wanted the game played out this way. That someone is still in the game to win, until that someone is hurt, very badly.

So, the failure of Fannie and Freddie, if it comes, ought to be managed to focus pain. No rescue that is leveraged off the diffuse capacity of the taxpaying middle class -- no, lots of pain inflicted on the 1/2 of 1%.

A proposal for an excise tax on being a Republican would be welcome.

[ken melvin]

Is Fannie really buying the loans at %100? Something about this propping up escapes me. Missing a golden opportunity increase home ownership at the right price I say.

[Bruce Wilder]

Barkley Rosser: "The current situation is driven by this insistence by the FASB . . ."

Is it?

The accounting only reflects the underlying reality. Being allowed to lie about the situation does not make the problem disappear.

At best, being allowed to lie, only puts off the day of reckoning to an actual cash-flow crisis, overtakes Fannie and Freddie. For Freddie, that cash-flow crisis may not be far off.

[Innocent Bystander]

Here's what I don't understand about the moral argument of having to bail out the GSE's so that large costs aren't imposed on "people who had nothing to do with creating the problems". Don't some innocent people always suffer when a firm fails because of the greed and avarice of others? Sure the scale of the suffering might be greater if Fannie Mae or Freddie Mac go belly up, but how is it different from the suffering of the hairdresser who loses all of her business when the factory in her town moves to Mexico. Why aren't we considering bailing out General Motors. Surely if GM goes bankrupt some people unrelated to GM will be affected and may lose their homes. Maybe a GM bankruptcy won't cause a "downward economic spiral", but surely the suffering of the innocents who are hurt by the bankrupcy will be as miserable as the suffering that might be caused by a GSE bankruptcy. So the question is, if are goal is to prevent the suffering of innocents shouldn't we bail out every firm that is about to fail? How much potential for innocent suffering does there have to be before a firm is deemed "to big to fail".

[Jas Jain]

--
"On the too big to fail issue, my view hasn't changed. If failure of these firms endangers the broader economy, and hence threatens to impose large costs on people who had nothing to do with creating the problems, then policymakers need to step in and do what they can to prevent a downward economic economic spiral and also change the rules and regulations that allowed the problem to emerge in the first place (thereby lowering moral hazard worries going forward)."

You didn’t see this coming, Prof Thoma? You are a fine example of morally bankrupt born-and-bred American dopes. It is not your fault; you are a trained economist to serve the Financial Nazis of America – the Debt Pushers. The sad part is that Financial Nazis of America will make German Nazis look good! What a shameless bunch of rogues that support govt bailouts under any guise. Have you morally bankrupt dopes figured out who will benefit and who will lose out in the near-term and in the long-term? I didn't think so.

Regrettably,

Jas

[RegularFolk]

I would say, let the show begin. Let them fail. Everyone (all the people) was directly or indirectly implicit in this disaster by not demanding more regulation and scrutiny. Some have learned the lesson, many have not. If there is bailout, those 'many' will not learn the lesson and keep on dancing to the same tune. It is better to suffer this less pain now than to face a major financial disaster in future from which there will be no way out.

[dd]

The goal is to protect the guilty few and make the many innocent pay in the name of protecting the "system," "stability" or whatever it is that will scare the many into supporting the few.
In any case it will be the way it has been these many years and to answer the question of what will be done; it is being done:
1. Identify worthless assets;
2. Pay top dollar to consolidate to government controlled entities and support banking (sort of an emergency yield curve);
3. Pretend all is well;
4. Make sure all evidence of wrongdoing is tainted;
5. Form government bailout;
6. Pretend there is not bailout plan;
6. Toss in lap of next administration;
7. Congratulate everyone on a job well done.
8. Move on to next round of innovation (anyone have any ideas? Alternative energy isn't new; medicine too expensive; Boone has cornered water; tech is exhausted until the next generation matures; finance has demonstrated that quantum mechanics belongs in 4th dimensional thinking and not one dimensional money; but someone somewhere has an idea that is will move things forward in a actual reality instead of this silly virtual financial Mobius loop).

[Fred]

There is no downward spiral that cannot be stopped by sufficient fiscal stimulus. Eliminate the payroll tax. Eliminate the income tax on incomes under $100,000. Give the states federal funds in exchange for the elimination of sales taxes. Together with a drop in cap gains and corp taxes due to the coming recession, these measure should push the deficit over $2 trillion, which should be sufficient to stop the downward spiral. If not, then break out the old Depression-era idea of guaranteeing the unemployed jobs digging holes in the ground and filling them back up again for sub-minimum wages. Most importantly, we need to require all economists and wannabe economic pundits to read Keynes and then read him again if they didn't understand him the first time.

[Jas Jain]

--
FYI -- I have distributed the above response under

Financial Nazis of America & Their Army of Economists – Re: Fannie and Freddie

Jas

[ndk]

I can't believe it. We're going to nationalize them, and they think they can pull it off in a way as to impact the national debt less than an explicit guarantee would.

http://www.nytimes.com/2008/07/11/business/11fannie.html?ref=business&pagewanted=print

They claim investors already believe the implicit guarantee to be explicit, which:

(a) ignores ~75-230bp in CDS; and
(b) means that installing new management is somehow going to fix things?

This is really, genuinely awful.

[Jas Jain]

--
A fine way to kill the economy, Fred.

I think that you don't understand Debt and its consequences, or the idea of debt slavery. I am sure that you make a good officer in the army of the Financial Nazis of America and get well compensated. It is not your fault; you were "educated" to serve the Financial Nazis of America. You are an intellectual whore (morally blind) and America is full of them under the rule of the Financial Nazis.

Jas

[dd]

ndk, the GSE's have always been "nationalized." The capitalism has always been a veneer; albeit the shareholders now understand that only bondholders and derivatives counter-parties are taxpayer protected. Hence the angst.

[Bruce Wilder]

U.S. Considers Takeover of Two Mortgage Giants - NYTimes.com: "Under a conservatorship, the shares of Fannie and Freddie would be worth little or nothing, and any losses on mortgages they own or guarantee — which could be staggering — would be paid by taxpayers."

I did not understand the above statement. Is it a fait accompli that a conservator would pay 100%?? How? Would there not have to be an appropriation by Congress for this purpose?

If Constitutional government is so far gone in the U.S. -- and it may be -- that the merely middle class lose their houses and their government securing the very wealthy and foreign banks against any scintilla of loss, then we really should just flush the country's carcass into the dying ocean.

[Clyde]

If allowed to fail, a depression would result as real estate would crash. F&F are providing 80-90% of mortgage loan financing today in the US. Ain't going to be contemplated, get over it.

[ndk]

Failure prevention is one thing. Temporary nationalization for the period of horrific losses incurred as a result of a period of stunning profit at the expense of borrowers is quite another. I'm furious.

[Bruce Wilder]

Real estate is already crashing, Clyde. That's why Fannie and Freddie are in such trouble.

Of the total wealth of 90% of the U.S. population, something between one-third and one-half is disappearing down the sinkhole, already.

Of course, something will have to done to keep the mortgage market working. But, that doesn't mean that the mortgage market has to be structured as the craps table at Casino America.

And, contrary to what Mark Thoma wrote, it is not enough to call in corrupt economists to write new rules, which they promise, this time, will correct the problems created by the rules they wrote the last time, with the promise that rolling back regulation wouldn't recreate the Great Depression. The rescue, itself, should be designed to cause lots of pain, to the right people. Torture is legal, now. Let's use it.

[David]

Why do we need a Fannie and Freddy? Their whole purpose is to keep money flowing into the mortgage market. There's only so much housing available, of course that leads to a bubble.

I'd also be curious about the consequences of letting them fail. Less revenue from property taxes, but it's far cheaper to bail out local government instead. If you live in your house and you have a "normal" mortgage, the value of the house dropping in half should have no consequences. It's just a paper loss - just like how stock portfolios around the world took a dive. You can hold onto it and have, so far, lost absolutely nothing.

I suppose one drawback is that people can no longer borrow against the bubble-value of their house. That's not something that needs to be encouraged anyway.

Some people will lose their homes, others will now be able to afford one. I don't see how home owners are in any way more worthy of protection than employees who lose their job to globalization. We know the latter leads to a better outcome in the long term, why not the former as well? When the cost of the bailout was a few billions, it was one thing. But we're looking at trillions here, that's not something the government can afford.

[skeptictank]

Clyde said:

"If allowed to fail, a depression would result as real estate would crash. F&F are providing 80-90% of mortgage loan financing today in the US. Ain't going to be contemplated, get over it."

Well Clyde, how did we arrive in this situation? You think that maybe Freddie & Fannie might have had something to do with it? So basically, we don't have a private mortgage industry in the US at this point. We have a pair of quasi-private-public creatures that are supporting 80% of the mortgages written right now. Another 10% comes from FHA (another government program) leaving the remaining 10% (oh, well, when you consider that some of that remaining 10% are VA loans, then maybe it's not a full 10%) of mortgages being written currently without government intervention of some sort. Do you see anything wrong with this picture?

[gordon]

Bruce Wilder: "Is it a fait accompli that a conservator would pay 100%??

Excellent point. One way of avoiding the conservator paying 100% would be to allow these mortgage holders to issue bonds secured on their stock of repossessed housing at an agreed valuation, the bonds to be taken up by the Commonwealth Bank of the US (see here and here.)

When the housing market recovers, the bonds could be redeemed as this stock is progressively sold off. And the credit of the US Govt. isn't compromised, because the debt is, so to speak, off its balance sheet.

Of course, you have to have the Commonwealth Bank of the US in place first.

[Lafayette]

Dysfunctional nonsense

BW: The cynical humorist in me thinks that a good solution might be to sell the whole shebang to the People's Bank of China for €1.

This is what Japan did coming out of its real estate bubble. Only the acquirer was not the B of C.

These just stuffed all the bad debt in a government owned entity and let it die there. I'll bet, one way or another, we end up doing the same. The debt will either refinance itself or the property confiscated and resold. It takes years and years, but there is no Quick Fix to such a humongous human error such as this sub-prime mess.

Sending the culprits to jail will salve bad feelings (about the bastards), but it wont change mentalities in a country that does not know how to impose rational controls on its finance markets.

All this agony in the name of the Exaggerated Exuberance? It's dysfunctional nonsense.

[BJ Feng]

I don't know why an implicit guarantee was assumed to be near 100%, in the past every single statement I've ever read by government agencies made it clear that there is NO federal guarantee of any kind. But I guess it doesn't take a genius to figure out that the government would have to in a crisis. Many institutional and pension organizations hold Freddie and Fannie guaranteed mortgages, and they would be forced to write down the value of those mortgages if Freddie and Fannie were to go bankrupt and the government didn't step in. That could create a dangerous destructive spiral. If not for that, I would say let those who bought Fannie and Freddie bonds take the consequences of their assumed guarantee. The mortgage market would not disappear, but the government would have to step into the shoes of Fannie and Freddie perhaps with GNMA. So far, the government run agencies like GNMA, and HUD have not been able to do anything near what Fannie and Freddie have done for mortgages.

What Freddie and Fannie have accomplished is to enable mortgages to be packaged and sold in a standardized form. THIS ALLOWS ORDINARY AMERICANS TO BORROW LIKE THE BIG BOYS. I have a 15 year mortgage at 5.25%, a crazy low number, and was able to borrow 80% of the value. The fact is that there isn't any other place where Americans can borrow for such a long time for such a low interest rate. Hell, you can't even borrow $100 for 5.25% without using some sort of mortgage. Personal loans, and even car loans, which are also packaged, have far higher interest rates and for much shorter terms too.

Ordinary Americans have benefited greatly, again, it's the only way we can borrow like the hedge funds. To put things in perspective, major companies like GAP, Amazon.com, Comcast, and Disney have to pay HIGHER interest rates than little ol' me when they issue bonds. And questionable companies like GM, and even Citibank recently, have had to pay far higher interest rates on their 10-year bonds (both GAP and Amazon.com aren't investment grade to be fair). This huge benefit cannot be ignored or dismissed!

I believe that, if Freddie and Fannie receive government help, the government must demand compensation in the form of future earnings. That is the government should get a majority of Freddie and Fannie's equity through either common or preferred stock so the taxpayer can benefit from future earnings. Over time, those shares will be resold back into the market, but by taking a majority of the company, current shareholders are diluted and punished, and prevented from benefiting too much. Taxpayers will be the ones who receive the majority of the benefit in case of recovery. That should be the method used for ANY bailout. Bailouts cannot be free, current shareholders should not get the majority of gains that might occur in the future thanks to a bailout.

Do we need a quasi-government entity like Fannie in the future? That's questionable. Mortgages would continue to be packaged, like car loans are, but then Americans would have to pay a far higher interest rate and might not be able to get 30 year fixed loans. In the commercial real estate sector, loans greater than 7 years are unheard of, you can't get them.

Ordinary Americans have benefited from the implicit guarantee. The problem is that shareholders of Fannie and Freddie have also benefited greatly, but there isn't an easy solution. The government is incapable to operating a business like Fannie and Freddie, GNMA and HUD have been left in the dust though they take the same sort of risk. Yet it's unfair for shareholders to get all of the gains when they depend on the government to do so. Let's try to come up with a reasonable solution, not the usual anti-private, ban all corporations crap. Maybe the best solution is to do nothing or almost nothing, that has to be considered also. Busts occur periodically, loses prevent overzealous lending for a while, no way has been found to permanently eliminate busts and the business cycle. Keep that in mind too.

[ndd]

What sootytern and Bruce Wilder say.

1. Any "conservatorship" or "nationalisation" should be like the 1970s Chrysler bailout where The American Taxpayer is the new shareholder/owner. Current shareholders must be cleaned out.
2. I see no reason whatsoever why current bondholders should receive 100% compensation. Did somebody say "free market"?
3. Can we please, please, please stop allowing the creation/consolidation of entitiies which are "too big to fail"?
4. I am glad to see others embracing what I have been saying for awhile now. We don't have to rely on toxic putrifying corpses of financial companies to be raised from the dead. New, healthy, properly regulated financial companies -- "nationalized" by Uncle Sam if necessary -- can take their place.

This current downturn is unlike the 1929-33 GD (although both feature staggering credit losses and asset declines). The GD hit manufacturing and employment immediately and drastically, even as 1930 began. This credit disaster is so far like a Neutron Bomb over Wall Street" destroying the financial houses but leaving the broader economy largely intact.

[baileyman]

In reading the above comments it seems there's a bit of slppy thinking about what "failure" means in this case.

One level is equity loses its value, the firms go BK and debthoders take over. Happens all the time. Operations can continue.

Another level, debtholders also lose. The senior most tranche here Could get the firm. Operations can continue.

But the USA is a quasi owner here. The firms could go BK, equity and debt could be wiped out, the USA takes ownership, making them the public agencies they ought to be, and operations continue.

The value they provide is in the guarantee operations. The USA can guarantee the guarantees. Problem solved.

We need not cry for the investors.

says...

Wall Street is looking for another bailout of equity and bond holders, not nationalization. They don't won't the US taxpayer to takeover Fannie and Freddie, they only want us to pay out their losses.

Like I've commented before, it will be nationalization without the nation.

[a]

"If as I noted on another thread the FASB does not impose the Basel II accounting rules on them, they do not have that big of a problem. The current situation is driven by this insistence by the FASB that they must revalue their position according to current market values. Why should they, especially given their quasi-public stabilization role?"

And why shouldn't adults believe in Santa Claus and the tooth fairy? Why don't we just pretend and pretend and close our eyes to all the problems in the world, click our heels three times, and hope everything gets better?

[esb]

The "pre-market" on FNM and FRE is signalling a "game over" moment is at hand.

Look for Paulson to grant an interview and spew out his usual bullshit.

Look for Bernanke to conduct an "emergency" meeting of the FOMC (Sunday afternoon sounds about right to me).

[anne]

http://krugman.blogs.nytimes.com/2008/07/11/fannie-freddie-sweden-japan/

July 11, 2008

Fannie, Freddie, Sweden, Japan
By Paul Krugman

Negative equity, here we come [Figure]

Will Fannie Mae and Freddie Mac have to be bailed out * by taxpayers? I have no inside information, but I’d say yes, for two reasons.

First, as Reinhart and Rogoff ** document, big financial crises always end with an expensive bailout of the banking system. It happened in Sweden, it happened in Japan. Why should we be different? Except that in this case banks proper took on very little of the risk; Fannie and Freddie, on the other hand, took on a lot of it.

Second, the housing bubble was immense; see the figure above, taken from the always excellent Calculated Risk. *** Fannie and Freddie only guaranteed conforming loans — loans that weren’t that big, didn’t have exotic financial features, and required a substantial downpayment. But so what? If real prices of houses in places like LA return to historical norms — and there’s no reason to think they won’t — many, many borrowers with conforming loans will end up with big negative equity anyway, and this in turn will produce a lot of defaults.

This crisis is a long way from being over.

* http://www.nytimes.com/2008/07/11/business/11ripple.html

** http://www.economics.harvard.edu/faculty/rogoff/files/Is_The_US_Subprime_Crisis_So_Different.pdf

*** http://calculatedrisk.blogspot.com/2008/06/case-shiller-tiered-home-price-indices.html

[hari]

In addition - this US housing crisis, in fact, is demonstrating extend to which European banking sector is caught-up with some of the ergerious swaps. It seems a lot of them will now have to write-off precarious investments and raise new capital to stay within BIS/Basel II requirements.

[esb]

Right on cue, Paulson is preparing to issue a pronounciamento.

Cue Bernanke.

[Common Sense]

Fact: Conforming loan foreclosure rate= .99%
Fact: Conforming loans required mortgage insurance for LTV over 80%
Fact: Total peak to trough RE values currently nationally around -20%
Fact: Less than 2% of loans were written during peak

Don't let the facts get in the way. F & F aren't going to need a bail out.

[esb]

Wow, exactly the opposite of what I expected from Paulson.

They are just going to allow the equity to run off.

Fair enough.

Kiks the cans into the Obama Administration where the problem will just be rolled into the new new deal.

The NND will have a lot of parts to it.

[esb]

Wow, exactly the opposite of what I expected from Paulson.

They are just going to allow the equity to run off.

Fair enough.

Kiks the cans into the Obama Administration where the problem will just be rolled into the new new deal.

The NND will have a lot of parts to it.

[Bruce Wilder]

Common Sense: Don't let the facts get in the way.

You might want to consider that Fannie and Freddie's obligations are measured in Trillions, with a capital "T".

Even 1% of five trillion dollars is a staggering amount of money and neither Freddie nor Fannie is anywhere near as heavily capitalized as a bank would be. During the runup to the peak, Fannie and Freddie were being raked over the regulatory coals (by a Republican Administration!) for fraudulent accounting practices and excessive executive compensation. Nobody's looking here for excellence in management practice.

The real fear here is that conservatorship, which may well be forced on Treasury in short order, would put a serious crimp in the continuing operations of Fannie and Freddie, which, in turn, would freeze the mortgage market, which, in turn, would cause the housing market to seize up, even as banks are trying to liquidate their REOs. If banks cannot sell the houses they have foreclosed on, or can only sell in a housing market where prices are depressed further by a dearth of mortgage financing, and the banks themselves cannot make money by issuing new mortgages . . .

Obviously, there's real potential, here, for the situation to spin wildly out of control in a major financial crash.

[hari]

BW - I am following you on this failure of a major housing financing institution implicitly guaranteed by Fed Gov.

After noting what's going on in the market and reporting by Bloomberg and Reuters, I would have to agree with you that market mechanism might foreclose the issue and Paulson may be just too late to rescue its fate.

Given the scale of CBs involvement in F&F, in EU, imagine the implications of failure in present circumstances.

Could it be that GOP is trying to pass the buck to next WH occupant - with all its political implications?

[Barkley Rosser]

Well, if they collapse it will happen before the next prez is in office, and it will have very unpleasant consequences.

I continue to say that the FASB should have left well enough alone. These entities only have a problem if they are forced to revalue and sell assets to raise capital, which could crash the whole darned system. We are dealing with the weird, half-bakedness of their status, which should have been left as it was.

Originally they were clearly government-based entities, designed to smooth the housing market, which they did very well. Then there was this ideological push to fully "privatize" them, a line still being officially maintained by Paulson et al. But, in fact the markets have long believed that they had this implicit guarantee behind their assets, as in the past officially. Indeed, if the market had not believed that, their lending would have already shut down and the mortgage markets would be in much worse shape right now than they are.

If their assets are backed up, then they are not in nearly as bad shape as all the official accounting says, as insisted upon by the FASB. So, sure, if Paulson is right and they are fully private, then let them follow the FASB requirements, discover that they are bankrupt, and let all hell break loose on the mortgage markets. Great.

[Eric Dewey]

Ultimately (and cynically, for BW), the issue is political - and it goes to the core of the question of trust in leadership.

The point I see going thru this thread (and others on the net) is that US citizens have very little trust left in their leaders, regardless of whether those leaders are GOP, DEM, or corporate.

Whatever happens with Fan and Fred will simply be another crack in the wall of confidence - and the size of the crack will depend on whether the public thinks that an inappropriate bailout has occurred or not.

I don't think McCain has a chance of regaining the trust of the voting public, and I'm beginning to worry that while Obama may have a chance to do so, his handlers will undermine that chance.

It's important to remember that any ruler is impotent to make change happen if their bureaucracy does not support the change.

[hari]

Eric Drew - I agree with you, in final analysis, it's all a political gamemanship that's going on right now in beltwat and hi street.

Let me give you a fig I just got from GRE Monitor claiming some $600+ Billion papers money (that's what it is!) are owned by EU domestic CBs - as well as - ECB.

[hari]

spelling - gamesmanship...beltway

[hari]

That is - *FF money trail* - I'm talking about.

If this collapses - it will be difficult to think of Oct'87.
It might go further and further....

[anne]

Always pay attention to Warren Buffett. Buffett was among the early owners of Freddie Mac, which was among the largest of share portions in the Berkshire Hathaway portfolio. However, after holding the shares for more than 20 years, they were suddenly gone, gone long before there was any evident problem with the company, gone when the home real estate market was strongest. Buffett explains why he buys, but never explains why he sells, but the point is always pay attention as Berkshire owners will.

Paul Krugman began complaining about housing prices some while after Buffett sold.

[a]

"These entities only have a problem if they are forced to revalue and sell assets to raise capital, which could crash the whole darned system."

If we pretend there is no problem, then there is no problem? I don't think so....

IMHO, there will be no change in what happens, only the timing. If the GSEs are not forced to revalue, the market will still starve them of capital, unless the Federal government provides an explicit guarantee, in which case the dollar and Treasuries will tank.

[esb]

Bernanke just answered his cue.

FRE and FNM can "discount" any toilet paper at the "Fed."

(Including derivatives used for hedging???)

[Lafayette]

Impressive kerfuffle by wailing Cassandras.

[BJ Feng]

The problem is with the guarantees. But Freddie and Fannie will not have to make good on any potential losses for years to come, the market is discounting for the future, Freddie and Fannie can continue operations for the foreseeable future. In worse case scenarios, they would have to raise more capital, but they have years to do that because the mortgages they guaranteed won't all go into default tomorrow.

As for the government guaranteeing the guarantees, well that would be needed only if Freddie and Fannie couldn't cover the defaults. That would make the US taxpayer have to swallow the losses. We are a long ways from that day though, the government should not be so concerned with stock market moves.

One more thing, a lot of the move is due to momentum trading. Financials are being pounded because of sentiment and the realization that shareholders are going to lose most of the money they've invested. Freddie and Fannie could lose 90% of their equity or more, than means the firm is only worth 10% of what it was. Any moves to raise additional capital would dilute the ownership of current shareholders so there is no way they can avoid the pain should loses materialize. Fannie and Freddie as stocks could be worth only a few cents a share, but that doesn't mean they can't continue operations.

[german_reader]

Interesting sentences in one of the New York Times articles anne has linked to above:

"If a bailout were to occur, it would most likely make it more expensive for the United States government to borrow money in the future, since the government’s potential obligations, which currently stand at about $9 trillion, would rise by an additional $5 trillion.

Moreover, such a bailout would potentially put taxpayers on the hook for billions to offset Fannie’s and Freddie’s losses."

How was it? Taxes are unpopular in the U.S.? Could be that they become much, much unpopular in the near future.

[german_reader]

"much, much MORE unpopular..." and the web link was:

http://www10.nytimes.com/2008/07/11/business/11ripple.html?pagewanted=2&_r=5

[Bruce Wilder]

BJ Feng: "Fannie and Freddie as stocks could be worth only a few cents a share, but that doesn't mean they can't continue operations."

It seems to me, that if, by "continue operations" we mean continue to buy new mortgages in volume, then, no Fannie and Freddie could not continue operations, with their shares worth only a few cents.

Did you mean something else?

[Jon H]

"It seems to me, that if, by "continue operations" we mean continue to buy new mortgages in volume, then, no Fannie and Freddie could not continue operations, with their shares worth only a few cents."

Er, why not? Their operations aren't bound to their stock price. It's not like they sell their stock to raise the money for homebuyers.

[hari]

See sidebar Greg Mankiw - FT (Feb 24, 2004)

"Keeping Fannie and Freddies's houses in order"

Greg ends his article..."provide (FF) with world-class regulator". He's also demanding removal of Pres. powers to appoint FF Directors (ie. conflict of interest).

Also on *sidebar* see his testimony to Congress dealing with regulatory assessment of GSE....(as Chairman/Econ Council).

It seems to me, from an objective assessment of current policy, there are serious problems to takeover FF liabilities because of its leveraged market position - in Trillions of dollars - sounds very similar to Hedge Funds.

Former Treasury Sec/Snow is declaring that he warned (while in office) to upgrade FFs regulatory controls - since he found it not satisfactory. Congress was not of his views, if I understand him right.

The bottomline, in this massacre will be Congressional politics and dealings with FFs mortgage underwriting operations in different congressional districts and how it affected legislators objectivity in dealing with FFs regulatory oversite. This is a very damaging political massacre of beltway business-as-usual.

[BJ Feng]

All guarantee companies like Fannie "leverage" because they don't expect 100% of the loans they guarantee to default. I'm not sure about accounting rules, but I don't think they actually have to write off loses until pay a guarantee. And remember that loses are never 100%. Fannie loans require a 20% downpayment, worse case 50% of the loan is recovered in foreclosure and I really do believe that's a high worse case scenario. We also know that more than 90% of Fannie's guaranteed loans will never have any problem, far more since default rates haven't come close to 10% in modern times. Will 5% default? These are supposed to be prime loans with a 20% equity cushion, not the subprime crap.

Fannie and Freddie guarantee about $6 trillion. 5% default means $300 billion in impaired loans. Now if 70% can be recovered, then both are on the hook for $90 billion or $45 billion each.

Common Sense is right, Freddie and Fannie should be able to survive without government help.

[clive ling]

The U.S and has been bankrupt for many years imo.Its true you are a hard working nation with big ambitions but you depend too much on oil and borrowed money.Extended oil prices will kill off the ability to function properly as a nation who need to get to work.You have a very poor public transport system and vehicles that are not fuel efficent,so many of you are having to leave them in the garage.The big suv you just bought has no trade in value and there is not a large enough diesel infrastructure to support turning over to diesel powered cars.
These two behmoths Fannie and Freddie are on the brink,actually they are past the brink imo but you have not been told the real story.The government have to act tonight to save these two because no action will cause instant depression in the U.S.Action now though will do nothing more than postpone it.This is me and my view looking over from England.
I do wish you all the best though having just spent a great holiday over there with you.America is now the only place I can afford to go on holiday because my pound goes so far against your currency.
Regards.