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Guest Post: Fannie and Freddie - The Exit Doors are Shut

Friday, August 20, 2010, 1:09 PM
by Ilargi of The Automatic Earth

This article ran for our enrolled users earlier this week and is one in a series from respected guest commentators while Chris is at work on his new book. Please welcome them to the PeakProsperity.com community and enjoy the fresh perspective.

From a purely political point of view, it’s a simple story.  Existing homeowners are a far more powerful force at the voting booth than potential owners, homebuyers, are.  It’s therefore very much in the interest of the incumbent government to keep home prices as high as it can.  Let them slide too much and you will pay for that at the next election.  For potential buyers, you can devise plans that lower interest rates and down payments, but that's all.  More affordability simply through lower prices is not on the political table.

Still, in the "listening conference" on US housing policies - Fannie Mae and Freddie Mac in particular - that started this week, it's not voters who have the biggest say.  That is reserved for the financial industry, and how could it not be?  Not that the Obama administration has to hear the truth from the bankers anymore:  Washington has long since realized that truth.  Which is that without Fannie and Freddie and the 80% stake the US took in them in 2008, as well as the unlimited financial guarantee issued by Tim Geithner at the end of 2009, it's not just the housing industry that would instantly collapse.  The banking industry would, like a shadow, rapidly follow in its footsteps.

Which is why the conference is largely an elaborate piece of public spectacle, bereft of any true substance.  It’s the government going through the motions of an exercise when it knows the outcome beforehand; perhaps silently praying for a miracle to come forward, but at the same time not even remotely considering the one and only solution to the problem.  Which is to get rid of Fannie and Freddie, let the share- and bond-holders take the haircuts they deserve for investing in overtly bankrupt walking dead, take the losses that remain on the federal balance sheet, and let the housing and mortgage industries sort it out for themselves for a while.  Say, five years.

And so what I’ve often labeled the biggest crime in US history continues unabated.  There is, on a regular basis, lots to do about the various bail-out schemes for too-big-to-fail institutions that have been initiated in the past two years, but the largest bail-out, consisting of Fannie, Freddie, and increasingly also Ginnie Mae and the Federal Housing Administration, is hardly ever mentioned in the same vein.

Undoubtedly, this has a lot to do with the way the money is made available, as well as with the permission to hide the true value of all the paper involved in the industry.  But it is still remarkable that the press hasn't been on top of it to a much greater extent.  If it had been, perhaps we wouldn't have had to listen to Tim Geithner opening the conference with trying to rationalize ongoing government (financial) support of the housing industry like this, reported by Ronald Orol at Marketwatch:

Geithner: Housing system needs government support

"Without such support, the risk is that future recessions could be more severe because the financial system would not have the capital to support mortgage lending on an adequate scale..."

Really? Pray tell, what is an "adequate scale" of mortgage lending in a recession?  And who decides that?  Do we consider what the market will tolerate "adequate," or is that off the table from the get-go?  Or does "adequate" simply indicate an ongoing level of lending and borrowing against the grain of the recession, in which lenders can continue to lure people into loans that they should perhaps not have signed, given the situation both the economy and they themselves are in?  In other words, keep the financials afloat at the cost of the people?

At least Bill "Skin-In-The-Game" Gross at Pimco, one of the largest holders of US mortgage backed securities, has a plan:

Gross recommended a major home refinancing program where homeowners with mortgages that have 5%, 6% or 7% down are reduced to the current 4% rates. "This home refinancing, to my way of thinking, where you take 5%, 6% or 7% mortgages and turn then into 4% mortgage would provide a push, a stimulus of $50 billion to $60 billion in consumption as well as potential lift of 5% or 10% in home prices," he said.

Sounds too good to be true.  What's wrong here?  Millions of homeowners get to live cheaper, enabling them to spend more; home prices would go up; and it would cost the government nary a penny.  Why didn't anyone else think of that?  Well, all you need to do is look at who, indeed, would pay the costs.  That would be the lenders, who would now receive 2-3% less in monthly interest payments.  Wall Street would never accept it, unless Washington makes up the difference.  Which Washington would never accept.

It would also make homes less affordable for potential buyers, since prices ostensibly would rise.  But even with today's record low mortgage rates, pending home sales are plummeting, while housing starts are anemic by "normal" July/August standards.

In other words, there is a fiction that says home prices need to remain high in order to save both the banks and the government (if only because of its 80% Fannie and Freddie stake), while at the same time there is a reality that says sales are dragging through the gutter in the face of record low interest rates.  And as is the case with so many plans and schemes that the Obama administration has so far come up with, the fictional tale is based on the biggest fiction of them all:  Economic growth must and will return, and wash all our sins away.

Bill Gross gives the government one more bit of reality, as Binyamin Appelbaum writes in the New York Times:

Geithner Affirms U.S. Role As Mortgage Backer

"To suggest that there’s a large place for private financing in the future of American housing finance is unrealistic," Mr. Gross said.[..] Pimco would not invest in bundles of mortgages that lacked government insurance unless the borrowers had made down payments of 30 percent or more

How'd you like them apples?  Gross has the actual guts to paint a picture of, well, let's say, what a mortgage looked like prior to heavy-handed government meddling in the market.  But he also makes clear that he doesn't want that:  His fortune was made precisely because the government is into the housing market up to its ears.

There are still plenty of Americans who will defend Fannie and Freddie for all the good they’ve done for people who couldn't have afforded a home through the past 70 years or so.  It's time for them to wake up and smell the roses, or whatever it is this is starting to smell like.  Fannie and Freddie have become nothing but tools for the financial industry, first, to raise home prices (the more potential buyers, the higher the prices), and second, to lure people into purchasing these now far more expensive homes that they can barely, or simply not, afford.

There is no recovery in the US, and there never was.  There was a short head-fake, provided by trillions of dollars in taxpayer funds that were thrown at Wall Street, and of which barely anything has stuck to that wall.  Foreclosures have remained at near-record levels, as has unemployment.  Another quantitative easing scheme announced last week by Ben Bernanke is dead before it was born, because Washington has run out of ways in which to fool Americans into thinking green shoots are here or just around the corner.  Record low home sales at record low interest rates tell the entire story.

But the government, despite all this, isn’t done yet.  It will take as long as it takes to kick the Fannie's and Freddie's solution down the road.  Until the next election, and then the next one after that.  And it does make sense to do this from their point of view, since there is no solution available that would leave either the banking system or their own political careers intact.  There is no way out; the exit doors are shut.  They can't keep alive both Wall Street and Main Street.  And so they live for the moment, make the best of what they have, pocket as many more taxpayer bucks along the way as they can (alongside their banking buddies), and damn the American people.


Ilargi has been writing for his site, The Automatic Earth, together with his colleague, Stoneleigh, since January 2008.  Their message is bleak:  Western economies are set for a large bout of debt-deflation, from which they will rise in unrecognizable shape and form.  The way we have lived in the past 5 to 10 decades is forever gone; even when our debts and dues will have been paid, which will take a very long time, our lack of access to the energy sources that have built our societies will ensure a standard of living much lower than what we have become accustomed to.  Stoneleigh and Ilargi recommend that you find ways to reconnect with the people around you, as well as the earth you walk upon.  Stoneleigh travels the world presenting her lecture, "A Century of Challenges," a professional video representation of which will imminently be available from their website.

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6 Comments

Ruhh's picture
Ruhh
Status: Gold Member (Offline)
Joined: Nov 12 2008
Posts: 259
Re: Guest Post: Fannie and Freddie - The Exit Doors are ...

Great to see The Automatic Earth get more and more recognition :)

For those near Ottawa, Stoneleigh will be doing a presentation at the Ottawa Public Library Auditorium on September 2nd, 7pm. Don't miss it.

http://transitionottawa.ning.com/events/a-century-of-challenges

Chaos's picture
Chaos
Status: Member (Offline)
Joined: Aug 19 2010
Posts: 1
Re: Guest Post: Fannie and Freddie - The Exit Doors are ...

Met Stoneleigh and experienced her presentation in Austin a few months back; if you get the chance, she's well worth seeking out.

Johnny Oxygen's picture
Johnny Oxygen
Status: Diamond Member (Offline)
Joined: Sep 9 2009
Posts: 1443
Re: Guest Post: Fannie and Freddie - The Exit Doors are ...
Chaos wrote:

Met Stoneleigh and experienced her presentation in Austin a few months back; if you get the chance, she's well worth seeking out.

Hi chaos!

Welcome to CM.

Tycer's picture
Tycer
Status: Platinum Member (Offline)
Joined: Apr 26 2009
Posts: 602
Re: Guest Post: Fannie and Freddie - The Exit Doors are ...

Welcome Ilargi.

DavidC's picture
DavidC
Status: Silver Member (Offline)
Joined: Sep 29 2008
Posts: 243
Re: Guest Post: Fannie and Freddie - The Exit Doors are ...

As Chris has said before, what can't carry on, won't.

A good article Ilargi, thanks.

DavidC

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