Fannie, Freddie and You: What It Means to the Public (Sept 7 – NYT)
So what does the federal takeover of two mortgage finance giants mean to consumers?
Mortgage rates may fall a bit initially but probably not enough to halt the decline in home prices anytime soon. Some delinquent borrowers may have a better shot at modifying their loans and ending up with lower fixed payments. And the rules on new mortgages could slightly change.
Oh, and the federal government will help pay for it all, using your tax money.
There’s not much ‘reason’ for any of the market reactions we saw today. Those have to be attributed to something other than a change in the fundamental landscape. To begin with, FNM and FRE always had implicit backing by the federal government, so making it explicit should, on the surface, do little to make the broad stock market rally. But rally it did. Here’s a partial list of other things that bailing out FNM and FRE won’t accomplish:
- It won’t stop house prices from sliding down further.
- It won’t create any new jobs.
- It won’t resuscitate the already insolvent banks.
- It won’t help the federal budget deficit; it will make it far worse.
However it DOES represent money that will not be used to fix bridges, repair our electrical grid, or send kids to college. And it DOES represent a bailout of everybody who is holding FNM and FRE paper (bonds and MBS and such).
How much money is all this going to cost? I figure somewhere between $250 billion and $750 billion before all is said and done. The next article does the math.
Deja Vu (Again) (July 7 – Hussman Funds)
As I noted in July “it is reasonable to expect that at least 4% of the mortgages held or guaranteed by Fannie Mae and Freddie Mac will ultimately fail by 2009 (when the open-ended commitment of the government sunsets). Assuming a 50% recovery rate, which is about what banks are running on foreclosure recoveries lately, the losses on the retained mortgages and the guaranty books of Fannie and Freddie would already exceed $100 billion.” Unfortunately, that $100 billion loss projection was based on the premise that the government’s commitment would extend only until January 2009, so I only included in that 4% the mortgages already in foreclosure and just a portion of the delinquent ones.
With that January 2009 “sunset” provision now gone, I expect that U.S. taxpayers will be on the hook for about $250 billion in losses. Look – 9.16% of U.S. mortgages are already delinquent or in foreclosure, with the likelihood of further delinquencies and foreclosures in the coming quarters. On a $5.2 trillion book of mortgage loans between Fannie and Freddie, and a prevailing recovery rate of 50% on foreclosed properties, an overall loss of about 5% of this book, or about $250 billion, is a fairly conservative expectation.
I happen to agree with Mr. Hussman here in the timing and direction of this. But $250 billion is pretty much my floor on the costs. I happen to think that we’ll experience something closer to a 10% to 15% default rate, which would yield a $500 billion to $750 billion loss estimate. But that will take a couple of years to unfold. I happen to think that $250 billion is a reasonable estimate of losses over the next year, which happens to coincide with the government fiscal calendar. If we add $250 billion to the US government’s already-estimated $500 billion deficit projection for FY 2009, we get to jack their total borrowing take for next year to around $750 billion – a record by far, just not the sort you want to be making right here.
And this assumes that there isn’t further deterioration in the area of income tax receipts, an assumption I am not willing to make. If things go bad on this front, too, a $1 trillion dollar borrowing need is not unthinkable.
Couple this vast need to borrow with declining imports, and suddenly it’s reasonable to ask where all this money is going to come from. Domestic savings? No, that’s not likely. Foreign private parties? No, that’s not likely either.
This leaves official CB intervention to plug the gap. And this is what just happened this weekend. We threw ourselves on the mercy of strangers. I sure hope we haven’t done anything lately to make them mad.
Fannie, Freddie Credit-Default Swaps May Be Settled (Sept 8 – Bloomberg)
Sept. 8 (Bloomberg) — Investors may be forced to settle contracts protecting more than $1.4 trillion of Fannie Mae and Freddie Mac bonds against default after the U.S. seized control of the companies in a bid to bolster the housing market.
Thirteen “major” dealers of credit-default swaps agreed “unanimously” that the rescue constitutes a credit event triggering payment or delivery of the companies’ bonds, the International Swaps and Derivatives Association said in a memo obtained by Bloomberg News today. Market makers for the privately traded contracts will discuss how to settle them in a conference call at 11 a.m. in New York, the document said.
“This is a big deal,” said Sarah Percy-Dove, head of credit research at Colonial First State Global Asset Management in Sydney. “The market is not experienced at settling a credit event for a name of this size, so it is a bit of an unknown.”
A credit-default swap is a derivative agreement where two parties place a bet on whether a particular bond will enter default or not. If the bond goes into default, the writer of the CDS pays the face amount to the buyer of the CDS and then takes possession of the bond. Normally if a bond goes into default, it suffers a pretty horrendous loss in value.
In this case, I am not so sure that much will be gained or lost by either party in this mess. The FNM/FRE bonds are still trading pretty close to full value (because of the government bailout/backstop), so all that will really happen here is that bonds and money will trade hands at close to parity. Still, it’s a pretty big pile to have to unravel.