Government Handouts Galore

Time flies.  It has been over seven years since the agencies, Freddie and Fannie, were placed under the conservatorship of the Treasury.  Think of it as a bankruptcy filing.   The difference being that there has been no reorganization plan, nor a liquidation plan.  In fact, there has been no plan at all, aside from letting the hole be dug deeper and deeper.


FNM HQFannie Mae’s headquarters in Washington – not bad for a technically insolvent company

Photo credit: Picture Alliance / DPA / EPA


The fixed income market has come to accept the agencies as government-owned agencies.  All losses will be backstopped by the Treasury, or rather taxpayers, while rates will be manipulated by the Federal Reserve via what they are labeling monetary policy.


Fannie MaeFannie Mae’s common stock since 2006. It has become a plaything of short term speculators in recent years, as a handful of hedge fund managers began to bet in 2013 that they could squeeze some reimbursement for shareholders of the bankrupt company from Washington – click to enlarge.


The real estate market has also accepted that the agencies in their current form as the new normal. The agencies will be there to provide easy financing when times are good, and even easier financing when times are bad.

Any such system works as long as prices are appreciating, and home prices have been appreciating, climbing over the low hurdle set after the sub-prime bust.  The higher the appreciation, the easier it is to mask any underlying problems, even a monster like sub-prime.  It is when prices stop appreciating that all hell breaks loose.

There is no argument that government intervention in the foreclosure process, massive bail-outs of loans in default, modifications of mortgages and Federal Reserve manipulation of interest rates all played a hand in this rising price trend.  The question is: What happens when the handouts stop?


A Huge Problem and no Fix in Sight

The markets are focused on Ms. Yellen and her symbolic hike, accompanied by some Fed-speak.  No one is paying any attention to the GSEs.  There are two recent articles on the subject from REwired:

Exclusive: Josh Rosner and Glen Corso on why it’s time for true GSE reform and

Affordable housing advocates on why conservatorship of Fannie, Freddie must end by John Taylor.

I encourage anyone who may be interested in real estate to glance through these articles.  They are excellent summaries of the state of conservatorship.  Here are the conclusions that I draw:


No Fix is Coming

There are no solutions other than the status quo. There are no political solutions.  There are no economic solutions.  (Read the two articles above and draw your own conclusions.)



Think of the agencies as insurance companies, which they are.  Instead of reserving for the potential losses, the agencies gave the insurance premiums to the Conservator and label them as “profits”.  This model would work as long as there are no disasters (as long as prices keep appreciating) but when the storms arrive, how to pay the claims is to-be-decided.


Unretractable Subsidy

Both articles claim that …


“[T]he conservatorship is having a real chilling effect on the activities of the GSEs, and has resulted in an excessive tightening of credit.”


I disagree.  In fact, the reverse is true.  If credit were excessively tight because of the GSEs, the market place would seize the opportunity to offer competing products to these so called deserving borrowers that have been unjustly denied credit. The fact that there is not a single product out there, with the exception of jumbles, suggests that no one wants to offer financing at the same rate and terms as the GSEs.  The real estate market will collapse without this subsidy.


A Sick Market

Headlines repeat how much foreclosure activities have dropped, as if the market were back to normal, whatever that means.  I often look at two pieces of evidence that indicate otherwise.  The first is the historical delinquency rate from the St. Louis Fed.  We are not even close to the level before the sub-prime bust.


Delinquency ratesDelinquency rates on single family mortgages – click to enlarge.


The second is from the Black Knight Mortgage Monitor October 2015 Report.  At the peak, there were 7.9 million non-current loans out of 55 million total loans.

Today, there are 3.1 million non-current loans out of 50.5 million.  In addition, there is an unknown number of troubled loans hiding under HARP or other loan modification programs.  Does this look like a healthy market to you?


TableNon-current mortgage loans, via the Black Knight Mortgage Monitor – click to enlarge.


The Answer Is Out There 

Michael Lewis should be writing the sequel to his excellent book The Big Short (if you are taking the time to read my rants, you should definitely read his book). The subprime bubble was so obvious that it did not take much analysis to see it.

If you make loans to unqualified borrowers with bad credit, no down-payment, insufficient income, exaggerated collateral value, using deferred payment schedules, what do you think the outcome will be?  If you subsequently package these loans and market them as prime products, what do you think the outcome will be?

Today, it is not as obvious and requires some number crunching.  This is a recent Freddie Mac decision, and I assume Fannie will follow soon:


“As part of a larger effort to increase transparency, Freddie Mac is making available loan-level credit performance data on a portion of fully amortizing fixed-rate mortgages that the company purchased or guaranteed from 1999 to 2014.”


While it may appear to be transparent, this release benefits only those with the necessary resources.  For example, if you give me a team of spreadsheet monkeys (aka MBAs), I am confident that I can come up with a wealth of tradable ideas.  Without the resources to crunch the numbers, I can only salivate and watch how the Blackstones or Paulsons of this world will benefit from the data.


Failure (Depreciation) Is Not An Option

Bernanke once thought subprime was a well contained problem, one that may only cost $100 billion or so.  How much did that mistake cost taxpayers?  Today, the market is just as complacent.  The real estate foundation is so weak that it would not take a big crash, say 20% drop in price, to cause major damage.

The bulls may believe that there is nothing to worry about, that the government is there and has their backs.  The bears would counter that it is time to worry, precisely because the government is there.

I believe that it will take no more than a flat market for the problems with GSE conservatorship to return to the limelight.  Regardless, if the number of non-current loans starts to increase again, it will be time to fasten our seat belts.


Charts and tables by: BigCharts, St. Louis Federal Reserve Research, Black Knight Mortgage Monitor


Image captions by PT




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One Response to “The GSEs: A Ticking Time Bomb”

  • therooster:

    If you think the “hole” has to be filled by the PTB, think again. How can that empower the populace ? It won’t. The solution and the reconfiguration of power, both, come by way of the market . We add (monetize) gold into circulation, adding to existing liquidity (debt) while also allowing debt to be purged. Market osmosis between the yin and the yang.

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