Fannie/Freddie’s Survival Spells Big Trouble for Housing Market

Posted on August 28th, 2008 in Daily Mortgage/Housing News - The Real Story, Mr Mortgage's Personal Opinions/Research

If these two companies survive as private, beware. House prices will continue to fall, defaults, foreclosures and inventory will continue to surge, which causes house prices to fall and defaults, foreclosures and inventory to surge…….and so on and so on.

Since CITI and Goldman chimed in this week on how these two runaway, over-leveraged, risk-taking, quasi-Government, hedge funds may survive privately without a loss to the common shareholders, debt holders and preferred holders, the market has calmed down and shares of the two have soared.

As a matter of fact, the financial sector in general is performing very well.  People are now convinced that the Fannie/Freddie problem is behind us.  But that could not be further from the truth. Kept private, these two companies will do much damage to the housing market going forward, as they shrink their balance sheets by restricting the purchase of loans; continue to raise lending standards reducing house price affordability; raise rates in order to achieve profitability, which is also a direct hit to affordibility; and as the market and as their MBS continue to trade based upon an ‘implicit’ guaranty and the counter-party risk that comes along with it, as the housing market worsens. These things will ultimately lead to their demise and/or the bailout needed right now, not down the road.  

What I find most amazing is that other than suggesting that the Government buy mortgage securities from the companies and put the credit risk on the US tax payer, the only other options publicly discussed were to ‘hope for the best’ and ‘let the GSE’s lever-up even higher’. You must be kidding me!  CITI and Goldman must have fairly significant exposure.

The Goldman report listed other options, including “take no action and hope for the best” and reducing the companies’ minimum capital requirements. Goldman didn’t predict what the Treasury will do. The Citigroup report said the companies should have enough capital to get through 2008 based on credit-loss estimates. (WSJ Online)

‘Reducing the capital requirements’ just as the ratings agencies and GSE’s have admitted to Prime and Alt-A defaults surging is absolute insanity. Perhaps if there was even the most remote signs of the housing crisis abating, this would be an option. But as of this point in time, conditions just keep worsening and there is no light at the end of the tunnel other than a series of trains.

This problem must be solved now. The GSE’s are responsible for 80%+ of the US mortgage market and without them actively buying and guaranteeing mortgages, availability of mortgage credit will be further depressed. 

Unless everyone starts paying cash for houses, the reduced availability of mortgages will cause house prices to fall further.  

There are so many moving parts to this story and so many hands out that want a bailout, the Treasury is hamgstrung.  The raters went after the preferred shares for exactly this reason.

In another sign of uncertainty over the Treasury’s intentions, Standard & Poor’s Ratings Service late Tuesday downgraded its ratings on the preferred stock of Fannie and Freddie to BBB-minus from A-minus, matching a move last week by Moody’s Investors Service. S&P cited “increasing uncertainty” on whether government support “will extend to these securities.”

If they keep these companies private, mortgage lending and housing will suffer because the GSE’s will be forced to shrink their balance sheets. You have already seen what happens when affordable financing is taken out of the housing market. 

Just look at CA home prices, which are off nearly 35% in the past 14 months. From 2003-2007, the mortgage lending in CA was primarily non-Agency and when that totally dried up in mid to late 2007, housing prices began their tumble towards the most readily available financing, which is Agency $417k and below.  House prices in CA fell 3% alone last month even as sales increased; a phenomenon rarely seen in history. Demand is supposed to drive prices.

In their latest monthly reports, Fannie and Freddie disclosed that they cut back on commitments to buy mortgage securities in July. Those purchase commitments, net of planned sales, totaled about $16.3 billion, down from $55.1 billion in June. The companies are providing less support to the mortgage market, while reducing their capital needs.

Fannie increased its holdings of “liquid” investments, cash and short-term securities that can easily be sold, to $103.6 billion, up 43% from June. The move gives the company more flexibility to reduce its future borrowings if market conditions worsen, company officials said.

Due to this, reports are now coming out that Fannie and Freddie are now wildly profitable and will be going forward. But again, their profitability spells doom for the housing market and their ultimate demise.

Bloomberg recently reported that:

“Fannie and Freddie’s holdings are shrinking at a monthly rate of about $20 billion because of refinancings, home sales and borrower defaults, according to an Aug. 21 report from New York-based Citigroup analysts Scott Peng, Brad Henis, and Brett Rose. That money can be reinvested into higher yielding securities. That is one reason “there is no pressing need” for a bailout, they wrote in the report, titled “All That Sound and Fury, Signifying Nothing New”.

So, once again Fannie and Freddie can muddle through but the mortgage and housing market will suffer. As housing prices fall, more are thrown into a negative equity position or a deep negative equity position, more are stuck in their homes unable to refi or sell and more will default.  This leads to more foreclosures, more supply and further house price declines. This is a nasty feedback loop from which there is no escape unless mortgage lending expands and not contracts.

All this while the GSE’s are rasing rates and adding rate adjustments for things such as lower FICO’s and higher LTV’s that were never required before.  They are also doubling their ‘adverse market delivery charge’, which is essentially a seller paid hedge fee. This will get passed on by the banks directly to the borrower. A .5% spike in interest rates from this hit alone makes housing considerably  less affordable.  Rates are rising and are going even higher, there is no doubt. Incomes are not rising. Therefore, house prices must fall further.

The companies are also boosting fees to guarantee home-loan securities, off-balance-sheet obligations for which they don’t need to borrow. Fannie plans on Oct. 1 it will double to 50 basis points an upfront “adverse market delivery charge,” introduced this year for every mortgage the company buys or guarantees. (Bloomberg)

Perhaps the introduction of ‘covered bonds’ is our first sign of the fate of the GSE’s. Over time, maybe this will replace buying and securitizing loans. If so, then the GSE’s can go away.

But until then, anything done that preserves the GSE’s as private companies will also constrict their ability to lend and/or force them to raise rates and is a terrible thing. People keep reading the headlines and figuring ‘as long as Fannie and Freddie survive all is good’. That is not the case. They need to survive and supply aggressive financing or they are will exacerbate the housing problem and seal their own fate along with all of our’s. -Best Mr Mortgage

Other Related Mr Mortgage Research

S&P Goes After Jumbo Prime With Heavy Downgrades

Prime and Alt-A Defaults Surge, Says S&P

Pay Option ARMs – Up to 48% Default Rate

Moody’s and Fitch Join S&P in Massive Jumbo Prime and Alt-A Downgrade Avalanche

27 Responses to “Fannie/Freddie’s Survival Spells Big Trouble for Housing Market”

  1. Down is up, up is down.
    At least until after the election, when the new guys will want to distance themselves as quickly as possible from the incumbent’s buried pile of toxic waste, digging it all up and hauling it all out to the public landfills. Then we get the true measure of the problem.

  2. it would appear that you are saying that the survival of Fannie Mae and Freddie Mac as privatized entities subjects them to such constraints in the private capital markets that they cannot supply sufficient financing to stop the downward spiral in the real estate markets, while, if public (as Fannie Mae apparently was, from about 1933 or so to 1950, as a differently named New Deal entity), they can access government financing free of such limitations, and keep the market alive

    Generally, I agree, but I do find it odd that you are adopting a sort of Keynesian economic approach here, in light of your otherwise market oriented philosophy. Nothing wrong, just interesting.

    Both of us may be underestimating, however, the extent to which the government itself subjects itself to the constraints of the capital markets (recall Rubin telling Clinton in 1993, right after he took office, “the bond markets won’t allow you to spend billions on a national infrastructure and urban development program” and he didn’t), and, hence, may lack the ability to provide sufficient funds beyond those available privately

    I guess that I have a nihilistic turn of mind these days

  3. […] Banks Beware on Pay Option ARMs – Up to 48% Default Rate! First Federal FeaturedRichard Estes on Fannie/Freddie’s Survival Spells Big Trouble for Housing MarketViv on Mortgage Insurer Downgrades – This One Could Sting…BadlyMr. Mortgage’s Guide to […]

  4. I do not see anything wrong with prices coming back down to 1997 levels. Easy Credit is what got us into this situation and Easy Credit isn’t the solution. The only thing that can save housing right now is to bring NINJA loans back and worry about the problem later.

  5. Mr. Mortgage
    You are one of the very few who gets the complete picture.
    1 Allan Greenspan’s NYU 1977 thesis was about “Housing Bubbles”. Barrons has an article about it in their April 28th edith. He hid this fact from the public for 31 years.
    2 Greenspan was warned numerous times about the “Housing Bubble” and loose mortgage practices from 2000 until he retired in 2006. He refused to take action.
    3 Carlyle Group put out a memo on January 7, 2007 stating that their would soon be a once in a “Lifetime” chance to buy equities for pennies on the dollar.

  6. Whoo..Hooo..
    Turn up the interest!! My pile of money is earning less than 2% in my bank account while waiting to buy. For every 1% rise in mortgage rate the sellers will have to drop their price by 10% to maintain the same afford ability. That means less property taxes and a chance to refinance to lower rates in the future.

  7. Oh yea… and higher rates means more to deduct on your tax return. Another bonus.

  8. Nabbobs be noodlin’…

    Fannie and Freddie by Twilight
    By Peter J. Wallison
    Posted: Tuesday, August 26, 2008
    FINANCIAL SERVICES OUTLOOK
    AEI Online
    Publication Date: August 26, 2008

    [ABSTRACT]
    Having now become explicitly government-backed entities, Fannie Mae and Freddie Mac (and their supporters in Congress) can no longer argue that they do not pose a risk to taxpayers. It is not politically feasible for the government to back private companies when their shareholders and managements keep the profits but the taxpayers cover the losses. [emphasis added] Thus, even if they escape their current precarious financial straits, Fannie and Freddie are now operating in a kind of twilight before they will eventually have to be nationalized, privatized, or liquidated. In addition, the recent attention to covered bonds as a way to finance mortgages suggests that, in the future, Fannie and Freddie’s traditional business–buying and holding or securitizing mortgages–will no longer be essential to U.S. housing finance. An analysis of the available options for policymakers suggests that the best course–from the standpoint of taxpayers–is not to keep Fannie and Freddie alive through the injection of government funds but to allow them to go into receivership. A receiver can continue their operations in the secondary mortgage market and–using the Treasury line of credit recently authorized by Congress–meet their senior debt and guarantee obligations as they come due. A decision to nationalize, privatize, or liquidate them can be made at a later time and can be implemented more simply and efficiently through a receivership than if the companies are helped to survive through government recapitalization.

    Link to the whole article.

    Hmm…

  9. Yeah!! You keep saying that house prices going down is a bad thing. What the hell is wrong with you? It’s freaking great! 50% deeecline baby! F@ck everybody who made me wait this long to even think about buying a house. Bitter? You bet biatches! Also, thank you for writing these articles. It keeps fence sitters like me keep on sitting making prices go down even further. If it wasn’t for you I’d probably be in debt up to my eyeballs by now. Thanks again sucka!

  10. What about FHA? With FHA anyone can buy homes with just 3% down.

  11. It sounds like your argument is:
    If the GSE’s are kept or made truly private, this will further crash the housing market…
    this would imply that they should be bailed out and nationalized IN ORDER TO REINFLATE THE HOUSING BUBBLE AND PUMP UP PRICES…
    even if a new housing bubble is at all possible via unlimited totally loose gov.
    lending, is this a good idea??? doesn’t it require extending the type of lending and fraud we have seen for the last 5-7 years??? and where does the gov get the money to lend – borrow it from china, tax it from joe six-pack, or print it??? Mish
    will have fun with you – don’t let him find out about this article.

  12. Mr Mortgage,

    Once again it appears that those who perform actual analysis and you are at odds.

    Also, your statements including, “They need to survive and supply aggressive financing…” show a total lack of understanding of the problem. Prices need to come down. The GSE’s should not be used as a tool to perpetuate high prices on the back of “aggressive financing” which will just lead to more defaults because the borrowers can’t actually afford “aggressive financing”.

  13. Good thing. Houses are still not affordable. That’s the real problem. It’s the same everywhere around the world ! No kidding. I coun’t care less if it kills New-York investments banks or London City financial firms. That’s the way it was supposed to work.

  14. MortgageMan – I have been at odds with the market since Dec 2006 when I wrote one of my first private reports saying New Century, NovaStar and Freemont would be gone within 6 months.

    I agree with you. Housing prices do have to fall and much further. But a mark to market this rapidly is exponentially exacerbating the problem creating more and more loan defaults and foreclosures with increasly higher grades of paper falling.

    We are at that tipping point now where as prices start to go through 2003 levels, you quickly start wiping out those who put 20% down, got 30-year fixed mortgages and have done everything right – just bought at the wrong time. But did qualify when they bought.

    Prices are already slaughtering those 20% down A paper borrowers whose only mistake was to get a heloc.

    My cousin, a 27-year only engineer is walking. It is a business decision. He missed his first payment to Wells Fargo on a 5/1 ARM last month. He moved into a builder home 2.5 years ago in CA for 360k with 20% down. Now the prop is worth $160k if lucky. He did everything right and his neighbors took him down.

    He owes $280k or so. Since he never refi’s or added a heloc he can walk scott-free. No recourse. That is the decision he is making. It is a good business decision.

    His neighborhood has turned into gang land with crack houses everywhere because prices are down so much. He has to leave. Wells won’t play. Now they will end up selling the home through foreclosure for $100k and taking a 66% loss.

    This is the Jumbo Prime implosion in living color. Even though his loan is not technically a jumbo, its a 5/1 portfolio Wells programs so there is no difference other than loan amount. Actually, his should be a little safer than a true jumbo.

    In my opinion, CA will fall another 50% and nationally the drop will be 30-40$ from here. But when it happens so fast borrowers and banks can’t adapt and work together on solutions such as mortgage modifications with principal balance reduction, rate reductions etc. everyone simply freaks, seizes up and everything that is done is to plug holes.

    This can’t be dragged out forever, thats for sure. But we need readily available financing so those that can afford to buy a home under new vintage loan guidelines and current rates and help to move some of this inventory.

  15. Wow! Are you people reading the same article I am? I don’t have nearly the same take away from this most recent post on Fannie and Freddie that some of you have.

    Mr. M. is right on target with this article and the simple fact of the matter is that the GSEs must exist or the mortgage market will basically shut itself down. Do you all really understand what that would mean? NO LOANS for mortgages for perhaps 7 out of 10 people looking to buy homes. Do you know what that would do to the entire industry? We are talking carnage folks… real bad and real serious issues for EVERYONE in the country would ensue.

    Why do you think congress voted to allow the treasury to “Bail Out” the GSEs in the first place? This cannot be allowed to happen as it will totally disrupt any attempt at keeping some stability in the markets. Prices are adjusting downward as they should, but this natural progression will not be allowed to continue if rates start to sky rocket and fees climb higher. There needs to be an orderly unwinding of this mess and unfortunately Fannie and Freddie will be a huge part of that being able to take place.

    I don’t like it anymore than you, but we already got ourselves into this mess. Now we have to find a way out of it and the total collapse of the mortgage market in this country is not a solution that we can handle right now without dire consequences. After this situation gets unwound we can deal with what to do to keep it from ever happening again as it has, but that is not now but rather much later. We need a smooth transition into that next phase and it won’t happen if these agencies fail or are left to operate on their own.

    The reality is that it is already a done deal anyway and the stall is simply the powers to be, working diligently on the paperwork and choices it needs to make. Do you think perhaps Russia and China may have been told to dump 50% and 25% of there holding in the GSEs since June and much more in July and August? Do you think Goldman just wrote down 50% of their value in holding for the heck of it? This is all unwinding so that when the “bail Out” is announced there is not chaos and panic in the streets. They are in my opinion behind the scenes working these details out and then it will happen. My guess is sooner rather than later.

    I totally understand the let them get theirs for the mess they created (lenders and GSEs), but lets not get carried away at are own expense as well. In the end they will all get theirs as some of you are calling for, but maybe the rest of us will can be left in one piece afterwards if it is done correctly…

  16. Since he never refi’s or added a heloc he can walk scott-free. No recourse

    Actually you can go with a heloc too. Just has to be purchase money, or the amount taken out used for the house to the original purchase price can qualify for the 07 relief act.

  17. Well things are certainly heating up before this long Labor Day weekend. The Treasury will have a lot of time to mull their next steps, but in the mean time know that the Chinese are really, really pissed off over this and I am now convinced sooner rather than later something will be done. In fact there are simply no way they can await the next administration coming in before doing something… anything? Japan and Russia are equally pissed and although I have not seen the oil nations protest I am sure they are just as upset too. Something will need to be done quite soon and forget the roll over of debt now because there is nobody left out there that will touch this crap at any price in my opinion at this point.

    This is heating up and although Paulson wishes he could just put his head in the sand and pull it out when he is no longer in charge, it appears less and less likely that will be an option for him. So does Bush sit with McCain and Obama before pulling the string or does he just go ahead and allow Paulson to act?

    Lot’s of questions but so far very few answers… that is all about to change!!!

    Some snippets from various articles out and about today:

    the increased reluctance of Japanese retail and institutional investors to hold GSE debt is worrisome

    Japanese retail and institutional investors are unloading foreign debt due to currency volatility and are particularly leery of Fannie and Freddie securities.

    JPMorgan Asset Management Japan Ltd. said last week it was reducing its holdings of debt issued by Fannie Mae and Freddie Mac.

    “Japanese investors have been constant sellers of agency debt,” said Hideo Shimomura, who oversees the equivalent of $4 billion as a chief fund manager at Mitsubishi UFJ Asset Management Co

    “Although Fannie and Freddie are being aided by the government, there still is no guarantee on their debt, so it is difficult to hold it,” said Daisuke Uno, chief bond and currency strategist at Sumitomo Mitsui Banking Corp. in Tokyo. “Without a guarantee, nobody will do anything as it’s too risky, so they sold the bonds.”

    A HIGH-RANKING Chinese economist has put his nation’s cards on the table in the global financial poker game by effectively telling the US to fix Freddie and Fannie … or else.

    “If the US government allows Fannie and Freddie to fail and international investors are not compensated adequately, the consequences will be catastrophic,”

    The Chinese have basically said “we have spent 10 years of savings on your junk and it is getting close to high noon” – and the US has come quickly to attention.

    The Chinese are not entirely happy with the fact they have been faithfully buying Freddie and Fannie and Ginnie and all the Macs and Maes that might come home by May Day itself. Their fear is that the US might be speaking with a forked tongue. They are starting to remember the history of Western behaviour and it has come upon them that they might be played for suckers, big time. Dr Strangelove is now sitting in Beijing saying “I smell a big dirty, er … commie er … rat.” And the good doctor is holding the financial equivalent of the entire ICBM arsenal of Russia over the US and, as the email points out, the world’s head.

    Suddenly it seems to have occurred to China that US administrations change and so do priorities and promises.

    The “quiet bailout” that Brad Sester had been quietly reminding us of through the Council on Foreign Relations amounts to the Chinese buying debt on a deal the new administration has not signed onto.

    The “quiet bailout” just got a lot louder.

  18. There are a few mistakes in this article, just to clarify one:

    They are also doubling their ‘adverse market delivery charge’, which is essentially a seller paid hedge fee. This will get passed on by the banks directly to the borrower. A .5% spike in interest rates from this hit alone makes housing considerably less affordable.

  19. I agree with many things in the article, but there are a few mistakes in the content. For one:

    ” They are also doubling their ‘adverse market delivery charge’, which is essentially a seller paid hedge fee. This will get passed on by the banks directly to the borrower. A .5% spike in interest rates from this hit alone makes housing considerably less affordable. ”

    The increase is from .25 to .5 in bps, not in interest rates. This of course will be passed along to consumers but is .25 points OR an increase in rates…. which is only ~.125% increase to the interest rate. So stating that it will be a .5% spike in interest rate is not accurate and just spurs panic.

    It is stated correctly in the quote you have from Bloomberg, where it shows it as a 50 basis point increase, not a .5% interest rate increase.

    The lending industry and the media need to be more responsible when they discuss financial matters with clients. It is those kind of quick statements and fast “facts” that led to the problems we are in.

  20. Also, as stated by plenty…. your solution to the housing crisis is MORE EASY LENDING???

    What do you want to see, stated income 100% financing again? Teaser rate ARMs? No doc loans?? Loans to those with low, low credit and no compensating factors??

    It was EASY CREDIT to anyone that wanted it that led to the housing bubble. More easy credit might be a temporary lift, but will only prolong the problem and pass it on to another decade (much like Social Security, the National Debt and all the other financial problems we have). Sooner or later someone needs to pay the bill, might as well get it over with now than just re-inflate the bubble.

    Fannie and Freddie do need to make changes in their policies and their stucture, but passing out money to borrowers isn’t the answer.

  21. Hold on Roland – the .250 that was put into place in the first place was only adopted on March 1st 2008. That means this year Fannie has added a .5 hit for an up from pair-off fee.

    Its 50bps to rate I believe.

    http://www.mortgagebankers.org/files/News/InternalResource/58763_FannieMaeAnn.07-21.pdf

  22. Roland – I never said ‘easy’ lending but not continual tightening beyond reasonability and based upon the weakness of the balance sheet. Not only are they tightening guidelines but raising rates for things at the same time.

    Yes, Fannie and Freddie will be wildly profitable but nobody will be able to qualify.

    We have gone back to 1983 lending overnight and values are plummeting. You can’t take back the past 10 years but we are on a path right now that will take every borrower class straight through full doc conventional Prime and sweep these people right into foreclosure unless guidelines losen somewhat and rates come down.

  23. I am all for bringing house values back to 1 to 4 times median household income levels over time. But the devastation you are talking about to good prime borrowers whose only mistake was to buy at the wrong time with 20-30% down on a 30-year fixed is unspeakable.

    Just like they do with drug addicts, you have to put them on some other drug and ease them off. If you took a herion addict, took him off and the next day you tied him to the back of a car with a rope around his neck and running shoes and made him run 5 miles you would in fact kill him.

    Housing assets need to be repriced nationally and do have much further to fall but it cant be done all at once of you are talking about the total collapse of our national infrastructure and social systems.

  24. a slow decline in house prices wipes out just as much equity as a fast decline of the
    same amount… so mr. mortgages fix is to reflate the bubble just enough to allow a slow decline back to acceptable levels… the only problem is that someone who buys today loses just as much either way, and so do current owners… basically, this is the japanese model – the financial institutions hide their losses, keep the game going with themselves still in charge, and the market declines 90% over a decade…

  25. re: japan
    remember the japanese have extreme social pressure against walking away from debts – that may have kept many of their mortgages paying off in the 90’s even though the owners were waaaay underwater on the deal…
    in the US, a lot more people will just walk away, regardless of whether the decline is fast or slow…

  26. “”in the US, a lot more people will just walk away, regardless of whether the decline is fast or slow…””

    That’s right on the money. That’s business. I always look at it like, if the tables were turned what would the mortgage holders do to us?

  27. […] – bookmarked by 1 members originally found by robertocunha on 2008-11-06 Fannie/Freddie’s Survival Spells Big Trouble for Housing Market […]

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