Monday, August 25, 2008

The Real Estate Conduit is Broken

Forget about the Government Sponsored Entity's (GSE'S) going bankrupt. That isn’t the problem. Fannie and Freddie were buying loans from banks, packaging them and selling them to investors. The banks then re-loaned those same funds out to another home buyer. This provided the markets with lots of liquidity.

What has happened now? There are no investment buyers for these loan packages. The market has dried up. The Government can’t force Freddie and Fannie to buy loans and try to sell these financial packages, their investor base is gone. There are no buyers at these interest rates.

Freddie or Fannie might unload some inventory to raise cash to cover bad loans in their inventory, but not purchase new loans even if it was top shelf stuff. The net effect is that market liquidity for home loans is gone. The middleman (the GSA) can’t move the merchandise. Freddie and Fannie are no longer a conduit for housing finance.

Now, the banks are limited in the amount of new loans that they can write (Freddie and Fannie are not buying their paper). So what do we have? Thousands of houses for sale with no financing available. What do the Banks have? A very big bag of HELOC’s and second trust deed loans and credit card debt. The HELOC’s and second trust deeds are toast and to make things worse the banks have a bad cash flow problem.

At this point, we have the banks trying to raise capital to cover their bad loans. There is no sense in issuing any new loans until the market settles. Where does the homeowner stand? They can’t sell a house without some bank financing the buyer.

The point not really fully realized, is that it was the high velocity of money traveling through the real estate market kept the game going at a super fast pace. The present inability of Freddie and Fanny to act as a conduit, has ended the housing boom. You can argue that Freddie and Fannie are a bail out problem, but they aren't going to drop dead in 6 months; our banks on the other hand are in melt down mode. The real estate market is going to go from bad to worse. The economy's problem is a lack of liquidity (money with velocity).

What does all of this mean? Interest rates have to rise to entice investors back into the GSE paper market. But as interest rates rise, the average home buyer can afford less house. For Freddie and Fanny, business is going to get even slower. Their losses could increase. Anything they took on an 80/20 basis has to fall to 80% and they still break even. Most financial organizations figure a worse case scenario of a 20% loss so Fannie and Freddie could still survive quite a while.

This meltdown has little to do with Fannie and Freddie. Our financial institutions that hold MBS's, CDS's, CDO's, second trust deeds, HELOCS and credit card debt are the ones in trouble. That stuff is pure crap. Who owns it? We know the GSE's DON'T own it. It has got to be the banks and mutual funds. Don't be surprised if we have 10 bank closings this Friday--Big 3 day bank holiday.

Plus Warren Buffet is buying more Wells Fargo or American Express (he didn't say which). It makes you wonder if the Sage of Omaha got a little Kansas "Weed" mixed into his Nebraska sage. I wouldn't hesitate to short either one, go figure.


Anonymous said...

Once we learn some lessons, take our losses, and get back to creating true wealth, America is going to be in good shape. This is a wake up call: slick financial engineering has no real value.

It is GOOD that these things are rediscovered. That the road to prosperity comes from ingenuity, perseverance and hard work.

This financial disaster will blow away the arrogance and stupidity that caused it.

America will once again be great.

Do not be scared. This is a time for renascence. A time for us to examine our failures and be reborn. We should be fearless, proud, and strong. Anything less would be truly un-American


But according to "Jesse", broad money is still growing.

I'm Not POTUS said...

anon answered the question "What would Jesus do?"

I'll hazard a guess at "What would HeliBenny do?"

HeliBen would try like hell to keep the game going. My guess is that he will "loan" the GSE's dollars to keep the new loans funded. The rate charged would appear ligit, but the experts will cook the books so that the fed gets nothing back in payments. Then the GSE's will fund interest payments from the new loans to pay off the non-performing dogs of yesteryear.
What this does to the market who knows. He just needs to keep the hamster wheel turning.
Just as long as the wizard of OZ can keep the curtain closed.

Jim in San Marcos said...

Hi Sack

I must be dense, that "Jesse" reference went over the top of my head. Can you elucidate?--just love a big word now and then :>)

Jim in San Marcos said...

Hi Potus

It isn't going to work quite that way. What the GSE are holding they will probably keep holding. What the banks are offering them to buy, they will refuse. The Banks want to sell their home loans to the GSE and recover the money loaned. This is the way the plan was suppose to work. The GSE's don't want to participate any more.

If housing values drop to 70% Fannie and Freddie are out of cash. At that point, the government might have to cover what is in their portfolio.

Half of the crap the GSE's wrote will probably never come back for redemption because it was hypothecated into abstract instruments that can't be assembled back into the original form for redemption.

The real point to remember is that no one is buying the GSE junk, it ain't moving. The government isn't going to be a buyer. They might support the player (GSE) but they ain't in the market for home loans.

They might help the GSE's with capital later on when things get really worse, but that doesn't include buying new home loans.

It will be interesting to see how this works out. Thank you for your comments

Jim in San Marcos said...

Hi Anon 12:27

We haven't left you out, things may get better, but sadly, it may not be in my lifetime (I'm 61).

Your thoughts have the presence of power, I want to believe what you say to the fullest, I too share your views.

Thank you for your comments.


Sorry Jim, forgot to snazzle the boondoggle on the doohickey last time - here's the link to "Jesse":

I'm Not POTUS said...

Hi Jim,

I would stay clear of phrases like
"The government isn't going to...."

This government has demonstrated a firm commitment to doing everything it is not supposed to do.

I agree with you for the big picture. I am just guessing at what trick is next in the bag. The folks running the administration only have a horizon that looks no farther than the first week of November.

I doubt anyone in the Administration has any enthusiasm to fight for anything more than that short term goal. Making the GSe's buy 100% of the loans will happen if conditions worsen. They will make the GSE buy loans, make interest payments. I wouldn't put it past them to make the Fed a direct lender for home loans. If they are stupid enough to involve the IRS as a $7,500 lien holder, they will do anything.

Did you see the WSJ article about the administrations push to move from GAPP to the International Standard by 2010?

Most see this as an attempt to goose earnings. I think the real reason is that it will make it just a little bit easier for the big corporations to jump ship quickly from the SS America if need be.

We are way past the event horizon of the credit black hole. The only thing keeping us intact are the Willie E. Coyote's in charge of gravity perception.

Jim in San Marcos said...

Hi Potus

We do have till November until the election, but one other thing to think about, is everyone in the present administration is unemployed as of January 20th of next year. So a lot of people in government might not give a damn after the election and that's not a good thing either.

On the home loan fiasco, the government can't force Fannie or Freddie to buy new loans. It's kind of like forcing a grocery store to buy more eggs from farmers when there are no customers wanting to buy eggs. There is a problem with the 6 trillion in eggs that they have already sold, there is a money back guarantee on those eggs (loans). Our government might be called on to repay those bad loans returned by investors to Freddie and Fannie. The guarantee has always been implied, now we will see if it is real (I sure hope not).

Your right about the credit card debt being a big black hole of unsecured debt. That has to be the next shoe to drop (gravity willing).