Wednesday, June 06, 2012

Put Fannie and Freddie to Sleep

In the beginning, Congress created Fannie and Freddie to make homes affordable to more Americans. It was a fulfillment of the American Dream, home ownership. There are renters and there are homeowners. Raise your hand if you have owned your home 100 years or longer; so basically everyone reading is a renter.

When the housing bubble took off, everyone was financing homes, and they sold the paper to the banks, Fannie, Freddie and private investors. Any bad performing loans that the banks held, have probably been turned in for foreclosure redemption. Basically the loan insurer eats the first 20 percent of the loan amount on a home (Fannie, Freddie and VA); the bank eats the second 20 percent. Looking back over time, there hasn’t been a span of time where a bank could sustain a 20 percent loss on a home loan with 20 percent down unless you go back to the Great Depression. The bank has an owner cushion of 20%, and their losses start from there, they could sustain a 40 percent drop in equity without sustaining a loss.

But about the year, 2000 everyone was writing zero down “no doc” loans. The two GSE’s, Fannie and Freddie packaged up the paper and sold it to anyone. They made gobs of money and then things started to go south.

Once the bubble burst, you have millions of home owners in homes with no money down and they are upside down on their loan. Fannie, Freddie and the VA are left holding the bag. They guaranteed the loans. Congress realizes that they need to bail out Fannie and Freddie to keep the housing market from collapsing. If it collapsed, the losses would be catastrophic. But if they can keep people in the homes and make payments of some sort, the game can go on. The other thing they needed to do was find a source of low interest rate financing to entice people to buy the homes that they have already guaranteed. The Federal Reserve did that by dropping interest rates to unheard of levels. Notice Fannie and Freddie didn’t drop the prices of the homes they held by much, but they did reduce the qualifying requirements for the loan - - nothing down, but take the original note with very little discount. Second, release the homes very slowly. Fannie and Freddie own these homes at full list bubble prices.

The government guaranteed these GSE’s and assumes all losses. Ask yourself one question. Has the mission statement of Fannie and Freddie changed? Is it to make homes more affordable to our children? Or to cut the losses of these GSEs? Fannie and Freddie have nothing to lose by selling a home to just about anyone with nothing down. A vacant home is on the books as a loss, a signed contract is a performing loan. The problem here, the new owner may make one payment and ride free for two years. As far as Fannie and Freddie are concerned, that’s a good thing; the house is occupied and less liable to be stripped out. Talk about job security, inefficiency keeps the ball rolling.

The issue here isn’t banks, it is Fannie and Freddie, these two programs are a dis-service to the community. They need to be stopped in their tracks and the homes put on the market, what ever the price. We need to sell homes with 20% down payments. Fannie and Freddie are circumventing this common sense rule. What they are doing should be against the law and it isn’t. The banks can’t do it so why should the GSE’s under government management.

It’s a little like when my dog was terminally ill, I was doing everything for him, because he was my best friend, and then I realized, I wasn’t really doing him a favor by extending his suffering, I was just satisfying my needs for his companionship. I had to make a hard decision, and it was something I still shed a tear over when I think back about it.

Reality is right around the corner (of course if you are dealing with deck chairs, it's a lifeboat away). Not sure how this will turn out, but it is obvious, the decisions that have to be made are not being made. Can we trust the political judgment of our government and Congress? I think not. But if we terminate those two (failed) GSE's, pricing reality may emerge in the real estate market. The real irritating thing, is that we know that just isn't going to happen!

Copyright 2012 by Jim Brubaker

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