Saturday, March 22, 2008

The Nationalization of Housing?

Doug Noland from Prudent Bear had a great piece on Fanny and Freddy. I briefly mentioned the the fact that that both of these companies had their capital requirements decreased so that they could do an additional $200 billion in mortgages. As Doug explains this is a very risky proposition. So the question now becomes is the government quietly nationalizing housing? The graph above shows you dramatically Fanny/Freddie's book of business has grown.

First a comment from OHEO(the Office of Federal Housing Enterprise Oversight) director James Lockhart in an interview on CNBC:

"Lockhart: “Well, it may take awhile. The mortgage market is one issue, but there are some other markets out there as well. I think this is going to be a major step forward. As you said, they can do $200bn in purchases immediately. And to the extent they’re guaranteeing mortgage-backed securities - that could almost get into the trillions. We’re looking at that they would have the capacity – between what we did today and the significant capital raising that they committed to – they could do over $2 trillion in business this year if the market needs that money.”

This is a very risky statement. When they start talking trillions you need to ask yourself how big do they plan on getting and what happens if housing prices continue to drop? We the American taxpayer will be the ones that take the hit because both of these companies are backed by the government and look to possibly be taken over by the government. Mr. Noland explains the risk of what could happen if this occurs:

" Somewhere along line, I think the Fed came to appreciate the extent to which they had relegated monetary (mis-) management to the agencies (and their Wall Street enthusiasts). Meantime, some politicians belatedly came to recognize what an affront the GSEs had become to the pricing and allocation of system Credit, as well as to the functioning of free markets more generally. Especially after the 2004 revelation of massive fraud and gross system inadequacies, a consensus developed in Washington that the GSEs needed both restraint and a powerful regulator (although the legislative details were much too slow to materialize). Apparently, all these justifiable concerns were chucked out the window this week in the name of “system stability”.

After first reaching $2.0 TN in 1999, Fannie and Freddie’s Combined Books of Business surpassed $5.0 TN in January. This “Book” increased $638bn, or 16%, last year, in what will surely be the greatest transfer yet of risky mortgage Credit to the GSEs (only to be greatly outdone in 2008). Interestingly, OFHEO, Washington politicians, and Wall Street analysts are keen to play a dangerous game pretending that there is limited risk in guaranteeing MBS (as opposed to the obvious risk associated with mortgages retained on their balance sheet). The absurdity of Mr. Lockhart stating that the GSEs will be in a position to take on an additional $2.0 TN of mortgage risk this year is simply incomprehensible. Keep in mind that the GSEs are on the hook for the “timely payment of principle and interest” on more than $5 TN of American mortgages – and counting… Such obligations will, in the Post-Bubble Era, prove untenable."

Basically if the downturn continues and prices continue to drop this will end up being a disaster. The result of expanding their ability to lend when they already have 5 trillion on the books will result in making the economy more destabilized(GSE's FYI are Fanny and Freddie). It will also result in us paying for this mess as these become government entities. Doug further explains:

"Not surprisingly, the Fed could not risk a Bear Stearns failure - not with all of its derivative, “repo” and counterparty exposures. It really was not a difficult fix. Yet the rapidly lengthening line of vulnerable non-bank lenders (Thornburg, CIT Group, and Rescap come immediately to mind) and hedge funds will pose a greater challenge. There are some very substantial balance sheets at risk and significantly more “de-leveraging” in the offing - and the big banks will have no appetite.

The S&P500 is down a modest 7% from the much changed financial and economic world of one year ago. While having little impact on the Unfolding Credit Crisis (or home prices), policymakers have thus far largely succeeded in sustaining inflated U.S. stock prices. But, in reality, the profound deterioration in the U.S. and global Credit backdrop has greatly altered prospects for the vast majority of companies, industries, and the U.S. and global economies more generally. Despite any number of policy actions and all the good intentions imaginable, there is absolutely no way that the U.S financial system will now be capable of sustaining either the (pre-bust) quantity of Credit or the uniform flow of finance that levitated Bubble Economy asset prices, household incomes, corporate cash-flows, “investment” spending or consumption. Huge sections of the Credit infrastructures (notably throughout Wall Street-backed finance) are inoperable and disCredited. Prominent Monetary Processes have been broken and the resulting Flow of Finance radically revamped.

Prospective Credit and financial flows will prove insufficient for scores of companies, as well as for state and local governments and various entities all along the economic food chain. Enormous numbers of business downsizings and failures – many by companies that thrived during the Bubble Era – will lead to huge losses of jobs and incomes (many at the “upper end” where the greatest excesses transpired). I simply see no way around it – Nationalization of U.S. mortgages notwithstanding. It is fundamental to my analytical framework that efforts to subvert the Unavoidable Adjustment Process only extend the misallocation of finance and real resources, while adding greatly to the future burden of the financial institutions today aggressively intermediating very risky pre-adjustment Credit (certainly including the banking system and GSEs). And I certainly don’t believe this week’s rally in the dollar should be viewed as a vote of confidence for the direction of U.S. policymaking. Nationalization will prove a further blow to already fragile confidence."

Bottom line is the government realizes that the bubbles of credit they created can no longer be supported by Americans with flat incomes and unemployment that continues to rise. Giving Fanny and Freddie these massive additional resources pretty much tells you that the gameplan is to attempt to nationalize housing that we can no longer afford. They have realized we are in way over our head.

The problem here is instead of stabilizing everything it will just confuse the situation and make everyone less confident in the housing market. The government doesn't know what to do other then to throw money at the problem. This could take decades to figure out.

Think about it this way. Would you buy a house if half of the block is being subsidized by government supported housing? How could you ever trust that the value of the house will stay flat or go up. Also, if the government backs all of this debt at inflated prices then who will be able to afford these houses? I am afraid that this is a problem with no good answer. I might live my whole life as a renter if nationalization happens. I am not convinced it will happen but maybe this is such a mess that its the only answer.


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