The Federal Government is preparing a takeover of the mortgage market. by Pat Smith
(conservative)
Thursday, July 17, 2008
Stockholm on the Potomac
Well it has come to this. Federal Reserve Chairman Ben Bernankie in an effort to stem the latest global financial crises has authorized the Federal Reserve to open its discount window to mortgage giants Fannie Mae and Freddie Mac. Not to be outdone, Treasury Secretary Hank Paulson has upped the ante by proposing that Treasury increase the line of credit to these hallowed institutions and suggest that the government provide a capital infusion and take an equity position. So there it is, The Federal Government is about to nationalize the mortgage industry, and the European Socialists could not be happier.
Fannie Mae, (Federal National Mortgage Association) was invented during the Great Depression as an instrument of the government to buy mortgages from commercial banks at a time when liquidity was non existent and banks were finding it impossible to collateralize their loans. At the time this may have been a good idea, but sometime in the intervening 70 years private entities have sprung up and are more than capable of filling this void. Congress and Lyndon Johnson recognized this in 1968 when the company was semi privatized. We say semi because an implicit government guarantee to secure the company's debt remained and exists to this day. Two years later our illustrious government doubled down on this bet by creating Freddie Mac, a Fannie Mae for saving and loans. Never mind that savings and loans have gone the way of the buggy whip, Freddie Mac survives. Fannie and Freddie now exist as Government Sponsored Entities (GSEs) to buy mortgages and other commercial debt, package it up into Mortgage Backed Securities (MBSs) and sell it off to unsuspecting investors around the world. These investors don't really care about the value of the underlying mortgages because the GSEs have sprinkled magic dust on the packages. This magic dust is an implicit US Government guarantee that Uncle Sam will step in the event that Fannie or Freddie should ever default on its obligations. This guarantee allows the GSEs to borrow at below market rates thereby enriching the GSEs investors and more importantly its officers and directors establishing a private profit at public liability. Nice work if you can get it, but you can't get it so don't try. A secondary benefit of this windfall is a private pool club of cash for the benefit of Congress. This pool is so large all 535 members of can swim in it at the same time
The beneficiaries of this windfall both elected and unelected would have you believe that this arrangement results in lower mortgage rates for the unwashed masses. If only. Mortgage rates are at exactly the same place as if the GSEs never existed. The profit stays right were it belongs, with the officers, directors, and pool club members.
Until recently this cozy relationship has flowed along beautifully. Fannie and Freddie only bought high quality mortgages, added its magic dust, sold the paper at rates just below what it was collecting, and spread the profit around like good little GSEs. But the players got greedy. Why make a little spread when you can make a big spread. Congress demanded the GSEs loosen their standards and buy less than optimal mortgages. This allowed them to look good with a greater majority of voters. Fannie and Freddie didn't really mind since these mortgages carried a higher interest rate and therefore a greater spread and increased profits. To keep the party going Fannie and Freddie asked for and received a reduction in its capital requirements. A typical commercial bank must keep between 6 and 8% of its outstanding commitments in capital or for every $100 a bank lends it must have between $6 and $8 in its capital account. Fannie and Freddie only have to keep between 1 and 2%. This paltry capital requirement has allowed them to run up a massive $5.7 trillion in debt. To put that in perspective the federal government currently carries about $9.5 trillion in debt, $5 trillion of that is treasury bonds and the like, the remainder is IOU's such as Social Security obligations. Once our government turns the implicit guarantee into an explicit guarantee our total debt will equal $14 trillion or roughly equal to our GDP. In order to take on this massive debt the Feds will insist it be given an equity position in the GSE's most likely through a preferred stock creation. Hence Stockholm, where nobody thinks twice about debt levels equal to or greater than GDP or when the government owns massive swaths of heretofore private enterprises. Once this deal is accomplished can GM be far behind? Finance, automobiles, and of course health care all owned by the federal government.
And all this under an erstwhile Republican administration. What pray tell will befall us once Obama occupies the Oval Office?
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