(emphasis mine) [my comment]
The Biggest Financial Bailout of Them All
Posted: March 6, 2010 04:30 PM
Let me take you back to Christmas Eve, 2009. It was a time to wrap gifts for loved-ones. That's how the Obama Administration felt about the financial industry when it lifted all caps in emergency bailout money to Fannie Mae and Freddie Mac [See U.S. promises unlimited financial assistance to Fannie Mae, Freddie Mac]. That means the taxpayer was on the hook for all losses at these two mortgage giants no matter how large the losses. The move caused a slight stir, but never got the attention of the American public because the announcement was timed to coincide with the peak season of distraction. And so it was forgotten ... but not by Fannie and Freddie.
On eight maids a milking day, also known as New Year's Day, Fannie Mae took advantage of this generosity.
"Effective Jan. 1, 2010, Fannie Mae brought an additional $2.4 trillion of its guaranty book of business on to the balance sheet under SFAS 166/167. Therefore, Fannie Mae expects to reflect approximately 18 million loans on its books compared with approximately two million loans as of Dec. 31, 2009. Management estimates that the cumulative effect of adopting FAS 166/167 will boost its net worth by $2 billion to $4 billion in its first-quarter 2010 results."
Stop! Hold the phone. What this statement indicates is that Fannie Mae, the largest mortgage company in the entire world, was holding eight times the amount of mortgages off-book than it had on-book.
Thus, despite the fact that it is losing tens of billions of dollars every quarter, and has borrowed $76.2 billion so far, it was actually hiding the vast majority of its worst performing mortgages off-book. The only reason you move assets off-book is if they are illiquid. And that's not even taking into account Freddie Mac, which has borrowed another $50 Billion from the taxpayers so far.
How bad are those assets? It's hard to say for certain, but after moving $2.4 Trillion dollars worth of assets, the net worth of Fannie Mae only improved by $2 Billion, or 0.083% of the assets.
[Notice how the federal government guarantees or owns 8 trillion dollars of mortgage debt. The next article has some nice graphics which show the total amount of mortgage debt outstanding for comparison]
Just how much is the taxpayer is on the hook for? Well, the former caps were limited to $200 Billion a piece, which the Treasury decided just wasn't enough. So if the losses are north of $400 Billion then we are entering the range of TARP bailout, but with almost none of the press coverage. Or to put it another way: "The taxpayer bailout of Fannie Mae and Freddie Mac will almost certainly be the most expensive of the financial crisis..." There has been at least one attempt at estimating the losses.
"The Congressional Budget Office estimates that Fannie and Freddie added $291 billion to the federal deficit in 2009 and will cost an additional $389 billion to run over the next ten years. However, Fannie and Freddie are currently considered "off budget" meaning the actual cost to run these agencies is not considered by the Office of Management and Budget."
This article contains two nuggets of information. For of all, we are looking at around $600 Billion in taxpayer bailout, assuming the market doesn't take another sharp downturn. That's nothing to sneeze at, and it certainly deserves a lot more press coverage than it has gotten. The second nugget is that all these losses are consider off-budget. So what we are talking about is moving hundreds of billions of dollars of bad assets from off-budget Fannie Mae to off-budget Treasury Department.
This accounting gimmick has disturbing parallels to another contemporary crisis. "It is the same sort of financial shell game that has brought governments like Greece to a crisis point. Hiding your debts just leads to a bigger day of financial reckoning down the road," said Representative Spencer Bachus. Bachus may be a Republican who supported fighting two wars off-budget, but in this case he is 100% correct. Hiding debts off-budget is exactly what broke the Greek government.
The Republicans are pushing to have the money put on-budget which would, of course, immediately blow out the federal borrowing limits. After weeks of pressing by the Republicans, the Obama Administration has finally agreed to consider it.
A carefully designed disaster
The collapse of Fannie and Freddie didn't start recently, and didn't happen by accident. It was a calculated decision by the Bush Administration to try to extend and pretend the housing crisis into the next administration. It all started in March 2008:
"By reducing the extra cushion of capital the two companies have been required to hold since 2004, the regulator, the Office of Federal Housing Enterprise Oversight, is enabling the companies to invest $200 billion more in home loans. In essence, the companies are being allow ed to take billions of dollars that had been used as a reserve against possible further losses and invest that money now in the housing market. But critics said that if the housing market continued to decline, the move could put the two companies on a less sure footing and ultimately require a huge taxpayer bailout. 'I think it's very dangerous and it's a sign that people are very frightened,' said Thomas H. Stanton, an expert on the two companies who teaches a course on credit risk at Johns Hopkins University. 'At a time in which finance companies are holding questionable assets and facing losses, regulators typically require more capital, not less.'"
On top of that, the size of the mortgages that Fannie and Freddie were allowed to buy was increased, from $417,000 to $729,750. This change happened in the face of collapsing asset prices.
Homes worth nearly 3/4 of a million dollars are not part of the original reasons why Fannie Mae and Freddie Mac were created, nor should they be. People that can afford homes of that price do not need public subsidies, nor should they get it.
"Now, thanks to Congress, junk bond investors will be able to pawn off their bad debt to Fannie and Freddie, instead of suing the big investment houses for ripping them off. This shift will certainly doom Fannie Mae and Freddie Mac, so don't be surprised if we, the taxpayers, have to bail out poor Fannie and Freddie - to the tune of more than $1 trillion."
It was a risky gamble, and it failed. Spectacularly. The balance sheet of Fannie and Freddie that was cut 6 months earlier was now in danger of collapse. It seems that the thin layer of cash reserves left over after the Bush Administration cut it 6 months earlier, wasn't enough to cover their massive losses. Yet the financial media failed to note that the Bush Administration was partly responsible for this enormous calamity.
But the Bush Administration was going to make it right. They were going to backstop Fannie and Freddie and calm investors ... at least that was the plan.
"The powers Paulson won from Congress last month enabling a government rescue of Freddie Mac and Fannie Mae -- authority he likened to a weapon whose mere existence made it unlikely it would have to be fired -- may end up making a bailout more likely, say analysts and investors.
They say the threat of government action is creating uncertainty that is raising the companies' borrowing costs and increasing the odds Fannie and Freddie will need taxpayer funding."
The problem with the bailout plan is that Paulson is the implied threat of a de facto nationalization of the two mortgage giants. This would leave existing shareholders with pennies on the dollar. Thus the bailout plan that Bush and Paulson assured us they would never have to do, caused stock prices of Fannie and Freddie to crater. This reduced their capital reserves even further, increasing the chances of a taxpayer bailout.
On the other side of the ledger, the Bush Administration also changed the rules in April 2008 to get the FHA more involved in the mortgage industry. According to James Bianco, "The government was using the Federal Home Loan Banks as a way to bail out the banking system early on."
One forgotten scandal was from late September 2008, the FHLB of Atlanta loaned Countrywide Financial $51 Billion in exchange for questionable mortgages as collateral [See Senator Schumer's Letter expressing concern over the lending practices of the Federal Home Loan Bank of Atlanta]. Countrywide went under shortly afterward.
The decision to increase the FHA's exposure to a collapsing housing market is now meeting its limits. [See Rising FHA default rate foreshadows a crush of foreclosures]
"The share of borrowers who are falling seriously behind on loans backed by the Federal Housing Administration jumped by more than a third in the past year, foreshadowing a crush of foreclosures that could further buffet an agency vital to the housing market's recovery.
About 9.1 percent of FHA borrowers had missed at least three payments as of December, up from 6.5 percent a year ago, the agency's figures show.
If the trend continues and the FHA's cash reserves are exhausted, the federal government would automatically use taxpayer money to cover the losses -- a first for the agency, which has always used the fees it charges borrowers to pay for its losses.
Adding to the trouble was a now-defunct FHA program that enabled sellers to cover the down payments of buyers. This meant many borrowers had no skin in the game and were more likely to walk away at early signs of trouble. The program resulted in excessive defaults before it was ended in late 2008, and it is projected to cost FHA an additional $10.5 billion in losses, Stevens said.
The program in question was another Bush Administration idea to bail out the housing industry
to the benefit of Wall Street. [to the benefit of Washington, by delaying the collapse of financial system]
Meet the New Boss
After inheriting this disastrous legacy from the Bush Administration, you could only assume that the Obama Administration would do things drastically different, right? [No, I would not assume that "the Obama Administration would do things drastically different". The choice facing Obama, presidents before him, was/is:
A) Be honest and watch the US economy collapse under his watch
B) Do whatever it takes to keep the financial ponzi scheme going for a few more months
"Fannie Mae will drop some credit-score requirements, reduce income-documentation standards and waive the need for appraisals in some cases, according to a notice yesterday to lenders posted on the Washington-based company's Web site. The changes apply to loans that the company owns or guarantees."
Let me translate for you. "Drop credit-score requirements" equals subprime. "Reduce income-documentation standards" equals liar loans.
And it just keeps getting better. The Obama Administration plans to subsidize at-risk borrowers. Has anyone bothered to ask "How long?" Meanwhile the Fed is buying up all those subprime, liar-loans that Fannie and Freddie are pumping out.
On top of it, the next part of Obama's plan had a ring of familiarity to it: "The loan-to-value (LTV) limit on mortgages Fannie Mae and Freddie Mac will be able to refinance as part of Obama's Homeowner Affordability and Stability Plan may go higher than the original 105 percent, according to National Mortgage News." Bush's disastrous legacy was to at first ignore the bubble, then to try to keep it inflated until he was out of office by using Fannie and Freddie. Obama's plan is to use taxpayer money to subsidize sub-prime, liar-loans at more than 105% of the home's value with Fannie and Freddie as a conduit. Thus attempting to recreate all the properties of the bubble that got us into trouble in the first place.
Seriously. Is this the best that Washington can do? [Yes, the alternative is financial collapse] Is our leadership really this bankrupt of ideas? [When you reach a certain point, it becomes harder and harder to keep a ponzi scheme going.]
One other item to note is that when the Obama Administration lifted all bailout caps, they also promised that plans on reforming Fannie and Freddie would be drawn up by February. Last week, that promise was broken.
"The Obama administration will wait until 2011 to propose an overhaul of mortgage giants Fannie Mae and Freddie Mac, Treasury Secretary Timothy Geithner said yesterday, arguing that he wanted to put some distance between a new system and what he called 'the worst housing crisis in generations.'
'We can't do everything right away,'' he said.
We don't expect you to do "everything" Timmy. We only expect you to do your job, which includes coming up with plans to reform these companies within the 13 months that you previously promised.
Meanwhile, Fannie and Freddie continue to be traded on the stock exchange, hand out dividends to stock holders (while asking for taxpayer bailouts), and pay their CEOs as much as $6 million a year.
Mybudget360 reports about negative equity nation for 1 out of 5 homeowners.
Negative Equity Nation for 1 out of 5 Homeowners: The Psychology of the 10 Million American Homeowners with Zero Equity.
Posted by mybudget360
Recent data suggests that the number one factor for walking away from a home is negative equity. For us to understand this dynamic, it is important to understand why someone would leave a home with a mortgage. According to the U.S. Census Bureau some 51.6 million owner occupied homes have a mortgage. This is data from late 2007 so we should be getting the updated data in the ACS that comes out in September of 2009. Another third of homeowners have paid off their mortgage. But with 26,000,000 unemployed and underemployed Americans, paying the mortgage has become more challenging.
We recently discussed the rise in bankruptcies which comes even with the stricter guidelines put in place in 2005. A recent Freddie Mac report found that 17 percent of the mortgages in their portfolio had negative equity while another 11 percent had equity of 10 percent or less. Now if you think about it, selling costs can be 6 percent so even those with 10 percent or less equity stand to lose money in a home sale. If we put this together, some 28 percent of Freddie Mac loans if they were sold today may yield the borrower zero or will cost them thousands. This is a recipe for disaster.
First let us take a look at the Freddie Mac world:
[keep in my that graph below doesn't show taxpayer exposure from FHLBs or Ginnie Mae.]
At the end of 2008 some $11.9 trillion in mortgage debt was outstanding. Between Fannie Mae and Freddie Mac, a total of $5.3 trillion was in their portfolios. The massive rise in debt followed in line with the multi-decade long housing bubble. Now Freddie Mac and Fannie Mae serve virtually the same role in the mortgage market. They provide so-called liquidity in the secondary arena. What this means is no one else would buy these mortgages now that they know Wall Street virtually turned many loans into casino like instruments. Now, the two giant government agencies are virtually the only game in town.
... the unemployment situation is causing even those with 30-year fixed mortgages to default. The problem with being underwater is that the owner has little motivation to keep paying the mortgage. For most people, they buy homes to live in but also to build up a steady stream of equity. Yet in this decade, we have seen something that hasn't occurred since the Great Depression. We have seen a nationwide housing market decline. And now, with websites like Zillow and also, local county assessors offices going online many people can check the "value" of their property with very little hassle. So what this creates is an obsessive real estate culture. Let us take a look at what occurred in this decade:
Since the 1980s for nearly 30 years housing prices have been on a tear. Now that the bubble has burst equity levels are now back to 2001. The peak was reached with zany valuation while the debt still exists. That is why on the chart above you'll notice housing prices declining while mortgage debt levels are still near their peak. ...
Federal Government huge exposure to mortgage debt
As of 2009, the federal government guarantees or owns 8 trillion dollars of mortgage debt.
Federal MBS Exposure
Since, at the end of 2009, about $11.7 trillion in mortgage debt was outstanding, the federal government now owns or guarantees 69% of all mortgages.
Federal MBS Exposure
mortgage debt outstanding
Percent of mortgage debt guaranteed or owned by federal government
The taxpayer bailout of Fannie Mae and Freddie Mac
1) all caps in emergency bailout money to Fannie Mae and Freddie Mac were quietly lifted last December.
2) The taxpayer bailout of Fannie Mae and Freddie Mac is expected to cost over $600 Billion.
"The taxpayer bailout of Fannie Mae and Freddie Mac will almost certainly be the most expensive of the financial crisis..."
3) Despite this enormous cost, there has b een little press coverage.
4) The Federal government considers Fannie Mae and Freddie Mac losses to be off-budget.
5) If the losses were put on-budget (as some Republicans are pushing for), it would immediately blow out the federal borrowing limits.
Extending the housing crisis
1) The Bush Administration tried to extend the housing crisis into the next administration by:
A) Reducing Fannie Mae's and Freddie Mac's extra cushion of capital, enabling the companies to invest $200 billion more in home loans.
B) The size of the mortgages that Fannie and Freddie were allowed to buy was increased, from $417,000 to $729,750.
C) Changing the rules in April 2008 to get the FHA more involved in the mortgage industry.
2) The Obama Administration is trying to delay by:
A) Lifting all caps in emergency bailout money to Fannie Mae and Freddie Mac.
B) Reducing Fannie Mae underwriting standards by dropping credit-score requirements, reducing income-documentation standards and waiving the need for appraisals.
C) Delaying plans to reform Fannie Mae and Freddie Mac.
FHA's exposure reaching its limits.
1) The decision to increase the FHA's exposure to a collapsing housing market is now meeting its limits.
2) About 9.1 percent of FHA borrowers had missed at least three payments as of December, up from 6.5 percent a year ago
3) If the trend continues and the FHA's cash reserves are exhausted, the federal government would automatically use taxpayer money to cover the losses.
My reaction: The federal government has a ridiculous amount of exposure to mortgage debt.
How did the federal government owns or guarantees 70% all mortgages?
The answer is simple. Presidential administrations (like Bush and Obama) have faced two choices with regards to their housing policies:
A) Increase involvement in mortgage/housing markets, decreasing the immediate short term cost (but increasing long term costs).
B) Reversing involvement in mortgage/housing markets, causing housing prices to crash and defaults to skyrocket, leading to massive taxpayer losses due to the government's existing exposure mortgage debt.
Every administration for the last 50 years has chosen answer A. Today, we are reaching the end of this sad game, and the fallout will devastate the US economy.
Outlook for housing prices
I see two possibilities:
A) If credit becomes unavailable and people can't get mortgages (due to worsening of financial crisis), the housing market could crash temporarily. However, a further decline in home prices would lead to massive immediate losses to the government as mortgage defaults soar, which is guaranteed to trigger a dollar crisis. As become desperate to buy hard assets get rid of their dollars, money will start pouring into housing market and prices will go parabolic.
B) The dollar crisis comes first and starts driving prices up. The unavailability to get mortgages, if it occurs, only serves to slow the price rises.
Scenario B is more likely in my opinion.
Federal Reserve's overflowing balance sheet
On a final note, the Federal Reserve now owns 1,234 billion mortgage debt (and has commitments to buy another 97 billion). The graphic below should be taken as another indication that we are reaching the end of the line.