Hensarling has the cutest little idea

OK, that’s about as snarky as I’m going to get with Congressman Jeb. Say what you will about the mouthbreathing Republicans some of You People have managed to elect in this state, Hensarling is probably the only member of the Republican caucus who isn’t a complete ideologue. I think his conversion began in the fall of 2008 when he got to see first hand what people like me had been saying for years…

MARKETS CAN FAIL (and Jeb got a nice view of that when TARP 1 failed to pass… it’s pretty scary looking into the laissez faire abyss).

I mention this as the opener to this article at the DMN regarding Hensarling’s push to get rid of FNMA and FHLMC, more affectionately known as Fannie Mae and Freddie Mac, respectively. Having spent way too much of my life in mortgage banking, I thought it might be good to actually ‘splain things a bit and help Jeb understand that this isn’t the place to go.

Fannie and Freddie (The Agencies) have been around for decades. They’ve operated without any problems and allowed Americans to buy homes with low down payments (usually about 5%) and at interest rates substantially below what a bank would charge. And therein lies the rub. The Agencies have, for decades, operated as private companies with an implicit Federal guaranty. As a result, they could sell debt at rates that were only marginally above those of US Treasury securities.

Banks can’t do that. So, they couldn’t make spread income off mortgage loans (the difference between the interest rate an entity pays for money and the interest at which it loans that money out) because the Agencies could always obtain their money far cheaper than the banks, which really pissed the banks off and they’ve spent those same decades trying to get rid of the Agencies. What the banks could do that the Agencies couldn’t was service loans and they’ve all made a nice business (and nice profits) from taking payments in every month. Americans got the benefit of all this because the Agencies didn’t take a whole lot for their work which meant that the benefits of obtaining money over the long term at near government rates was in large part passed on to the American people. That benefit amounts to, at the very least, 100 basis points (aka, 1%) year after year that Americans have saved on interest payments because of Fannie Mae and Freddie Mac. That’s just on the loans that end up with them… by creating competition, they’ve put a ceiling on how much a bank can charge which has a carry over effect.

If you’re looking for a dollar amount, it’s probably close to $25 BILLION per year that Americans have saved because of this arrangement. Since 1980. Just adding it all up, without taking into account compounding the resulting savings, means that Americans have saved roughly $750 BILLION in interest payments. Nice deal for us, no?

Flash forward to the just after 9/11. Interest rates fall dramatically and investors go in search of higher yields since Treasuries are paying comparatively little. Increasingly they look at housing because of two perceptions…

1) House prices ALWAYS go up. Therefore, banks are in a no-lose situation because even if they have to foreclose, the collateral will ALWAYS be worth more than what the bank lent against it.
2) People ALWAYS pay their mortgages. Even in the event of job losses, they’ll let everything else go except the house.

Given that investors thought these two ‘truths’ were ALWAYS true, banks were free to lend to anyone on ever more outrageous terms. Voila! Opportunity, meet rationalization and desire. This is, by the way, the formula for every financial disaster we’ve ever had in this country. Prior to all the regulation morons (both Democratic and Republican flavors) spend time bashing, we used to have depression level financial events in this country ever 10-20 years or so. After all that regulation, we started to have recessions instead and we stopped having bank panics altogether. Well, until 2008 that is. How’s that for the benefits of regulation in less than 20 seconds? But back to Fannie and Freddie (I promise, this all comes together).

At first the Agencies didn’t really bother with any of these new fangled subprime and alt-a loans. In fact, these were some of the same products that failed at alarmingly high rates in the early nineties, then again in the late nineties. However, they’d never been used in super large numbers so their collapse had a relatively minor effect on the economy. Wall Street being Wall Street inferred from the available evidence that subprime can’t be all that bad which is OK… you can draw the wrong conclusion and still win for a long time. Amateur gamblers have been proving it for years. The best of them know when it’s time to quit, like when you draw that first run of bad cards.

Wall Street gets addicted like a bad amateur and never quits until the entire financial system goes raaaaather pear shaped. Who would… these were loans that had interest rates made up of two digits. Investors were only demanding a slightly higher return over Treasuries, mostly because Wall Street got all this junk rated triple A (the ratings agencies did it because it was geographically diversified and supposedly all uncorrelated… forget the bullshit about the browbeating and intimidation by the banks. Even if that hadn’t have happened, they still would have screwed up the rating because their models were wrong) and also because this was all based on housing. Remember the two golden rules a few grafs up?

NOW, investors in the Agencies (remember, the Agencies are government sponsored but privately owned) start wanting a higher return (which they see the banks making) and they want to see the Agencies regain some of the market share they’ve lost to private banks. Of course, this happens at the top of the housing market and private banks unload as much garbage into the Agencies as they can. Even some of the loans that were ‘supposedly’ underwritten to Agency guidelines are garbage (thanks, Citi) so it’s a one two punch both with the new business they’re being sold and the bad business coming in under their existing master purchase agreements.

From the outside, it looks like Fannie and Freddie caused the crisis because they wound up so publicly with so much of this junk. Problem is, they bought it already originated and securitized. The banks did all that and Fannie and Freddie were, actually, their victims. Well, to be fair, we should point out that management at the Agencies was as piss poor as it is everywhere else in corporate America. Toward the end, they did loosen their internal guidelines and created new programs, like Flex at Fannie, that made it easier for bad borrowers to get loans but that was at the tail end. By then, the damage was already done. And those same idiot managers made off with millions.

So, forget blaming Fannie and Freddie for the crisis since they’re no more guilty than any other bank (and it wasn’t the Community Reinvestment Act either, though Jeb didn’t go there. Which is good because then he’d fall off the good Republican list) but that doesn’t mean they shouldn’t be changed. For one thing, I’ve never understood the need for two companies, doing essentially the same thing, to exist with a government charter.

Now that you all have a basis for understanding all this, let’s dive into the DMN article…

“I don’t think they are needed,” said Hensarling, a senior Republican on the House Financial Services Committee. “Why, when I look at other industrialized nations, do I see higher rates of homeownership and no … [Fannie and Freddie]? I see lower rates of foreclosure. I don’t see the compelling reason why we want them except that we’ve done it this way.”

Actually, government chartered housing banks are nothing new. That they can get into trouble is also nothing new. The Germans had to inject large amounts of capital into several Landesbanks. As for a compelling reason for them to exist, let’s remember the net savings to consumers, around $750bn over thirty years.

Experts say that peculiar structure provided an incentive for the government-sponsored enterprises, or GSEs, to make risky investments, including buying exotic mortgages for their own portfolios. The Bush administration seized the companies in 2008 as they suffered huge credit losses on portfolio investments and guarantees on mortgage-backed securities.

And this is where I have a problem with the DMN… who are these experts? Give me their names so that I might find out if they are, in fact, experts. Because a real expert wouldn’t say this. Why? Because up until the mid part of the decade, the Agencies never took undue risks. In fact, their underwriting guidelines stayed pretty consistent for a really long time. It wasn’t until the very end when they were desperate to rebuild market share that they really started to screw up. But that was a management decision and, frankly, it’s the same one the managers at almost every other large bank in this country also made. In fact, it took down Bear Stearns and Lehman Bros. It was well on it’s way to taking down Citi, BofA, Merrill, Morgan Stanley and ultimately Goldman Sachs and JPMorganChase.

So, let’s just make it clear right from the get go that this bad decision making wasn’t just limited to the Agencies.

Hensarling insists the government shouldn’t guarantee most mortgage loans. But some economists and bank lobbyists say the 30-year fixed-rate loan isn’t viable without special federal support.

“The 30-year fixed is probably the most sustainable mortgage we have,” said Mark A. Willis, resident research fellow at the Furman Center for Real Estate & Urban Policy at New York University. “That would definitely be – if not jeopardized – extremely more expensive to get without the government guarantee.”

Oh, dear. What we really need here is a little more common sense and a little less ideology. Regardless of your feelings about government involvement, the reality is that unquestionably the Agencies have made life better for Americans. Willis is absolutely right and Hensarling just hasn’t thought it out… here it goes. You’re a bank and you have depositors to whom you are paying 2% interest. You then make the decision to lend that money out for 30 years at 4% giving you a 2% spread. The only problem is that the deposits you’re lending against are all demand deposits or short term time deposits (like a CD). What happens if your depositors start demanding 6% on their money? Ah, then you’re on the wrong side of the spread. What you’d normally do is sell off whole loans to Fannie and Freddie and make some new ones, at higher rates, to regain the spread income.

That’s the textbook scenario. In the real world, banks don’t lend for 30 years. They start choking on 5 year notes. So, to account for that negative spread risk, and if no Fannie or Freddie exists and everyone is securitizing into the market without any implicit government guarantee, they’re going to demand much higher rates. The DMN points to two studies that are deeply flawed and estimate increased interest costs of 6-30 bps for consumers.

That’s balls… Bill Gross of PIMCO (he manages almost as much money as God) estimates it’s close to 300 basis points. At that level, you take my $750bn over 30 years and multiply it by 3. Jeb, apparently, doesn’t know Bill Gross…

Hensarling says those benefits aren’t enough to warrant the $150 billion that taxpayers have injected into the companies during the recent housing-market meltdown. He says he’s not convinced that private lenders wouldn’t offer 30-year fixed-rate loans without a federal guarantee.

“In some cases, it’s a difference [on a loan] of between 6 percent and 5.92 percent,” he said. “Is that really worth $150 billion?”

The Congressional Budget Office has estimated that the total cost to taxpayers for taking over the companies could reach $389 billion. Even so, some House Democrats have said there is no hurry to reform the companies because they have largely stopped purchasing risky mortgages since their near-collapse in 2008.

It’s so painfully obvious a child could see it but Jeb insists on looking at the wrong numbers. The spread between what rates would be without and what rates are because of the Agencies is 100-300 basis points. And yes, that’s FAR greater than the $150 bn. It’s also much, much more than the $389 bn the CBO estimates. Further, think about this in terms of what we had to do in the private market. We’ve had to give Citi almost $400 BILLION to survive, not to mention the other money center banks who got to suck on the government teat. Comparatively, Fannie and Freddie have cost us very little and the private banks Republicans think should be running everything without regulation.

The simple reality is that government involvement in housing finance is an absolute necessity. What’s needed, however, is not a public private structure, what’s needed is something closer to the structure of FHA. The private banks may not like it, but it’s necessary for consumers.

After all, without government involvement in housing, no one would have been able to get a mortgage in this country in late 2008 or 2009.

Jeb’s absolutely right that something has to be done, but he’s absolutely wrong on the solution and it seems like his thought process on this is being driven more by ideology than anything else. I know it’s hard but Republicans have got to start breaking out of this ideological trap that all government is bad.

From the standpoint of saving ordinary Americans money, that’s just not true. Not when Americans can borrow money for 30 years at 3.875%.

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