Michael Gracie

Daniel Mudd wanted the loans to “optimize the business“…

Internal documents show that even late in the housing bubble, Fannie Mae was drawn to risky loans by a variety of temptations, including the desire to increase its market share and fulfill government quotas for the support of low-income borrowers.

Hmm. Just a few weeks back, Paul Krugman said (emphasis mine)…

But here’s the thing: Fannie and Freddie had nothing to do with the explosion of high-risk lending a few years ago, an explosion that dwarfed the S.& L. fiasco. In fact, Fannie and Freddie, after growing rapidly in the 1990s, largely faded from the scene during the height of the housing bubble.

You’d think a professor of economics (at Princeton University no less) might have some idea what he is talking about, particularly when allowed to regularly op-ed at the New York Times. Note that this wasn’t supposition - it was an attempt to relay facts well after the events.

Even though they’ve long been THE largest purchaser of mortgages, maybe the fact that Fannie Mae didn’t originate the pile of bad loans equates to “had nothing to do with”? I wish I knew the answer, but I’m no famed academic.

UPDATE: Oops…h/t to Paul Kedrosky on the Post story.

This question posted on LinkedIn was too good to pass up:

Does anyone else think Fanny May and Freddie Mac sound more like cartoon characters than finance companies?

I’m thinking Wile E. Coyote and Homer Simpson, only not quite as funny.

Your thoughts?

As previous noted, Paul Krugman of the New York Times tried wishing away Fannie Mae and Freddie Mac’s problems by pinning the housing crisis on sub-prime. Now the guy is contradicting himself, while claiming more informed statements are non-contradictory.

Krugman said…

Fannie and Freddie had nothing to do with the explosion of high-risk lending a few years ago, an explosion that dwarfed the S.& L. fiasco.

And the better informed laughed…

Fannie and Freddie had about as much to with the “explosion of high-risk lending” as they could get away with.

Considering the GSEs touch almost half of the mortgages in America, it’s quite improbable for them not to have at least minor complicity. Nonetheless, Krugman is again explaining away…this time the glaring difference of opinion - it’s not contradictory!

Well, at least he got the S&L bit right. But I wonder who he’s going to be covering for when the liar-leveraged McMansions start falling…

Data as of 1/07; compliments of the Irvine Housing Blog

According to a New York Times report from early this morning, the Bush Administration is considering taking temporary control of Fannie Mae and Freddie Mac. That was quick.

First and foremost, this doesn’t mean bankruptcy, but it does mean the equity holders would get wiped out. It sounds like “receivership” too, but it’s not that - a receiver is generally engaged with an enterprise to extract what’s owed to creditors, particularly where those creditors have liens on the entity’s assets. No, we’re talking something more akin to a judge designating a guardian for a mentally incapacitated adult. A conservator monitors, and steps in with power of attorney to make decisions as need be. In this case, it’s going to be a lot like having a new board of directors, potentially new management, and likely a guarantee of bond payments. Or at least let’s hope.

SIDE NOTE: What this may also mean is that liquidity for home mortgages, including the wild bailout notions that the government conjured, is going to dry up. While the government guarantee might stir reason for Fannie and Freddie’s borrowing costs to go down (i.e. the spread between their paper and that of the US Treasury should shrink to nothing) and hence mortgage rates to follow, I contend the markets have a way of surprising people. The prime lending rate actually remained fairly stable during a big portion of the housing run up (some analysis will follow in a later post). What really set things afire was the liquidity that securitization provided - Fannie and Freddie were a big cog in that liquidity engine, while the banks and brokers reaped the benefits. The GSEs and their partners are now hamstrung, meaning the previous buyers of that paper (the investors that never seemed to be at the negotiating table during the bailout talks) will be hard pressed to continue the buying spree.

UPDATE: Still tumbling:

Investors appeared unimpressed by a statement from Treasury Secretary Henry Paulson, who said the government’s focus is ensuring that Fannie Mae and Freddie Mac remain as presently constituted to carry out their mission. Some investors had been hoping that the government would announce plans to take over one or both of the companies.

I think Hank Paulson is too intelligent to believe the concept that Fannie Mae and Freddie Mac will remain in business-as-usual mode and/or be capable of assisting struggling homeowners. Even if the GSEs are able to raise more capital on the back of a government guarantee, the credit markets suggest that the yields will have to be higher. This means either F & F will have to pass on that cost to homeowners or suffer continuing losses.

In other words, without buyers for those bonds there is no housing bailout.

UPDATE 2: Of course, Congress critters and their lobbyist pals are still enthusiastic. This may mean the GSEs now go straight to liquidation .

Following up on the “insolvency” bit…

• Hank Paulson sidesteps questions on the issue. Let’s also note that “government-sponsored” does not mean government guaranteed, and obviously Mr. Paulson knows this.
• The doomsday scenario, noting the government is counting on the siblings to fix the housing problem. Raising those caps isn’t looking like such a bright idea, just months later.
• The Legg Mason Value Trust and its manager Bill Miller are feeling the pain. I feel a bit sorry for the fund owners - buying into drops is rarely a good idea.  What goes down can hit the ground - gravity rules us all.
• But everyone breath easy - as has been said time and time again, they’re “adequately capitalized“…

Via Bloomberg:

Chances are increasing that the U.S. may need to bail out Fannie Mae and the smaller Freddie Mac, former St. Louis Federal Reserve President William Poole said in an interview. Freddie Mac owed $5.2 billion more than its assets were worth in the first quarter, making it insolvent under fair value accounting rules, he said. The fair value of Fannie Mae’s assets fell 66 percent to $12.2 billion, data provided by the Washington-based company show, and may be negative next quarter, Poole said.

Raising additional capital here is a tricky issue. Existing equity holders have been decimated, and infusions are going to cut them off at the knees. They’d like their knees. But new money is a foregone conclusion if bondholders are to continue getting paid. Plus, the equity holders would have to walk in a restructuring situation, but at the same time the right side of the balance sheet is byzantine - there would be more classes of creditors than you could waggle a telephone pole at.

These are GSEs - sovereign wealth funds will not be stepping up to the plate; the Fed, maybe with the cooperation of money center banks, will most certainly be taking some action, and soon.

UPDATE: You have to step back a few years to find Fortunes’ blow by blow on the GSEs (around accounting scandal time). Good stuff, and well worth the read. I’m guessing nobody read it back then .

The Fed Chairman is “reiterating” ad nauseum. Screwing follows.

I reiterate we need to forgive people for their misinterpretation of basic economic fundamentals

Bernanke, in a speech in New York today, reiterated his call for lenders to forgive portions of mortgages for some struggling homeowners. He said proposals should be “tightly targeted” at borrowers at greatest risk of losing their properties, and avoid providing an incentive for defaults.

The map is not pretty (scroll to the bottom) - states that are vital to the condition of the overall economy are showing heavy leverage, heavy delinquencies, as well as heavy “non-owner” occupation. Price drops are now being singled out as THE reason people are getting pummeled, and the Fed is urging banks to unilaterally revise mortgage terms to put mortgagees on an even keel. Screw market economics.

The people most at risk of default are: 1) those who have the least “skin in the game” (i.e. those who put the least amount of money down under the assumption that home prices would rise forever); and 2) those that as a result of delusional assumptions thought becoming a real estate investor was a guaranteed lottery win. As generous as banks are historically known to be, they aren’t going to reduce mortgage principal to a point where borrowers are sitting pretty - no, they are going to revalue homes and adjust loans down to just that new level. Mortgagees will still be without their imaginary wealth, and they’ll still be on the hook for the original principal amount should the house sell down the road. In other words, they are still screwed, and I suspect there will be few takers either.

The potential ill side effect of this?

During summer past, everyone thought that the mortgage problem was contained to the sub-prime sector. It was portrayed across the media spectrum as a low-income borrower, low-end housing problem. “Sub-prime, sub-prime, sub-prime” was drilled into the citizen vocabulary. However, it is becoming more apparent to more people that containment wasn’t the case, and now that the problem is being recast as a nationwide, multi-tiered issue of pricing. The predicted result - accelerating defaults. Anyone with the means to continue paying their mortgage, and who has now bought into the idea that their home really is worth less than their mortgage, is going to bring their stated income down to size and either beg the bank for a favor or downright threaten their lender with walking unless they do. The latter becomes an even more substantive ploy if the borrower is aware of the court backlog in foreclosure proceedings, the growing inventory of bank-owned properties, and/or the fact that the court system isn’t buying shoddy mortgage record keeping.

I reiterate that government subsidization is the answer, no matter what the long term cost may be

Bernanke also reiterated his call for a stronger role for Fannie Mae and Freddie Mac, the government-chartered companies that are the biggest sources of money for U.S. mortgages, to ease the crisis.

This, in spite of the fact that Fannie Mae lost 2.2 billion in the latest quarter and is now planning to raise billions in additional capital to stay afloat. As THE primary funder of mortgages, Fannie Mae (and Freddie Mac) are getting screwed - they will wind up taking a hit for the principal reductions on in-house paper. But with the Fed behind them, they can probably screw investors down line - the ones who invested in their bonds for their secure, income-generating potential. The ones that aren’t invited to the negotiating table. And of course they get to screw the last money in - $6 billion is likely the minimum necessary to keep the GSAs’ regulatory formulas in line, but unless they magically begin turning a profit they’ll be back at the trough in no time.

In the midst of conjuring this post, the market was not reacting as such. While Fannie Mae bleeds from all orifices, the market was taking light of the fact that Fannie said their loan quality was going to go up, and the stock was following the same path. It may take a few days or weeks to sink in, but dilution and/or unservice-able debt are rarely good ingredients for a stock’s price. Furthermore, the magic awaits - how is Fannie going to increase their purchases of “at-the-money” loans to desperate borrowers while portraying it as a higher quality portfolio? They can’t…someone’s going to get screwed.

Cringing at the thought of more screwing, and looking forward to continued reiteration.

UPDATE: Dan Mudd, CEO of Fannie Mae, says…

“We’ve got to get across a bridge where we don’t miss the opportunities we have…we will feast off this book of business we are putting on.”

Easy to say when the alternative is feasting on taxpayer dollars if you don’t get across the bridge, thereby missing all those wonderful opportunities.

UPDATE 2: More Fannie Mae facts.