“We’re” is an understatement, and hundreds of billions might be too…

“We’re talking hundreds of billions,” Treasury Secretary Henry Paulson said in a press conference. “This needs to be big enough to make a real difference and get to the heart of the problem.”

Paulson and Fed Chairman Ben S. Bernanke’s plans, which include the removal of illiquid mortgage securities from companies’ balance sheets, sent stocks from the U.K. to China soaring. The dollar gained, while two-year Treasury notes fell the most in 23 years, sending the yield up from the lowest level since mid-March.

“We’re” doesn’t mean the Treasury Secretary and the Chairman of the Fed personally (although some will inevitably debate whether it includes the mice in their pockets). And as Forbes notes, the price tag will almost assuredly wind up being much more than originally estimated.

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.

I’ve seen this question pop up a number of times, and in each case different numbers are floated as the answer. So why not throw out another?

According to the Federal Reserve the aggregate market value of all the residential real estate in the US, as of Q1 - 2008, was (a) $19.718 trillion. In addition, there was (b) $10.601 trillion in mortgages against that real estate. Chart of growth below (click for larger view):

The estimate replacement cost of residential real estate structures at Q1-2008 was (c) $14.283 trillion. And here is a graph of the change in replacement cost of those residential structures over the period - this should provide some idea of the amount of value injected into the economy as a result of residential real estate construction (inflation notwithstanding):

Note: There are probably a few apples versus orange discrepancies as it relates to values, mortgages, and replacement costs on farm households, mobile homes, and second homes, as well as second liens taken out against properties. Also, multi-family residences were excluded where possible, as I could not ascertain what might be purely rental property.

Source: The Federal Reserve Flow of Funds Statements
(a) B.100 Balance Sheet of Households and Nonprofit Organizations - line 4
(b) L.100 Households and Nonprofit Organizations - line 25
(c) B.100 Balance Sheet of Households and Nonprofit Organizations - line 42

Via WSJ:

Do all Washington politicians get their loans directly from CEOs in the mortgage industry? Readers might be wondering after learning about Countrywide Financial and its VIP treatment for Senators Christopher Dodd (D., Conn.) and Kent Conrad (D., N.D.)…

Mr. Conrad then recounted how he came to receive preferential treatment from the country’s largest mortgage lender. The Senator evidently believes that his latest version of events, in which he gets a sweetheart mortgage from a CEO only after first contacting the former CEO of the largest wholesale purchaser of home mortgages, somehow makes his conduct appear more appropriate.

Pffsst. Aren’t these the same folks that are now trying to bail out the mortgage industry?

Via Bloomberg:

Rising consumer prices will leave more U.S. consumers unable to pay their debts and may lead to a “financial tsunami,” according to Bennet Sedacca, president of money manager Atlantic Advisors LLC in Winter Park, Florida…

Sedacca wrote that current financial-market conditions remind him of “someone standing on a lonely beach, armed with only a small bucket, trying to stop a rare tsunami that hits the shores. It is how I feel about our markets and the tools being utilized by the Federal Reserve, the European Central Bank and other regulatory bodies. They are overmatched for what they are facing and, worse yet, they helped create the mess in the first place by being far too easy with money and debt creation.”

I’m tossing in the chart that Bloomberg’s site left out:

I suspect the Central Bank is going to meet a pervasive lack of cooperation with regard to quelling international demand - the situation reminds me of how “uncoordinated” world partners (i.e the U.S., Germany and Japan) became before the 1987 market correction. It seems raising rates may only serve to exacerbate the in-house financial crises - meanwhile, if Sedacca’s thesis is correct, demand for (at least) domestic goods and services is likely to falter regardless of Fed action.

Peter Bernstein pits Mellon against Keynes (and Greenspan and Bernanke against the tide). The tome is shutting off the open bar to prevent the hangover.

(h/t to The Big Picture)

Editor’s Note:

Bernstein is author of two books I’ve read, The Power of Gold: The History of an Obsession and Against the Gods: The Remarkable Story of Risk. They are both quite worthy, and both certainly relevant to our “inflation ex-inflation” (quote pilfered from Barry Ritholtz) times. However, I found The Power of Gold more enlightening than the latter - Bernstein waxes poetic on the history of the metal, and concludes its worth is only in the eyes of the beholder. Against the Gods, on the other hand, won’t hit you like a Louisville Slugger unless you have some minimal exposure to elementary statistics. I’ve long since passed “Gold” on to a commodities trading friend, but Against the Gods still sits on the shelf. And if someone can develop a salient, but not necessarily completely risk-averse, argument as to why the Fed (and Congress, and the Treasury, and the rest of the Administration) should play hands off here, invariably allowing the meek to inherit (or at least take full economic advantage of) the scraps, I’ll send them my un-abused copy of Against the Gods for their reading pleasure.

Post your thesis in the comments, or put it on your blog and post a link down yonder. In addition, rationale to the contrary (why governmental bodies should step in and start paying your neighbor’s mortgage) will also be accepted, although taking that path may be fraught with risk.

Is Fannie Mae building a new ATM?

Incentive for default…crumbling balance sheet…taxpayer bailout?

Haven’t heard that before.

In theory, what if…

You let those who are about to be foreclosed on be foreclosed on. Bank inventories would rise, and house prices would fall. This is called correction, and in many circles it is considered healthy. Rather than pour capital into the inevitably failing cause of bailouts, relax restrictions on the purchase of foreclosure properties. Lenders provide capital to those that qualify, instead of requiring investors to show up with a check for the full purchase price. Potential buyers sitting on the sidelines (with healthy credit ratings and plenty of savings) move in because there is now the visible possibility of a return on equity. Prices stabilize.

Meanwhile, people that probably shouldn’t have been owners in the first place - they didn’t have a down payment and/or had to fudge their income - go back to renting. Rents rise with demand, and price/rent ratios move towards historical equilibrium. Those highly credit-worthy borrowers with an understanding of the basic concept of return on capital and positive cash flow (please move over, Carlton Sheets crowd), move in further. This time they are buying to maintain, rent out, and garner a long term return on their investment - not flip to the next joker two days after they close.

Lenders are already putting the kibosh on home equity lines, so there is no need to argue this will bring the consumer-led economy to a screeching halt. Prices of everyday goods are taking care of that, and much of the non-core inflation is a direct result of interest rates and the falling dollar. Yes, demand will fall, but a significant amount that demand is consumers’ insatiable appetite for foreign goods. If the influx of good manufactured outside the US slows, you trip a decline in commodities prices - foreign demand in foreign currencies slows as a result of shrinking sales to the US, exacerbated by a stronger dollar on the back of dwindling supplies of it.

While markets aren’t keen to consider the effects of negative growth with a smile, maybe they should consider the effect of rising margins too. Falling prices means decreasing cost of goods too. Meanwhile, price conscious consumers see bargains everywhere, which negates some of the revenue declines and the unemployment associated with it.

Heck, we’re a services economy anyway, and it’s going to take plenty of accountants and attorneys and bankers to get those foreclosed homes into the right hands. And plenty of plumbers and electricians and interior designers to fix them up. Retirees make crap a few bricks while watching the Dow correct itself, but if you have 2/3rds of the savings you had before while a gallon of gas costs 1/3rd what it did while you were socking away, why would that matter? We might also see rising interest rates under this scenario, which means fixed income portfolio losses (on paper) but plenty of extra cash flow to support daily needs.

Yes, it all means some pain, especially for trading partners. I suspect the far east economies wouldn’t be particularly pleased at the thought of forced moderation to their now improving lifestyles. And first you have to buy into the idea we do truly live in a global economy - and that decoupling doesn’t exist.

Could it work?

UPDATE: Some of this might happen whether we like it or not - the Fed is finally already warning on inflation.

UPDATE 2: More on housing price/rent ratios. Note that the forecast doesn’t reflect rising rents - the spike is caused by projected housing price adjustment.

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.

Nobody got the memo, and I got all this in my feed reader simultaneously

• The Obvious, to everyone other than the NAR - Home Prices Fall 12.7% (The Big Picture)
• The Cheers, from Walmart shareholders - Consumer confidence drops in April on inflation, job worries (Associated Press)
• The Quandary, from the Taxpayer Defamation League - Bottom Falls Out of California Budget (Paul Kedrosky)
• The Expected, from those watching a little more closely - ‘Underwater’ Subprime, Alt-A Mortgages to Swell by Midyear (Bloomberg, with “expectation” here)

I’m closing my browser for the rest of the day.

UPDATE: Hearing Wal-mart cheers.