Copyright National Association of REALTORS®, Reprinted with permission
Economist's Commentary: September 22, 2008
$700 Billion for What?
By Lawrence Yun, Chief Economist
A massive $700 billion bill will be fast-tracked through Congress this week to give the U.S. government the authority to buy bad mortgages off the books of Wall Street firms. People are calling it the 'mother of all bailouts' and the 'biggest bailout in the history of mankind.' I am inclined to view it as the biggest sovereign wealth fund investment to date.
Several sovereign wealth funds - essentially a mutual fund run by a government for the government (or its taxpaying citizens) - have been investing in Wall Street firms and mortgage-related debts since late last year. Singapore, South Korea, United Arab Emirates, Saudi Arabia, and China were among the countries putting up a few billion dollars in the hopes of turning a big profit once the housing market recovers. Treasury Hank Paulson, a former CEO of the top U.S. investment bank Goldman Sachs and perhaps missing his old job, has now created a U.S. sovereign wealth fund that outstrips in size all other sovereign funds put together. Some may even view it simplistically as the Treasury Department going "all-in" in this $700 billion Texas Hold 'Em poker bet.
The principal goal of this new Treasury authorization is not to make money but to unclog the financial pipelines. Worries about capital inadequacy, further mortgage debt write-downs, and margin calls have hemorrhaged the movement of capital. The overnight borrowing rate has been skyrocketing, as any firm with excess cash was unwilling to lend that precious dough should it face the fate of Lehman Brothers. The very essence of capitalism - of allocating capital to its most productive use - was collapsing before our very eyes last week. The whole economy and Main Street civilians would have eventually suffered greatly from the mistakes of Wall Street.
The way to unclog the system is to buy certain mortgage backed securities off the books of financial firms. Because of illiquidity many mortgage securities, even those performing reasonably well, are being valued at pennies on the dollar if forced to sell. Let's say, for example, that you as a bank hold 100 mortgages and half of your clients are paying mortgages on time. At worst, these 100 mortgages would get at least 50 cents on the dollar. However, if you need to raise capital because of margin calls in the current panic, you would not get 50 cents but only few pennies on the dollar. These unrealistically low valuations are paralyzing the balance sheets of financial institutions and hindering the liquidity flow.
Treasury intervention will help restore the proper valuation of these illiquid assets. However, Treasury should not reward the mistakes of Wall Street by bailing out at an unreasonably high price and handing out "free money." Buying at a deeply discounted price could potentially lead to huge revenue benefits for Treasury on the behalf of taxpayers once the housing market and mortgage debt valuation recovers, but the financial firms may be unwilling to sell at unreasonably low prices. If this happens, we are back to square one. Subsequently, a delicate balance must be pursued with the goal of helping unclog the financial pipeline, but also protecting taxpayers' money.
Understandably, there will be anger and outcries from the Main Street public of this massive Wall Street 'bailout.' Politicians will feel the heat in this election year. But those same politicians have no choice: if the bill does not pass, the acute financial pain will quickly trickle down to Main Street.
The Main Street disgust of executive pay is also understandable. I will defend the '$700 billion bailout' to help stabilize the housing market and economy, but not the golden parachutes of fallen Wall Street executives. How is it that failed managers are able to get away with a fistful of dollars? The same can be said of Fannie Mae (FNMA) and Freddie Mac (FHLMC) executives. Many past managers of these government sponsored enterprises were paid a gigantic sum for running the very simple business of borrowing cheap and lending high. It was possible for Fannie and Freddie to borrow cheap on the backs of government (i.e. U.S. taxpayer) guarantees. Most of this borrowing cost advantage should have been passed onto consumers and not kept by Fannie/Freddie managers.
Hank Paulson has a tough task. He must permit capital to move around. That is the essence of capitalism. He must at the same time also protect taxpayer money. The return on the taxpayer gamble depends on two things: at what price the Treasury will buy bad mortgage debts off Wall Street books, and the future mortgage default rate. The default rate, in turn, will depend on the housing market recovery. Knowingly or not, the 75 million homeowners and 100 million taxpayers have now become the key stakeholders on the side of housing market recovery. In the end, if all goes better than anticipated, Mr. Paulson may perhaps get his own super hero figure made for returning a healthy rate of investment to taxpayers on this $700 billion gambit.
Copyright National Association of REALTORS®, Reprinted with permission
Wednesday, September 24, 2008
Tuesday, September 16, 2008
NAR Commentary on Fannie Mae, Freddie Mac takeover
Copyright National Association of REALTORS®, Reprinted with permission
Economist's Commentary: September 8, 2008
Government Takes Over Fannie and Freddie
By Lawrence Yun, Chief Economist
You wake up one Monday morning to find Fannie (FNMA) and Freddie (FHLMC) no longer exist - that was a scenario that NAR staff have been contemplating over the past month. Well, the government has in effect taken over Fannie and Freddie this weekend and it is in fact Monday morning. The federal government had no choice because the capital situation of two organizations was insufficient to face the upcoming realities of rising mortgage defaults. Now what?
Mortgage rates will trend down over the short run. But how much of a decline will depend on how actively the government - more specifically the Treasury Department and the FHFA - loosens their mortgage liquidity spigot. For over the next 12 months at least, the FHFA has the authority to purchase more than the normal amount of mortgages from lenders to put into their portfolio holdings. That means all conforming loans, including the newly conforming jumbo loans up to $625,000, will qualify for purchase by the FHFA. That will help drive down mortgage rates. In about two year time, when the housing recovery is assumed to be well underway, the government will trim its mortgage portfolio. Then Fannie and Freddie will be completely restructured. It will be up to the next administration and Congress to determine that structure in for which NAR will make our 1.3 million voices heard.
The credit spread between the 10-year Treasury and the 30-year mortgage rates has greatly widened in recent past months due to uncertainties surround the fate of Fannie and Freddie. The typical historic spread has been about 150 to 180 basis points. That means if the 10-year Treasury yield is 4%, then the 30-year mortgage would be about 5.5% to 5.8%. Rather, we have seen the spread at 250 to 300 basis points in recent months. With the government takeover, the spread will surely narrow and hence result in lower mortgage rates.
One legitimate concern is over taxpayer bailout. It is certainly possible that the Treasury will be forking over federal dollars if the default situation worsens. It is also possible for the Treasury and the taxpayers to come out ahead if the mortgage defaults slow down. The defaults will depend heavily on the direction of home prices and the home prices, in turn, are driven heavily by whether or not housing inventory gets trimmed. Assuming there are notable declines in mortgage rates from the federal takeover, then the demand for homebuying will return to the market place and help lower inventory. Therefore, it is very possible that this unprecedented move by the federal government may not cost the taxpayer a dime.
We should also be mindful that even if some taxpayer funds are used in the end, it was just not permissible to have Fannie and/or Freddie go under without any government backstop. The global economy would no doubt have entered one of the harshest recessions in recent memory. Loss of income and jobs would have been brutal, unnecessary collateral damage to ordinary people from the mistakes of the flawed mortgage lending model (which included no down-payment, no documentation, unloading the risk to the secondary market after originations, exuberant credit ratings by Moody's and Standard and Poor's, etc.)
Over the long term, after the above time-out phase of government activism, we need to ensure continuous flow of capital into the mortgage market to help consumers. The restructuring of Fannie and Freddie must meet this important criterion. The final restructuring will combine many innovative ideas, including:
Counter-cyclical mortgage intervention which loosens the liquidity spigot in times of need and tightens when the housing market heats up.
Covered bond market - which is the European way of funding mortgages
Sound underwriting standards to assure a sustainable, healthy housing market (it is in no one's interest to have an unprepared homebuyer that ultimately leads to a foreclosure) Clearly separating out the public and private mission of the Fannie/Freddie or new entities. A model of private profits for the shareholders and losses for the taxpayers does not pass any common sense test.
Copyright National Association of REALTORS®, Reprinted with permission
Economist's Commentary: September 8, 2008
Government Takes Over Fannie and Freddie
By Lawrence Yun, Chief Economist
You wake up one Monday morning to find Fannie (FNMA) and Freddie (FHLMC) no longer exist - that was a scenario that NAR staff have been contemplating over the past month. Well, the government has in effect taken over Fannie and Freddie this weekend and it is in fact Monday morning. The federal government had no choice because the capital situation of two organizations was insufficient to face the upcoming realities of rising mortgage defaults. Now what?
Mortgage rates will trend down over the short run. But how much of a decline will depend on how actively the government - more specifically the Treasury Department and the FHFA - loosens their mortgage liquidity spigot. For over the next 12 months at least, the FHFA has the authority to purchase more than the normal amount of mortgages from lenders to put into their portfolio holdings. That means all conforming loans, including the newly conforming jumbo loans up to $625,000, will qualify for purchase by the FHFA. That will help drive down mortgage rates. In about two year time, when the housing recovery is assumed to be well underway, the government will trim its mortgage portfolio. Then Fannie and Freddie will be completely restructured. It will be up to the next administration and Congress to determine that structure in for which NAR will make our 1.3 million voices heard.
The credit spread between the 10-year Treasury and the 30-year mortgage rates has greatly widened in recent past months due to uncertainties surround the fate of Fannie and Freddie. The typical historic spread has been about 150 to 180 basis points. That means if the 10-year Treasury yield is 4%, then the 30-year mortgage would be about 5.5% to 5.8%. Rather, we have seen the spread at 250 to 300 basis points in recent months. With the government takeover, the spread will surely narrow and hence result in lower mortgage rates.
One legitimate concern is over taxpayer bailout. It is certainly possible that the Treasury will be forking over federal dollars if the default situation worsens. It is also possible for the Treasury and the taxpayers to come out ahead if the mortgage defaults slow down. The defaults will depend heavily on the direction of home prices and the home prices, in turn, are driven heavily by whether or not housing inventory gets trimmed. Assuming there are notable declines in mortgage rates from the federal takeover, then the demand for homebuying will return to the market place and help lower inventory. Therefore, it is very possible that this unprecedented move by the federal government may not cost the taxpayer a dime.
We should also be mindful that even if some taxpayer funds are used in the end, it was just not permissible to have Fannie and/or Freddie go under without any government backstop. The global economy would no doubt have entered one of the harshest recessions in recent memory. Loss of income and jobs would have been brutal, unnecessary collateral damage to ordinary people from the mistakes of the flawed mortgage lending model (which included no down-payment, no documentation, unloading the risk to the secondary market after originations, exuberant credit ratings by Moody's and Standard and Poor's, etc.)
Over the long term, after the above time-out phase of government activism, we need to ensure continuous flow of capital into the mortgage market to help consumers. The restructuring of Fannie and Freddie must meet this important criterion. The final restructuring will combine many innovative ideas, including:
Counter-cyclical mortgage intervention which loosens the liquidity spigot in times of need and tightens when the housing market heats up.
Covered bond market - which is the European way of funding mortgages
Sound underwriting standards to assure a sustainable, healthy housing market (it is in no one's interest to have an unprepared homebuyer that ultimately leads to a foreclosure) Clearly separating out the public and private mission of the Fannie/Freddie or new entities. A model of private profits for the shareholders and losses for the taxpayers does not pass any common sense test.
Copyright National Association of REALTORS®, Reprinted with permission
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