So much for tighter GSE regulation
Roughly ten days ago, the Administration officially flew the white flag in attempting any further regulation of the GSEs.
Legislation not pending?
As reported by The Wall Street Journal, with its usual Burma-Shave sub-headlines:
Firms, Once Hemmed In,
Are Freed for Bigger Role
In Aiding Mortgage Market
We’re constrained as to our market movements
Federal regulators, in an effort to contain financial turmoil, are handing government-sponsored companies an even bigger role in propping up the mortgage market.
Officials affirmed yesterday that government-sponsored mortgage investors Fannie Mae and Freddie Mac will enjoy loosened capital requirements, allowing them to pile more mortgage securities onto their balance sheets.
We’re working on the executive summary right now
Two years ago in the ongoing Fannie Mae story, when the blistering OFHEO report came out, I posted at length about the multi-billion-dollar risks to taxpayers of GSEs turbocharging their balance sheets.
Fannie and Freddie could purchase an additional $200 billion of mortgage securities, equivalent to about 10% of expected
I believe, as do many others, that this was an explicit quid pro quo negotiated by Secretary Paulson, with the GSEs being given the latitude to make a lot more money by boosting their balance sheets, but at the price of raising more equity capital.
Regulators in the past few years have required Fannie and Freddie to hold 30% more capital than their usual minimum while they fixed problems with their accounting and risk controls, a process now viewed as virtually complete. That capital surcharge is now falling to 20%.
Under the lower surcharge, Fannie and Freddie must hold capital equivalent to 3% of the mortgages they own, down from 3.25%. That, plus additional adjustments on the capital required for loans guaranteed by the companies, frees up about $6 billion in capital that can support $200 billion in additional mortgage holdings.
Meanwhile, the companies have indicated they intend to raise similar amounts in new capital, probably by selling preferred shares. Details haven’t been determined.
That last fragment is a clue about who promised what to whom.
Promises? Who makes promises?
As I posted in Banking on value, the Administration’s domestic policy makers — Fed chair Bernanke, Treasury secretary Paulson, and their counterparts – have been comprehensively adding liquidity to the system, by opening all the financing valves they can reach:
Get those secondary loan markets moving!
The Feds aren’t just opening the bank petcocks, they’re turning on all the liquidity taps:
More liquidity where that came from
The government will also accept mortgage-backed securities issued by government-sponsored companies like Fannie Mae and Freddie Mac.
We’ve previously seen that the GSEs enjoy awfully big advantages, which lets them rapidly grow or even turbocharge their balance sheets. That brings a lot of risk, but it also brings benefits, one of which is on display here: the GSEs can be open 24/7 if the Fed lets them.
Macro-economically, as I said last Monday, it’s the right thing to do:
The moves could help keep interest rates low for home buyers. Rates on mortgages rise when investors in securities backed by such loans demand a premium to compensate for what they see as growing risks. Aggravating that problem, some financial institutions that hold mortgage securities have been dumping them to raise cash.
That mortgages are sold has created a truly paradoxical consequence: because they could be sold, they were being sold, simply to raise cash to cover less liquid objects. With all the banks facing the same problem, the rush of sellers of perfectly good products was depressing their price.
The markets are lacking perspective
So Treasury and the Federal Reserve loosened the strings on the entities who could buy, in infinitely expandable quantity, without depressing the price – the GSEs.
O boy O boy O boy we’re gonna make more loans!
Fannie and Freddie face risks. They own or guarantee about 45% of all
Once again, the GSEs benefit from being Congress’s wrong-side-of-the-blanket offspring. Their big writeoffs – which we predicted (it wasn’t hard!) — are kin to those of the private banks, but unlike the banks, they have implicit backing, so where others have to sell, Fannie Mae and Freddie Mac can buy.
When Fannie and Freddie buy more mortgage securities, they raise their exposure to the risk of write-downs. “I think it’s a huge gamble on the backs of the U.S. Treasury,” said Sen. Mel Martinez (R., Fla.), a member of the Senate Banking Committee.
Senator Martinez is right — it is a big gamble, Treasury-backed, but far from the only such gamble Treasury’s taken lately. Banking on value, the Fed has lent $200 billion into the securities system, and arranged a shotgun wedding of Bear Stearns and JP Morgan (which had to up its price partway through).
The Federal Reserve last week sought to stabilize the mortgage market by saying it would lend as much as $200 billion in Treasury securities to bond dealers in return for mortgage-backed securities. That gives these securities only a temporary home at the Fed, while Fannie and Freddie typically hold the securities for the long term.
For the nation as a whole, it was the right move. As I said at the time (barely a week ago!):
If Ben Bernanke and the Fed are right, their moves will unjam the gridlock and get capital moving again.
If they’re wrong, the consequences could be disastrous for all of us.
I hope they’re right. Fortunately, I think they’re right.
It’s a gamble, Senator Martinez, but neither the biggest bet nor the riskiest. Having laid out the cash to many other links in the housing value chain, it’s neither illogical nor inappropriate to put some behind the GSEs, which are after all constructed for just this purpose.
It’s got a cost, though. Increased GSE regulation is now politically dead.
Regulatory legislation is dead, and the GSEs are grateful
“It is a complete defeat for the anti-GSE ideologues” in the Bush administration, said Kenneth Posner, an analyst at Morgan Stanley, using an acronym for government-sponsored enterprises.
Accounting scandals that erupted in 2003 and 2004 put Freddie and Fannie on the defensive.
Nobody who gives away $200 billion of new borrowing authority in a political heartbeat without getting pending legislation enacted has any credibility about trying to push it later.
Fannie and Freddie are likely to buy or guarantee 80% of all new home loans made this year, says Guy Cecala, publisher of Inside Mortgage Finance, a trade publication. Mortgages insured by the Federal Housing Administration or other government agencies will account for an additional 10% of the market, he expects. Last year, Fannie and Freddie’s share was about 55%.
I thought something like this might happen – although I never predicted our current credit gridlock.
Sung to the tune of, “never saw it coming”?
The GSEs are enormous, and have an enormous impact on the American housing market, and the American political market. As I posted long ago:
$2.1 trillion is the Gross Domestic Product of France. As I discussed in my extended series on Fannie Mae, that much leverage has enormous volatility and systemic risk for taxpayers, the more so when Fannie Mae’s accounting and financial control (previously used to give the illusion of smoothness) remain unproven, leaving taxpayers at grave risk.
Two years ago, right after the 2006 Congressional elections, I posted that the GSEs would be happy to see a change in control of Congress:
Among those certain to have been cheering the Democrats’ recapturing of both houses of Congress must have been the two GSEs, Fannie Mae and Freddie Mac, for the result dramatically changes the political calculus of their future regulatory structure.
In political terms, Democrats are GSE supporters, Republicans are GSE skeptics. (Departed former CEO Franklin Raines was President Clinton’s OMB Director) Additionally, the Bush Administration is even more skeptical than the Republican Senate, and the President had previously threatened to veto even the Senate’s legislation, to say nothing of the House’s milder version, with its 5%-of-profits half-tithing provision. The halt-tithe was the brainchild of Barney Frank, who in the 109th Congress is ranking minority member of the House Financial Services Committee, but who in the 110th will be its chair.
The Administration, I thought at the time, should reach across the aisle and make common sense cause with the Democrats:
The Republicans could conference between the House and Senate bills if they could reach agreement. Or, if the Republican leadership were worried about corralling the votes in one body, the Senate could simply accept the House-passed version — if they thought the legislation could be enacted.
Yet the Administration had previously signaled veto. Why would it reverse course and accept the House legislation now?
Because sometimes it’s cool to be a lame duck
Because, from the Administration’s perspective, the House bill is better than nothing — which is what the 110th Congress might well enact. Indeed, the GSEs are probably hoping for a no-action 110th:
I thought this was a good idea for both parties:
Compared with a no-action Congress, the House legislation looks good for both the Administration and Mr. Frank:
1. The Administration gains an improved regulatory structure.
2. Mr. Frank gains the half-tithing 5%-of-profits, worth $400 million a year for affordable housing, at no cost to the Federal government.
Here then is the prospect of political pragmatism: doing business on an issue for mutual benefit.
“Everybody has won, and all must have prizes.”
But that’s as dead as a dodo
That opportunity is now gone for good – and with it, a casualty minor but of our tribe, the half-tithe affordable housing trust fund.
Investors welcomed the shrinking gap and news of a greater role for Fannie and Freddie. Fannie’s shares rose 8.8% yesterday to $30.71, while Freddie shares were up nearly 15% to $29.90.
It’s understandable that the GSEs, having now been freed from their capital incarceration, are incapable of stifling their triumphalism:
“Do a little examination and ask yourself, ‘What do you think the housing market in the
And their lust to expand:
However, the companies also see an opportunity for profit, should the crisis pass and the securities now trading at distressed prices rise in value. “It’s kind of a shopper’s paradise right now,” said Daniel Mudd, Fannie’s chief executive officer.
Their potential regulators are glumly pragmatic:
While Treasury Secretary Henry Paulson supported yesterday’s move, he said he remains frustrated that lawmakers haven’t bolstered oversight of Fannie and Freddie.
“We almost had ‘em, but then they got away.”
Mr. Secretary, get used to it. That ship has long since sailed.
Taking the GSEs’ constitution with it?
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